Intermediate Accoun/ng

IFRS Edi/on
Kieso, Weygandt, War:eld
Fourth Edi+on

Chapter 9
Inventories: Addi+onal Valua+on Issues
Prepared by
Coby Harmon
University of California, Santa Barbara
Westmont College

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Copyright ©2020 John Wiley & Sons, Inc.
Learning Objec/ves

AEer studying this chapter, you should be able to:

LO 1 Describe and apply the lower-of-cost-or-net realizable
value rule.
LO 2 Iden+fy other inventory valua+on issues.
LO 3 Determine ending inventory by applying the gross proQt
method.
LO 4 Determine ending inventory by applying the retail
inventory method.
LO 5 Explain how to report and analyze inventory.

Copyright ©2020 John Wiley & Sons, Inc. 2

PREVIEW OF CHAPTER 9

Copyright ©2020 John Wiley & Sons, Inc. 3

 Learning Objec/ve 1
Describe and apply the lower-of-cost-
or-net realizable value rule.

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Lower-of-Cost-or-Net Realizable Value
(LCNRV)
A company abandons the historical cost principle when the
future u+lity (revenue-producing ability) of the asset drops
below its original cost.
Net Realizable Value
Es+mated selling price in the normal course of business less
• es+mated costs to complete and
• es+mated costs to make a sale.

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 5

 Computa/on of Net Realizable Value

Illustra/on: Assume that Mander AG has unQnished inventory with a cost

of €950, a sales value of €1,000, es+mated cost of comple+on of €50, and
es+mated selling costs of €200. Mander’s net realizable value is
computed as follows.
cost>NRV=loss
COST<NRV=gain

ILLUSTRATION 9.1
• Mander reports inventory on its statement of Qnancial posi+on at
€750.
• In its income statement, Mander reports a Loss on Inventory Write-
Down of €200 (€950 − €750).
LO 1 Copyright ©2020 John Wiley & Sons, Inc. 6
LCNRV Disclosures

ILLUSTRATION 9.2

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Determining Final Inventory Value

Jinn-Feng Foods computes its inventory at LCNRV (amounts in

thousands).

ILLUSTRATION 9.3

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Methods of Applying LCNRV

• In most situa+ons, companies price inventory on an item-

by-item basis.
• Tax rules in some countries require that companies use an
individual-item basis.
• Individual-item approach gives the lowest valua+on for
statement of Qnancial posi+on purposes.
• Method should be applied consistently from one period to
another.

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Alterna/ve Applica/ons of LCNRV

Assume that Jinn-Feng Foods separates its food products into two
major groups, frozen and canned.

ILLUSTRATION 9.4

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Recording NRV Instead of Cost

Illustra/on: Data for Ricardo SpA

ILLUSTRATION 9.5

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Income Statement Presenta/on
Cost-of-Goods-Sold and Loss Methods of
Reducing Inventory to Net Realizable Value

ILLUSTRATION 9.6

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Use of an Allowance

Instead of credi+ng the Inventory account for NRV adjustments,

companies generally use an allowance account, ohen referred to as
Allowance to Reduce Inventory to NRV.
Using an allowance account under the loss method, Ricardo SpA makes
the following entry to record the inventory write-down to NRV.
Loss Due to Decline of Inventory to N RV 12,000
Allowance to Reduce Inventory to NRV 12,000

ILLUSTRATION 9-7

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Recovery of Inventory Loss
Recovery of Inventory Loss
• Amount of write-down is reversed.
• Reversal limited to amount of original write-down.
Con+nuing the Ricardo example, assume the net realizable value
increases to €74,000 (an increase of €4,000). Ricardo makes the
following entry, using the loss method.

Allowance to Reduce Inventory to NRV 4,000

Recovery of Inventory Loss 4,000

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E^ect on Net Income of Adjus/ng
Inventory to Net Realizable Value
Allowance account is adjusted in subsequent periods, such that
inventory is reported at the LCNRV.
Illustra/on 9.8 shows net realizable value evalua+on for Vuko
Company and the eiect of net realizable value adjustments on
income.

ILLUSTRATION 9.8

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Evalua/on of LCM Rule
LCNRV rule suiers some conceptual deQciencies:
1. A company recognizes decreases in the value of the asset and the
charge to expense in the period in which the loss in u+lity occurs—
not in the period of sale.
2. Applica+on of the rule results in inconsistency because a company
may value the inventory at cost in one year and at net realizable value
in the next year.
3. LCNRV values the inventory in the statement of Qnancial posi+on
conserva+vely, but its eiect on the income statement may or may not
be conserva+ve. Net income for the year in which a company takes
the loss is deQnitely lower. Net income of the subsequent period may
be higher than normal if the expected reduc+ons in sales price do not
materialize.

