11.3 Lower of Cost or Net Realizable Value (LCNRV) & Shrinkage

Why cost is not the last measurement word

Cost-flow methods (FIFO, LIFO, average) answer which historical cost remains. They do not answer whether that cost is still recoverable from customers. Damaged cartons, obsolete SKUs, and price collapses can leave inventory on the shelf at a recorded cost the firm will never recoup. U.S. GAAP then requires a write-down.

AIPB’s current certification page and 99-hour course copy tell candidates to cost inventory using weighted-average, moving-average, FIFO, LIFO, and lower of cost or net realizable value (LCNRV). Some older AIPB handbook language still says lower of cost or market (LCM). This independent OpenExamPrep section teaches LCNRV as the current U.S. GAAP measurement phrase for inventory and as the phrase AIPB now prints. It is not an AIPB publication and does not claim official approval, review, partnership, or exact equivalence with AIPB materials. Where an old workbook page still says LCM, map it to today’s NRV computation unless the item is clearly testing the historical replacement-cost / ceiling / floor “market” test and gives those inputs.

FASB Accounting Standards Update 2015-11 (Inventory / Topic 330) measures inventory at the lower of cost and net realizable value. Net realizable value (NRV) is estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The ASU applies to inventory measured by methods other than LIFO or the retail inventory method—for example FIFO and average cost. LIFO and retail-inventory-method inventories keep a subsequent lower of cost or market test. For AIPB Part 3 items that say LCNRV, compute NRV and compare it to cost. Do not invent a replacement-cost “market” unless the problem still uses old LCM wording and gives replacement cost, a ceiling, and a floor.

After a write-down, the reduced amount is the new cost basis. U.S. GAAP does not restore inventory through earnings if NRV later recovers; recovery shows up as a higher margin when the goods are sold. IFRS can allow reversals in some cases. AIPB is testing U.S. bookkeeping, so do not credit a recovery gain on the allowance just because next quarter’s catalog price improved.

Part 3 remains an untimed open-book Mastering Inventory final at 70%. Open-book still requires the NRV formula, the correct debit and credit, and a count that matches the card before you test LCNRV.

NRV, item by item: Nettle & Twine Stationers

NRV per unit = estimated selling price − costs of completion − costs of disposal (and transportation to sell, when given).

Nettle & Twine’s year-end count, already costed under FIFO:

NRV checks:

• Clipboards: $20 − $3 = $17 ≥ cost $12 → no write-down
• Desk sets: $32 − $4 = $28 < cost $30 → write down $2 × 25 = $50
• Folios: $48 − $5 = $43 < cost $50 → write down $7 × 10 = $70
• Binders: $11 − $1 = $10 ≥ cost $8 → no write-down

Item-by-item LCNRV write-down = $50 + $70 = $120.
Inventory should be reported at $2,090, not $2,210.

Trap — selling price without subtracting costs. Using $32 against $30 for desk sets would skip the $4 disposal cost and miss the write-down. NRV is not list price.

Trap — writing inventory up. Clipboards have NRV $17 above cost $12. Do not mark them up to $17. LCNRV is a lower of test, not a revaluation to NRV.

Grouping changes the number

If you compared total cost $2,210 with total NRV (40 × $17 + 25 × $28 + 10 × $43 + 60 × $10 = $680 + $700 + $430 + $600 = $2,410), NRV exceeds cost and a total-inventory application would record $0 write-down. Gains on clipboards and binders would offset losses on desk sets and folios. U.S. practice typically applies LCNRV to individual items or to pools of similar items, not to one grand total that hides damaged SKUs. Item-by-item is the conservative default on exam computations unless the problem defines a pool.

Journal entries: direct COGS versus allowance

Direct (COGS) method — common on small-business books:

Dr Cost of Goods Sold 120
Cr Merchandise Inventory 120

Loss method (write-down presented separately from ordinary COGS):

Dr Loss from Inventory Write-Down 120
Cr Merchandise Inventory 120

Allowance method (keeps the inventory subledger at historical cost):

Dr Cost of Goods Sold (or Loss) 120
Cr Allowance to Reduce Inventory to NRV 120

The allowance is a contra-asset. Net inventory on the balance sheet is still $2,090. Subsequent allowance adjustments set the allowance to the new required write-down; they do not reverse last year’s write-down into a gain just because prices recovered, under U.S. GAAP’s new-cost-basis approach.

