Inventory measurement and net realizable value

Learning goals

• Determine which costs and goods belong in ending inventory.
• Apply FIFO and weighted-average cost flow accurately.
• Test inventory at the lower of cost and net realizable value (NRV).

Prerequisite check

Goods physically present are not automatically owned, and goods in transit are not automatically excluded. Ownership/control follows shipping and consignment terms. Inventory cost then flows to cost of goods sold when the related goods are sold.

Vocabulary

• NRV: estimated selling price less completion and selling costs.
• FIFO: earliest costs flow to cost of goods sold first.
• Weighted average: goods available cost divided by units available.
• Consignment: owner places goods with another party that sells as agent.
• Purchase commitment: agreement to buy goods later, analyzed separately from inventory on hand.

Core idea

Inventory is initially measured at costs necessary to bring it to its present location and condition, then reported no higher than recoverable selling value. IFRS (IAS 2) and Canadian ASPE Section 3031 both prohibit LIFO and generally use FIFO, weighted average, or specific identification when appropriate.

Why this treatment makes sense

Capitalizing unrelated storage, waste, or selling costs delays expenses and inflates profit. The NRV test prevents damaged, obsolete, or low-margin goods from being shown above the amount expected from sale.

A repeatable method

1. Establish ownership at period-end, including transit and consignment.
2. Include purchase price net of discounts plus eligible conversion and bringing-to-location costs.
3. Exclude abnormal waste, most storage, administration not tied to production, and selling costs.
4. Apply the same cost formula to similar inventories.
5. Calculate NRV by item or appropriate group.
6. Write down cost where NRV is lower; reassess reversals when conditions recover.
7. Reconcile quantities, costs, write-downs, and gross margin.

Worked example

Prairie Trail Gear has beginning inventory of 100 units at $24, buys 150 at $26 and 100 at $29, and sells 230 units.

Goods available: 350 units costing $9,200. Ending units: 120.

FIFO ending inventory = 100 × $29 + 20 × $26 = $3,420; COGS = $9,200 − $3,420 = $5,780. Periodic weighted average = $9,200 ÷ 350 = $26.2857; ending inventory = $3,154.28 and COGS = $6,045.72.

Within the FIFO balance, 30 specialized units costing $29 each can sell for $31 but require $4 each for finishing and delivery. NRV = $27, so write-down = 30 × ($29 − $27) = $60. Adjusted FIFO inventory is $3,360. Debit Inventory Write-down/COGS $60; credit Inventory (or allowance) $60.

Journal, ledger, and statement connection

Receiving reports and count sheets support quantities; purchase and production records support cost. The inventory subledger must agree to the control account. Cost formula and NRV affect current assets, cost of sales, gross margin, and turnover.

Common mistakes

• Including customer-owned consignment goods in the consignee's inventory.
• Applying NRV to total inventory so gains on one item hide losses on another.
• Using selling price as NRV without completion and selling costs.
• Treating a cost-flow assumption as the physical flow.

Guided practice

An item costs $42, sells for $47, and requires $3 finishing plus $4 delivery. NRV is $40; write it down $2 per unit. For 200 units, debit loss/COGS $400 and reduce inventory.

Independent practice

Level 1 — ownership: Identify whether the consignor or consignee reports $18,000 of goods held on consignment.

Level 2 — cost flow: Beginning 80 units at $10; purchase 120 at $12; sell 150. Calculate FIFO and periodic weighted-average ending inventory.

Level 3 — NRV: Forty units cost $75 each, sell for $79, and need $6 completion and $2 selling cost. Calculate adjustment and explain the margin signal.

Self-check and solutions

Level 1: The consignor retains inventory until sale because the consignee acts as agent.

Level 2: Ending 50 units. FIFO ending = 50 × $12 = $600. Average cost = $2,240 ÷ 200 = $11.20; ending = $560.

Level 3: NRV = $79 − $6 − $2 = $71; write-down $4 × 40 = $160. Expected selling proceeds no longer recover recorded cost, indicating pricing, waste, or obsolescence pressure.

Retrieval practice

1. State the NRV formula.
2. Is LIFO acceptable under IFRS or Canadian ASPE?
3. Which party reports consigned goods before sale?

Answers: selling price less completion and selling costs; no; consignor.

Exam-style application

Resolve four year-end count exceptions, calculate ending inventory under an assigned cost formula, perform an item-level NRV test, and explain the direction of the gross- margin and current-ratio effects.

Lesson summary

Reliable inventory combines ownership cut-off, eligible cost, consistent cost flow, and an item-sensitive NRV test supported by counts and sales evidence.