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LCNRV Problem
P9.1 Remmers SE manufactures desks. Most of the company’s desks are standard models and are
sold on the basis of catalog prices. At December, 2022, the following Qnished desks appear in the
company’s inventory. The 2022 catalog was in eiect through November 2022, and the 2023 catalog is
eiec+ve as of December 1, 2022. All catalog prices are net of the usual discounts. At what amount
should each of the four desks appear in the company’s December 31, 2022, inventory, assuming that
the company has adopted a lower-of-F IFO-cost-or-net realizable value approach for valua+on of
inventories on an individual-item basis?

Finished Desks A B C D
2022 catalog selling price €450 €480 €900 €1,050
FIFO cost per inventory list 12/31/22 470 450 830 960
Es+mated cost to complete and sell 50 110 260 200
2023 catalog selling price 500 540 900 1,200

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LCNRV Problem Solu/on

Item Cost Net Realizable Value* Lower-of-Cost-or-NRV

A €470 €450 €450
B 450 430 430
C 830 640 640
D 960 1,000 960

*Net Realizable Value = 2023 catalog selling price less es+mated costs
to complete and sell. (2023 catalog prices are in eiects as of 12/01/22.)

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 18

 Learning Objec/ve 2
Iden/fy other inventory valua/on
issues.

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Valua/on Bases
Net Realizable Value

Departure from LCNRV rule may be jus+Qed in situa+ons

when
• cost is diocult to determine,
• items are readily marketable at quoted market prices, and
• units of product are interchangeable.
Two common situa/ons in which NRV is the general rule:
• Agricultural assets
• Commodi+es held by broker-traders.

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Net Realizable Value
Agricultural Inventory—Biological Asset

Biological asset (classiQed as a non-current asset) is a living

animal or plant, such as sheep, cows, fruit trees, or copon
plants.
• Biological assets are measured on ini+al recogni+on and at
the end of each repor+ng period at fair value less costs to
sell (NRV).
• Companies record gain or loss due to changes in N RV of
biological assets in income when it arises.

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Net Realizable Value
Agricultural Inventory—Agricultural Produce

Agricultural produce is the harvested product of a biological

asset, such as wool from a sheep, milk from a dairy cow,
picked fruit from a fruit tree, or copon from a copon plant.
• Agricultural produce are measured at fair value less costs
to sell (NRV) at the point of harvest.
• Once harvested, the NRV becomes cost.

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Agricultural Accoun/ng at NRV

Illustra/on: Bancroh Dairy produces milk for sale to local cheese

makers. Bancroh began opera+ons on January 1, 2022, by
purchasing 420 milking cows for €460,000. Bancroh provides the
following informa+on related to the milking cows.

ILLUSTRATION 9.9

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Agricultural Accoun/ng at NRV
Journal Entry to Record Change in Carrying Value
As indicated, the carrying value of the milking cows increased during
the month. Part of the change is due to changes in market prices for
milking cows. The change in market price may also be aiected by
growth—the increase in value as the cows mature and develop
increased milking capacity. At the same +me, as mature cows are
milked, their milking capacity declines (fair value decrease due to
harvest. Bancroh makes the following entry to record the change in
carrying value of the milking cows.
Biological Asset (milking cows) (€493,800 - €460,000) 33,800
Unrealized Holding Gain or Loss—Income 33,800

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Agricultural Accoun/ng at NRV
Financial Statement Presenta/on

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Agricultural Accoun/ng at NRV
Two More Journal Entries
Illustra/on: Bancroh makes the following summary entry to record
the milk harvested for the month of January.
Inventory (milk) 36,000
Unrealized Holding Gain or Loss ─ Income 36,000

Assuming the milk harvested in January was sold to a local cheese

maker for €38,500, Bancroh records the sale as follows.
Cash 38,500
Cost of Goods Sold 36,000
Inventory (milk) 36,000
Sales Revenue 38,500

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Net Realizable Value
Commodity Broker-Traders

Generally measure their inventories at fair value less costs to

sell (NRV), with changes in NRV recognized in income in the
period of the change.
• Buy or sell commodi+es (such as harvested corn, wheat,
precious metals, hea+ng oil).
• Primary purpose is to
o sell the commodi+es in the near term and
o generate a proQt from ructua+ons in price.

