Question

You have been asked by the financial vice president to develop a short presentation on the LCNRV method for inventory purposes. The financial VP needs to explain this method to the president because it appears that a portion of the company’s inventory has declined in value. Instructions The financial vice president asks you to answer the following questions. (a) What is the purpose of the LCNRV method? (b) What is meant by “net realizable value”? (c) Do you apply the LCNRV method to each individual item, to a category, or to the total of the inventory? Explain. (d) What are the potential disadvantages of the LCNRV method?

Short answer

1. The LCNRV method is used to report the inventory at a net realizable value to record the loss resulting from a decline in inventory.
2. Net realizable value is the estimated amount that the business will be able to generate by selling the inventory.
3. The LCNRV method is applied on an individual basis, category basis, and total inventory basis.
4. The disadvantages include the override cost principle; the loss related to declining is recorded in the year of loss.

Step-by-step solution

Purpose of LCNRV method

a. Lower-of-cost-or-net- realizable-value (LCNRV) is used to report the inventory at the lowest net realizable value or original cost of the asset. In case the future utility of the inventory reduces due to obsoleteness, deterioration, change in price levels, etc., the inventories are recorded at net realizable value, and loss is recorded for the decline in the inventory.

Definition of net realizable value

b. Net reliable value (NRV) is compared with the original cost to measure the inventory per LCNRV. Net realizable is estimated by subtracting the cost of completion, disposal, and transportation from the selling price of the product.

Application of LCNRV

c. On an individual basis, the LCNRV approach is applied based on each item produced by the business. Under major categories basis, LCNRV is applied to the major categories of inventories produced by the business. Under the total inventory method, the original cost of total inventory is compared with the NRV of total inventory to apply LCNRV.

Disadvantages of LCNRV

d. The disadvantages of LCNRV are as follows:

• Under the LCNRV method, inventories are reported at lower-of-cost-or-net-realizable-value, which is incorrect as per the cost principle, wherein inventory must be reported at the original cost.
• The loss related to a decline in inventory value is recorded in the year of reduction, not in the year of sale of inventory.