Either COGS or a separate loss hits earnings in the period the decline occurs (ASC 330). Do not park the $120 in retained earnings or wait until the desk sets are sold.

If the folios are truly unsaleable scrap with NRV $0, write them to zero (10 × $50 = $500 if they still sit at cost), not to a hopeful $43.

The mermaid diagram after this section is the decision order: compute cost, compute NRV, compare, then either keep cost or write down with the COGS/Loss debit and Inventory/allowance credit.

Shrinkage: the count versus the perpetual card

Shrinkage is the gap between book quantity (perpetual inventory) and physical count, valued at the costing method’s unit cost. It is not a cost-flow method. It is a quantity loss: theft, breakage, spoilage, unrecorded samples, owner draws, receiving shorts, or a count error.

Oak & Tally Mercantile keeps perpetual moving-average records. Book inventory at year-end: 800 units @ $14.50 = $11,600. The physical count is 786 units. Shrinkage = 14 units × $14.50 = $203.

Dr Cost of Goods Sold (or Inventory Shrinkage) 203
Cr Merchandise Inventory 203

After posting, the perpetual card matches the count: 786 × $14.50 = $11,397.

If the count is higher than the books, do not automatically debit Inventory and credit COGS. Investigate: unrecorded purchases, double-counted bins, or units still in receiving. Writing inventory up to a sloppy count invents assets.

Perpetual versus periodic: where shrinkage is visible

That is why cycle counts still matter on periodic books: the year-end count is both the inventory amount and the sponge that absorbs theft.

Theft versus breakage versus count error

Shrink percentage (simple) = shrinkage dollars ÷ goods available (or ÷ sales, if you are matching a retail metric). Oak & Tally: $203 ÷ $11,600 ≈ 1.75% of book inventory. A spike versus last year is a control signal, not a rounding plug.

Damaged units that remain on the floor at a reduced selling price may need both a quantity adjustment (if they are discarded) and an LCNRV write-down (if they remain in stock at lower NRV). Do not double-count: if you already removed the units, they are not also on the LCNRV worksheet.

Physical count practicalities

A usable count needs a count date, freeze or cut-off of receiving and shipping, two-count teams or tags, and a reconciliation to the perpetual file before the shrinkage entry. Units of measure must match the card (12 boxed kits are not 12 loose units). Consignment goods you do not own stay off your inventory; goods you own at a customer’s location stay on. FOB destination purchases in a truck on count night are not yours yet; FOB shipping-point purchases in transit are.

Apply LCNRV to the units that exist after the count and shrinkage entry. Oak & Tally should test NRV on 786 units, not on the 800 book units that include missing stock.

Realistic scenarios

Scenario A — NRV with leftover packaging. Folios will sell for $48 only after $5 of gold-stamping and marketplace fees. Costing them at $48 without the $5 overstates NRV and understates the write-down.

Scenario B — buried periodic theft. Periodic COGS “looks about right” because nobody compared a purchase roll-forward to the count. A 14-unit theft never gets its own line. Install even a simple perpetual for high-theft SKUs.

Scenario C — count then LCNRV. Cost the count first, post shrink, then run the NRV worksheet. Mixing the 14 missing Oak & Tally units into an LCNRV table double-counts a quantity problem as a valuation problem.

Traps

• Treating LCNRV as a write-up to selling price
• Using estimated selling price as NRV without subtracting completion and disposal costs
• Applying one total-inventory netting so healthy SKUs hide obsolete ones
• Crediting Inventory and debiting COGS (signs reversed) for a write-down or for shrinkage
• Booking shrinkage as a reduction of sales
• Posting shrink before investigating a unit-of-measure count error
• Reversing last year’s U.S. GAAP write-down into a gain because prices recovered
• Calling current GAAP “LCM” without noting AIPB’s current LCNRV wording and the ASU 2015-11 NRV test