Question

Answer the following questions related to the lower-of-cost-or-net realizable value (LCNRV) method and/or the lower-of- cost-or-market (LCM) method. 1. Why are inventories valued at the LCNRV or LCM? (i.e., why is it necessary to perform this calculation for inventories)? 2. What two methods are used to record the necessary journal entry for LCNRV and LCM? Which method is preferred and why?

Answer 1

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Answer 1

Where there is evidence that the utility of goods to be disposed of in the ordinary course of business will be less than cost, the difference should be recognized as a loss in the current period, and the inventory should be stated at net realizable value in the financial statements. This is because Generally accepted accounting principles require that inventory should be valued at lesser amount of its actual purchase cost and the amount in which it is likely to be sold. This is to show correct picture of financial statements and accepting losses which is prevalent on the date of financial statements.

Answer 2

The two methods are:

Cost of goods sold method and Loss method.

Under Cost of goods sold method loss on valuation of inventory is adjusted to cost of goods sold and reduced from Inventory.

Under Loss method loss on valuation of inventory is shown as Loss Due to Decline of Inventory to NRV and an allowance called Allowance to Reduce Inventory to NRV is created with the same amount. Inventory balance is not reduced and is kept same.

Cost of goods sold method is preferred because the loss is not carried forward and is charged off from the inventory in the year occurred.