Cost is a ceiling, not a floor
◈ 8 cardsComputing net realizable value, comparing it with cost, and recording the write-down within cost of goods sold.
The overvaluation problem
Cost is the right number for inventory only while the goods can still be sold for more than cost. When they cannot — a fashion changes, a competitor cuts prices, a product is superseded, stock is damaged — carrying the goods at cost overstates an asset and defers a loss that has already happened. Both IAS 2 and Section 3031 therefore measure inventory at the lower of cost and net realizable value (LCNRV). Cost is a ceiling: inventory can be carried below cost, never above it.
Net realizable value
NRV is what the company expects to net from selling the item in the ordinary course of business:
Two things it is not. It is not the selling price — a case that will fetch $11 but costs $1 to finish and ship is worth $10 to the company, not $11. And it is not replacement cost — what it would cost to buy the item again today is the US "lower of cost or market" idea, which neither Canadian framework uses. NRV looks forward to the sale, not sideways to the supplier.
Worked example — Kettle Creek's item A
At 30 June Kettle Creek Foods holds 400 cases of item A, a blueberry preserve, at a cost of $12 a case. A retailer's price cut means the cases will now sell for $11. Each still needs $0.40 of packaging to be saleable, and selling costs (commission and freight) run $0.60 a case.
NRV of $10 is below cost of $12, so each case is written down by $2:
Kettle Creek's policy — and this course's convention — is that inventory write-downs are charged to cost of goods sold and credited to Inventory directly:
Dr Cost of Goods Sold 800
Cr Inventory 800After the entry, item A sits on the balance sheet at 400 × 4,000, and the period's COGS is $800 higher than the units sold alone would make it. The loss is recognised now, in the period NRV fell, not later when the cases are sold. Waiting for the sale is precisely the deferral LCNRV exists to prevent.
The two accounts a prompt may tempt you with
Loss on Inventory Write-down. Some companies present a material write-down as a separate line rather than inside COGS. That is a presentation choice, and a prompt will state it when it applies ("material write-downs are shown as a separate loss"). Absent that statement, the write-down goes to COGS — the default under both frameworks, since a write-down is part of the cost of the goods that were, or will be, sold.
Allowance for Inventory Decline. A contra-asset can be used instead of crediting Inventory directly, so that the cost layers stay intact in the sub-ledger. It produces the same carrying amount. This course always credits Inventory; the allowance appears on the chart only as the trap it is.
Item C, the same way
600 units of item C, cost 7: write-down 600 × (8 − 7) = $600, Dr Cost of Goods Sold 600 / Cr Inventory 600. The arithmetic is never hard; the marks are in picking the accounts and in remembering that the comparison is with NRV, not with the selling price.