"If net realizeable value is less than the balance sheet value of the inventory"
By balance sheet value, they are talking about cost, correct?
II.) I am having a tough time understanding inventory reporting under GAAP. Could someopne dumb it down a bit for me? Especially regarding NPV vs. NPV-normal profit vs. replacement cost? Thank you.
Depending on the cost flow assumptions used by firm (i.e. FIFO/WAC for IFRS, FIFO/LIFO/WAC for U.S. GAAP), the ending inventory (balance sheet) will be valued correspondingly. Using the following criterions:
IFRS: Lower [Cost, NRV]
Consider a numerical example. Cost per unit of inventory is $10. Selling price per unit is $15 and selling & completion costs amount up to $8 per unit.
i.e. NRV = $(15-8)= $7
Hence, firm will value it’s inventory @ NRV which is $7 and a $3 loss per unit is recongized in the income statement
Replacement Cost will always be between both boundaries.
Using the earlier example in the previous post, we have NRV= $7 and cost per unit =$10. Let’s consider further that normal profit margin per unit is $3.
NRV- normal profit margin = $4 and;
NRV= $7
Case 1 : Replacement Cost= $2
In this case we have replacement cost _ lower _ than NRV- normal profit margin, hence we will take the value of $4.
Case 2: Replacement Cost =$6
Here, RC fall _ within _ the boundaries and hence we take $6
Case 3: Replacement Cost =$8
RC is _ greater _ than NRV, we take the value of $7.
Depending on which case it is, inventory will be written down respectively and loss recongised in the income statement .
The above us US GAAP which is a little more confusing.
For IFRS:
As a firm procures/manufactures inventory, all directly attributable costs in either purchasing or fabricating that inventory (and for mft firms, fixed manufacturing overhead is allocated based on statndard units of production). If at any point, the firm’s expected sales price, net of selling costs, is below the carrying amount (cost) of a particular unit or group of similar inventory; then the inventory is written down to NRV.
Simple example:
Company A manufactures DVD players, total MFT costs are $50.
Due to competitors coming out with more advanced DVD players, Company A is having difficulty selling their product and is has become nearly obselete. As such, they can only sell the DVD players on hand through a local distributor for $40, which also charges a 5% commission on the sale.