Question

Question:Why are inventories valued at the lower-of-cost-or-net realizable value (LCNRV)? What are the arguments against the use of the LCNRV method of valuing inventories?

Short answer

The loss related to the decline in the utility of the inventories should be charged against the revenue for the period, not in the year of sale of inventories.

The arguments are:

• Allocation of the purchase price on the basis of sales value, to the individual items.
• Purchase commitments accounting

Step-by-step solution

Step-by-step-solutionStep1:

The value of the inventories gets reduced due to obsolescence or deterioration, in this situation inventories cannot be reported at the cost, hence it is important to record the loss related to inventory value reduction in the year which it is incurred.

Step 2:

In case multiple units are purchased at a single lump-sum price, then the business allocates uses the sales value basis to allocate the total purchase cost of the inventories.

There is another argument, which is related to accounting for purchase commitments. Some may believe that assets and liabilities should be recorded when the contract is signed, and some other groups may believe that delivery date should be considered to record the assets and liabilities.