Question

Why are inventories valued at the lower-of-cost-or-net realizable value (LCNRV)? What are the arguments against the use of the LCNRV method of valuing inventories? in 300 words.?

Answer 1

Why Inventories are valued on LCVRV :

Under normal circumstances, cost of inventory is always lesser than the net amount business can earn by selling the inventory, called net realizable value (NRV). Common sense dictates that cost has to be lesser than NRV to make profit. But following a concept of conservatism, even if NRV is higher than cost, value of inventory is kept at cost and gain is not recognized until the inventory actually sells.

However, if NRV of inventory falls below the cost of inventory, following the same concept of conservatism, entity must write down the value of inventory to the amount that can be realized. Hence the recognition of loss to the extent expenditure on inventory are not expected to be recovered. It does not make sense to report an asset at any value higher than the amount it can recover and may overstate the assets materially. Therefore, entity must switch to NRV basis from historical cost basis of measurement if recoverable amount falls below cost of asset.

Argument Against this approach :

The application of LCNRV will results in inconsistency because they maybe report inventory cost in one year and market value in next year that will distort some data