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Rela/ve Standalone Sales Value

Used when buying varying units in a single lump-sum

purchase.
Illustra/on: Woodland Developers purchases land for $1
million that it will subdivide into 400 lots. These lots are of
diierent sizes and shapes but can be roughly sorted into
three groups graded A, B, and C. As Woodland sells the lots, it
appor+ons the purchase cost of $1 million among the lots
sold and the lots remaining on hand. Calculate the cost of lots
sold and gross proQt.

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Alloca/on of Costs, Using Rela/ve
Standalone Sales Value and Determina/on
of Gross Pro:t

ILLUSTRATION 9.10

ILLUSTRATION 9.11

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Purchase Commitments—A Special
Problem
• Generally seller retains +tle to the merchandise.
• Buyer recognizes no asset or liability.
• If material, the buyer should disclose contract details in
note in the Qnancial statements.
• If the contract price is greater than the market price, and
the buyer expects that losses will occur when the
purchase is eiected, the buyer should recognize a liability
and corresponding loss in the period during which such
declines in market prices take place.

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Purchase Commitments (1 of 2)
Illustra/on: Apres Paper AG signed +mber-cutng contracts with
Galling Land Ltd. to be executed in 2023 at a price of €10,000,000.
Assume further that the market price of the +mber cutng rights
on December 31, 2022, dropped to €7,000,000. Apres would make
the following entry on December 31, 2022.

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Purchase Commitments (2 of 2)

Illustra/on: When Apres cuts the +mber at a cost of €10

million, it would make the following entry.
Purchases (Inventory) 7,000,000
Purchase Commitment Liability 3,000,000
Cash 10,000,000

Assume that Galling Land Ltd. permits Apres to reduce its

commitment from €10,000,000 to €9,000,000. Apres would
make the following entry.
Purchase Commitment Liability 1,000,000
Unrealized Holding Gain or Loss—Income 1,000,000

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 Learning Objec/ve 3
Determine ending inventory by
applying the gross pro:t method.

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Gross Pro:t Method of Es/ma/ng
Inventory
Subs/tute Measure to Approximate Inventory
Relies on three assump/ons:
1. Beginning inventory plus purchases equal total goods to
be accounted for.
2. Goods not sold must be on hand.
3. The sales, reduced to cost, deducted from the sum of the
opening inventory plus purchases, equal ending inventory.

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Applica/on of Gross Pro:t Method

Illustra/on: Cetus SE has a beginning inventory of €60,000 and

purchases of €200,000, both at cost. Sales at selling price amount
to €280,000. The gross proQt on selling price is 30 percent. Cetus
applies the gross margin method as follows.

ILLUSTRATION 9.13
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Computa/on of Gross Pro:t Percentage

Illustra/on: In Illustra/on 9.13, the gross proQt was a given. But

how did Cetus derive that Qgure? To see how to compute a gross
proQt percentage, assume that an ar+cle cost €15 and sells for €20,
a gross proQt of €5.

ILLUSTRATION 9.14

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Formulas Rela/ng to Gross Pro:t and
Applica/on of Formulas

ILLUSTRATION 9.15

ILLUSTRATION 9.16

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Gross Pro:t Method Problem

E9.14 Astaire ASA uses the gross proQt method to es+mate

inventory for monthly repor+ng purposes. Presented below is
informa+on for the month of May.
Inventory, May 1 € 160,000 Sales € 1,000,000
Purchases (gross) 640,000 Sales returns 70,000
Freight-in 30,000 Purchases discounts 12,000

Instruc/ons:
a. Compute the es+mated inventory at May 31, assuming that the
gross proQt is 25% of sales.
b. Compute the es+mated inventory at May 31, assuming that the
gross proQt is 25% of cost.
LO 3 Copyright ©2020 John Wiley & Sons, Inc. 38
Gross Pro:t Method Problem
Solu/on for a.
a. Compute the es+mated inventory at May 31, assuming that the
gross proQt is 25% of sales.

LO 3 Copyright ©2020 John Wiley & Sons, Inc. 39

Gross Pro:t Method Problem
Solu/on for b.
b. Compute the es+mated inventory at May 31, assuming that the
gross proQt is 25% of cost.

LO 3 Copyright ©2020 John Wiley & Sons, Inc. 40

Evalua/on of Gross Pro:t Method

Disadvantages
1) Provides an es+mate of ending inventory.
2) Uses past percentages in calcula+on.
3) A blanket gross proQt rate may not be representa+ve.
4) Normally unacceptable for Qnancial repor+ng purposes
because it provides only an es+mate.
IFRS requires a physical inventory as addi+onal veriQca+on of the
inventory indicated in the records.
Note that the gross proQt method will follow closely the inventory
method used (FIFO or average-cost) because it relies on historical
costs.
LO 3 Copyright ©2020 John Wiley & Sons, Inc. 41
 Learning Objec/ve 4
Determine ending inventory by applying
the retail inventory method.

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Retail Inventory Method

Method used by retailers to compile inventories at retail prices.

Retailer can use a formula to convert retail prices to cost.
Requires retailers to keep a record of:
1) Total cost and retail value of goods purchased.
2) Total cost and retail value of the goods available for sale.
3) Sales for the period.
Methods
• Conven+onal Method (or LCNRV)
• Cost Method

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Retail Inventory Method Concepts

Markup—an addi+onal markup of the original retail price.

Markup cancella/ons—decreases in prices of merchandise that
the retailer had marked up above the original retail price.
Markdowns—decreases in the original sales prices.
Markdown cancella/ons—occur when the markdowns are later
oiset in increases in the prices of goods that the retailer had
marked down.
Neither a markup cancella+on nor a markdown cancella+on can
exceed the original markup or markdown.

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Retail Inventory Method Concepts
Cost Ra/os

Conven/onal Retail Method—Computes a ra+o aher net markups

but before net markdowns.
Cost Method—Computes a ra+o aher both net markups and
markdowns.

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Net Markups and Net Markdowns

Designer Clothing Store recently purchased 100 dress shirts from

Marroway Group. The cost for the shirts was €1,500, or €15 per shirt.
Designer Clothing established the selling price on these shirts at €30 a
shirt. The shirts were selling quickly, so the manager added a markup of
€5 per shirt. This markup made the price too high for customers, and
sales slowed. The manager then reduced the price to €32. At this point,
we would say that the shirts at Designer Clothing Company have had a
markup of €5 and a markup cancella+on of €3.
A month later, the manager marked down the remaining shirts to a sales
price of €23. At this point, an addi+onal markup cancella+on of €2 has
taken place, and a €7 markdown has occurred. If the manager later
increases the price of the shirts to €24, a markdown cancella+on of €1
would occur.
LO 4 Copyright ©2020 John Wiley & Sons, Inc. 46
Data for Retail Inventory Method
Example
In-Fusion SA can calculate its ending inventory under two assump+ons, A and B.
Assump+on A: Computes a cost ra+o aher net markups but before net
markdowns. This assump+on is referred to as conven+onal retail or LCNRV.
Assump+on B: Computes a cost ra+o aher both net markups and net
markdowns. This assump+on is referred to as referred to as the cost method.
In-Fusion data for calcula+ng ending inventory at cost under the two
assump+ons is as follows.

ILLUSTRATION 9.18

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Cost-to-Retail Ra/os for Assump/ons A
and B

ILLUSTRATION 9.18

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Value of Ending Inventory for In-Fusion

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Comprehensive Conven/onal Retail
Inventory Method Format

ILLUSTRATION 9.21

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Special Items Rela/ng to Retail Method

• Freight costs
• Purchase returns
• Purchase discounts and allowances
• Transfers-in
• Normal shortages
• Abnormal shortages
• Employee discounts
When sales are recorded
gross, companies do not
recognize sales discounts.

LO 4 Copyright ©2020 John Wiley & Sons, Inc. 51

Conven/onal Retail Inventory Method
—Special Items Included

ILLUSTRATION 9.22

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Evalua/on of Retail Inventory Method

Used for the following reasons:

1) To permit the computa+on of net income without a physical
count of inventory.
2) Control measure in determining inventory shortages.
3) Regula+ng quan++es of merchandise on hand.
4) Insurance informa+on.
Some companies reQne the retail method by compu+ng inventory
separately by departments or class of merchandise with similar
gross proQts.

LO 4 Copyright ©2020 John Wiley & Sons, Inc. 53

 Learning Objec/ve 5
Explain how to report and analyze
inventory.

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Presenta/on of Inventories (1 of 2)
Accoun+ng standards require disclosure of:
1) Accoun+ng policies adopted in measuring inventories, including
the cost formula used (weighted-average, FIFO).
2) Total carrying amount of inventories and the carrying amount in
classiQca+ons (merchandise, produc+on supplies, raw
materials, work in progress, and Qnished goods).
3) Carrying amount of inventories carried at fair value less costs to
sell.
4) Amount of inventories recognized as an expense during the
period.

