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IFRS vs US GAAP: lower of cost and NRV

While both IFRS and US GAAP generally require carrying inventories are lower of cost or market value (also called NRV), there are some key differences.

Inventory valuation – IFRS: lower of cost and NRV

IFRS requires inventories to be held at lower of cost or net realizable value (NRV). NRV equals their estimated selling price in the ordinary course of business less estimated costs to get the inventory to the condition of sale and estimated selling costs. Companies assess whether the inventory carrying value is higher than their net realizable value either item by item or by groups of similar items. When carrying value is higher than NRV, the difference must be expensed, either to the cost of sales or as a separate line item. Subsequently, when the written-down inventory recovers its value, a reversal of the impairment can be recognized only to the extent of initial write-down by reducing the cost of goods sold.

US GAAP inventory valuation: lower of cost and market

US GAAP requires inventories measured using other than LIFO method and retail inventory method, to be valued at lower of cost or market value.

Unlike IFRS, US GAAP prohibits the reversal of any write-downs.

For inventories measured using LIFO method or retail inventory method, market value is defined as the current replacement cost subject to upper and lower limits. The upper limit is equal to the net realizable value (NRV) and the lower limit is equal to NRV minus normal profit.

Impact of write-down of inventories on financial statements

Write-down of inventories adversely affects profitability, liquidity and solvency ratios but may affect efficiency ratios positively. Companies may be reluctant to record inventory write-down unless they have evidence that it is permanent, particularly under US GAAP (because it does not allow any reversal).

Valuation of inventories of agricultural and natural resources

IAS 2 Inventories (the IFRS standard relevant to inventories) exclude agricultural and forest products and minerals and mineral products from its scope. These are typically carried at NRV (i.e. fair value less cost to completion less cost to sell) based on active market prices or recent market prices. Any changes in value are recognized in profit and loss.

Inventory write-down is a major concern, particularly where technological obsolescence is a significant risk. Potential for inventory write-down also depends on the inventory valuation method used by a company. Companies following LIFO are less likely to incur inventory write-down because LIFO values closing inventories are the oldest costs thereby reducing the probability that the historical cost would be higher than the current market price.

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