The lower of cost or net realizable value (LCNRV) rule is a common method used to value inventory for financial reporting purposes. It is used to determine the amount of inventory that must be written down to reflect a decrease in the value of the inventory.
For a video explanation of the Lower of Cost or Net Realizable Value rule, watch this:
Under the LCNRV rule, inventory is valued at the lower of its cost or its net realizable value. Cost refers to the cost of acquiring or producing the inventory, while net realizable value (NRV) refers to the estimated selling price of the inventory, less any costs necessary to complete the sale.
The LCNRV rule requires companies to periodically review their inventory to determine if there has been a decrease in its value. If the value of the inventory has decreased, the company must write down the value of the inventory to the lower of its cost or its NRV. This is done to ensure that the inventory is not overstated on the balance sheet.
To determine the value of the inventory write-down, the company compares the cost of the inventory to its NRV. If the cost of the inventory is higher than its NRV, the company must write down the value of the inventory to its NRV. This write-down reduces the value of the inventory on the balance sheet and increases the cost of goods sold on the income statement.
For example, if a company has inventory with a cost of $10,000 and an estimated NRV of $8,000, the company must write down the value of the inventory by $2,000 to reflect its lower value. This write-down reduces the value of the inventory on the balance sheet to $8,000 and increases the cost of goods sold on the income statement by $2,000.
In summary, the LCNRV rule is a method used to value inventory for financial reporting purposes. It requires companies to periodically review their inventory to determine if there has been a decrease in its value. If the value of the inventory has decreased, the company must write down the value of the inventory to the lower of its cost or its NRV. This ensures that the inventory is not overstated on the balance sheet and reflects its true economic value.
For more about Inventory Write-Downs using the Lower of Cost or Market Rule, check out this article (with video):