Lower of cost and NRV accounting

Assets are generally recorded in the books of account as per historical cost principle. Historical cost principle restricts the accountants to record any upward adjustment in the value of assets. However, inventories are measured as per lower of cost and NRV rule which is explained below.

Inventory must be valued at lower of the following:

  • Cost
  • Net realizable value (NRV)

Net realizable value (NRV)

As the name suggests, it is the amount that can be realized by selling the inventory after considering any additional cost required to make the inventory saleable.

FORMULA: NRV

NRV = Expected selling price – expected cost to make the item ready for sale

Cost

Cost is simply the purchase price paid/ payable for the inventory item plus any additional costs such as carriage, conversion cost etc. incurred to bring the item in its present condition and location.

Where inventory consists of small number of large or precious items, it is possible to identify individual items of inventory and their actual costs. However, in most of the cases, it is not possible. Usually inventory consists of large number of items and keeping track of actual costs of each item is virtually impossible. In such cases, one of the following inventory valuation methods can be used to calculate cost of inventory: