The upper and lower limit of market value of Inventories

CFA Level I FRA
#1

In GAAP Inventory value is lower of cost or market. Why does upper and lower limit of market value of Inventories are set as Net Realizable Value and Net Realizable Value - Normal Profit Margin respectively? Why there are limitations for the market value? I don’t understand the logic behind it.

#2

if you were going bankrupt - (and you held inventory on your books that you had to give up)

two choices:

  1. you would sell the inventory outright. -> achieve net realizable value -> that goes to the creditors.

  2. you would sell the product. earn the selling price (includes the profit margin) take off the cost of the inventory (COGS) and then the remainder (net realizable value - profit margin) would go to the creditors.

given that profit margin (a positive number) is being taken off -> upper limit = net realizable value and lower limit = net realizable value - profit margin.