LO 5 Copyright ©2020 John Wiley & Sons, Inc. 55

Presenta/on of Inventories (2 of 2)

Accoun+ng standards require disclosure of:

5) Amount of any write-down of inventories recognized as an
expense in the period and the amount of any reversal of write-
downs recognized as a reduc+on of expense in the period.
6) Circumstances or events that led to the reversal of a write-
down of inventories.
7) Carrying amount of inventories pledged as security for
liabili+es, if any.

LO 5 Copyright ©2020 John Wiley & Sons, Inc. 56

Analysis of Inventories

Common ra+os used in the management and evalua+on of

inventory levels are inventory turnover and average days to
sell the inventory.

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Analysis of Inventories
Inventory Turnover
Measures the number of +mes on average a company sells the inventory
during the period.
Illustra/on: In its 2019 annual report Tate & Lyle plc (GBR)
reported a beginning inventory of £419 million, an ending
inventory of £434 million, and cost of goods sold of £1,621 million
for the year.

ILLUSTRATION 9.25

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Analysis of Inventories
Average Days to Sell Inventory
Measure represents the average number of days’ sales for which a
company has inventory on hand.

ILLUSTRATION 9.25

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 Learning Objec/ve 6
Compare the accoun/ng for inventories
under IFRS and U.S. GAAP.

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Global Accoun/ng Insights

Inventories
In most cases, IFRS and U.S. GAAP related to inventory are the
same. The major diierences are that I FRS prohibits the use of
the LIFO cost row assump+on and records market in the L CN
RV diierently.

LO 6 Copyright ©2020 John Wiley & Sons, Inc. 61

Global Accoun/ng Insights
Similari/es

• U.S. GAAP and IFRS account for inventory acquisi+ons at

historical cost and evaluate inventory for lower-of-cost-or-net
realizable value (market) subsequent to acquisi+on.
• Who owns the goods—goods in transit, consigned goods, special
sales agreements—as well as the costs to include in inventory are
essen+ally accounted for the same under U.S. GAAP and IFRS.

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Global Accoun/ng Insights
Di^erences
• U.S. GAAP provides more detailed guidelines in inventory accoun+ng. The
requirements for accoun+ng for and repor+ng inventories are more principles-based
under IFRS.
• A major diierence between U.S. GAAP and IFRS relates to the LIFO cost row
assump+on. U.S. GAAP permits the use of L IFO for inventory valua+on. IFRS
prohibits its use. FIFO and average-cost are the only two acceptable cost row
assump+ons permiped under I FRS. Both sets of standards permit speciQc
iden+Qca+on where appropriate.
• In the lower-of-cost-or-market test for inventory valua+on, U.S. G AAP deQnes market
as replacement cost subject to the constraints of net realizable value (the ceiling)
and net realizable value less a normal markup (the roor) for inventories accounted
for under LIFO or retail inventory methods. IFRS deQnes market as net realizable
value and does not use a ceiling or a roor to determine market.

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Global Accoun/ng Insights
More Di^erences

• Under U.S. GAAP, if inventory is wripen down under the lower-of-cost-

or-market valua+on, the new basis is now considered its cost. As a result,
the inventory may not be wripen up back to its original cost in a
subsequent period. Under IFRS, the write-down may be reversed in a
subsequent period up to the amount of the previous write-down. Both
the write-down and any subsequent reversal should be reported on the
income statement.
• IFRS requires both biological assets and agricultural produce at the point
of harvest to be reported at net realizable value. U.S. GAAP does not
require companies to account for all biological assets in the same way.
Furthermore, these assets generally are not reported at net realizable
value. Disclosure requirements also diier between the two sets of
standards.

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Global Accoun/ng Insights
On the Horizon

One convergence issue that will be diocult to resolve relates to the

use of the LIFO cost row assump+on. As indicated, IFRS speciQcally
prohibits its use. Conversely, the LIFO cost row assump+on is
widely used in the United States because of its favorable tax
advantages. In addi+on, many argue that LIFO from a Qnancial
repor+ng point of view provides a beper matching of current costs
against revenue and therefore enables companies to compute a
more realis+c income.

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Global Accoun/ng Insights
About the Numbers
U.S. GAAP Inventory, Presenta+on and Disclosures

ILLUSTRATION GAAP 9.1

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Copyright

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