Inventory Write-Down and the Lower of Cost or Net Realizable Value Test
Ridgeway Outfitters reports inventory at December 31 using the lower of cost or net realizable value (LCNRV) applied by product line. Three lines are flagged:
- Tents: cost $95,000; expected selling price $110,000; estimated selling costs $18,000.
- Boots: cost $60,000; expected selling price $52,000; selling costs $4,000. A firm order exists to sell the entire lot for $58,000, but the buyer requires $6,000 of rework that Ridgeway must perform.
- Packs: cost $40,000; normal selling price $50,000. A competitor's price cut has pushed the current replacement cost to $33,000, but Ridgeway expects to still sell at $50,000 with $5,000 selling costs.
The prior-year allowance for inventory write-down was $8,000. The controller wants to record a single write-down to the lowest replacement cost across all lines, arguing conservatism. Net income before any adjustment is $150,000.
1. Compute NRV for each line and determine the required write-down. Is the controller's 'lowest replacement cost' approach correct?
Read the worked answer
NRV = estimated selling price − costs to complete/sell.
- Tents: NRV = $110,000 − $18,000 = $92,000. Cost $95,000 > NRV $92,000 → write down to $92,000, loss $3,000.
- Boots: Use the firm order price and required rework: NRV = $58,000 − $6,000 rework − $4,000 selling = $48,000. (Alternatively on the general price: $52,000 − $4,000 = $48,000.) Cost $60,000 > $48,000 → write down to $48,000, loss $12,000.
- Packs: NRV = $50,000 − $5,000 = $45,000. Cost $40,000 < NRV $45,000 → no write-down. Replacement cost ($33,000) is irrelevant under LCNRV; it only matters under the lower-of-cost-or-market method where it is bounded by NRV (ceiling) and NRV less normal profit (floor).
Total required write-down = $3,000 + $12,000 = $15,000. The controller's single lowest-replacement-cost approach is incorrect - it is not LCNRV and would overstate the loss by dragging Packs down to $33,000.
2. The existing allowance is $8,000. Record the adjusting entry and explain the effect on net income and the inventory carrying amount.
Read the worked answer
Required allowance = $15,000; existing = $8,000; additional expense = $7,000.
Entry:
- Dr. Cost of goods sold (or inventory write-down loss) $7,000
- Cr. Allowance for inventory write-down $7,000
Effect: Net income falls from $150,000 to $143,000. Inventory carrying amount falls by $7,000 (to cost less the $15,000 allowance).
Key judgment: the write-down is measured as the incremental amount needed to bring the allowance to the required balance, not the full $15,000 again. Reversals are permitted under LCNRV for subsequent recoveries up to original cost, but not above it.