Accounting
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Inventory Management
Lower of Cost or Net Realizable Value: How to Apply the Inventory Write-Down Rule
Last updated: October 8, 2026 · Independent guide · We do not sell rankings or coverage.
Under US GAAP, inventory measured with FIFO or average cost is carried at the lower of cost or net realizable value (LCNRV), where net realizable value is the estimated selling price in the ordinary course of business less reasonably predictable costs of completion, disposal and transportation. When an item’s NRV falls below its cost, you write it down to NRV and recognize the loss in the period. Inventory measured with LIFO or the retail inventory method still uses the older lower of cost or market (LCM) test.
The rule and the journal entries
NRV = estimated selling price − costs to complete − costs to sell, dispose of and transport
Write-down = cost − NRV (only when NRV < cost)
| Account | Debit | Credit | Note |
|---|---|---|---|
| Cost of goods sold (or Loss on inventory write-down) | Write-down amount | Direct method. Present the loss within cost of goods sold, as described below. | |
| Inventory | Write-down amount | Reduces the item’s carrying amount to NRV. | |
| Cost of goods sold | Write-down amount | Allowance method, used when the subledger keeps the original unit cost. | |
| Inventory valuation allowance (contra-asset) | Write-down amount | Tracked by item so it can be relieved when the item is sold or scrapped. | |
| Inventory valuation allowance | Allowance on items sold or scrapped | Relief entry. The allowance follows the units out of inventory. | |
| Cost of goods sold (or Inventory, for scrap) | Same amount | Prevents the loss from being recognized twice. |
The allowance is a presentation and tracking device. It does not change the rule: the SEC staff’s view in Staff Accounting Bulletin Topic 5.BB is that a write-down “creates a new cost basis that subsequently cannot be marked up” (SEC, SAB Topic 5).
Worked example: a year-end LCNRV test
The following figures are an illustration. A component maker using FIFO tests four items at December 31, 2026. Selling costs include sales commission and outbound freight. Item C is a work-in-process subassembly that needs further work before sale.
Steps 1 and 2. Pull cost and estimate NRV. Take FIFO cost from the subledger, then estimate NRV from current prices and post-period sales, less costs to complete and sell.
| Item (units) | Unit cost | Unit NRV | Write-down |
|---|---|---|---|
| A, current model (1,000) | $40 | $55 price − $5 selling = $50 | $0 (carry at $40,000) |
| B, price-pressured model (500) | $80 | $78 price − $6 selling = $72 | $8 × 500 = $4,000 |
| C, WIP subassembly (200) | $120 to date | $150 price − $35 to complete − $10 selling = $105 | $15 × 200 = $3,000 |
| D, discontinued part (300) | $25 | $8 liquidation offer − $1 disposal = $7 | $18 × 300 = $5,400 |
| Total | $111,500 at cost | $99,100 carrying amount | $12,400 |
Step 3. Compare item by item. Item A stays at cost and is not marked up. Items B, C and D are written down to NRV.
Step 4. Book the entry. Using the allowance method:
| Account | Debit | Credit | Note |
|---|---|---|---|
| Cost of goods sold | $12,400 | December 31, 2026 LCNRV write-down | |
| Inventory valuation allowance | $12,400 | B $4,000; C $3,000; D $5,400 |
Step 5. Relieve the allowance as units leave. In February 2027 the company sells all 300 units of Item D for $8 each and pays $300 to ship them. The system posts $7,500 of FIFO cost to cost of goods sold; you debit the allowance $5,400 and credit cost of goods sold $5,400, so net cost of sales is $2,100. Revenue of $2,400 less $2,100 and the $300 disposal cost leaves no further gain or loss.
If the company had tested all four items in total instead of item by item, total NRV of $109,100 ($50,000 + $36,000 + $21,000 + $2,100) against cost of $111,500 would have produced a write-down of only $2,400, because Item A’s headroom absorbs the losses on the others. That gap is why the level of aggregation should be a written policy agreed with your auditors, not a choice made at each close.
LCNRV vs LCM: which inventory methods use which
FASB issued Accounting Standards Update 2015-11, Simplifying the Measurement of Inventory, in July 2015. It replaced lower of cost or market with lower of cost and net realizable value for inventory measured using FIFO or average cost. It does not apply to inventory measured using LIFO or the retail inventory method, and it took effect for fiscal years beginning after December 15, 2016 (FASB, ASU 2015-11, July 2015; Dean Dorton, September 25, 2015). In the Codification the guidance sits in ASC 330-10-35.
| Cost method | Book test (US GAAP) | What you compare cost against |
|---|---|---|
| FIFO, weighted average, moving average, specific identification | LCNRV | NRV only |
| LIFO | LCM | Replacement cost, capped at NRV and floored at NRV less a normal profit margin |
| Retail inventory method | LCM | Same market definition, applied through the retail cost ratio |
Under LCM, market starts at current replacement cost, cannot exceed selling price less cost to complete (the ceiling), and cannot be less than that amount less a normal profit margin (the floor) (Becker, no date shown; Becker sells CPA exam review courses). Standard costing is not a separate category: standard costs that approximate actual FIFO or average cost follow the LCNRV test. Our guide to standard cost vs actual cost covers when standards qualify.
IFRS reporters apply IAS 2, which also measures inventory at the lower of cost and net realisable value (IFRS Foundation, no date shown). The main practical difference is that IFRS requires a write-down to be reversed, up to the original amount, when NRV recovers, while US GAAP prohibits reversal (AnalystPrep, August 28, 2019; AnalystPrep sells exam prep).
Tax treatment is different
Federal tax rules do not follow ASC 330. Treasury Regulation 1.471-4 lets taxpayers value inventory at lower of cost or market, compares market value with cost for each article on hand, and defines market by reference to current bid prices for the basic elements of cost (eCFR, 26 CFR 1.471-4, up to date as of October 6, 2026). LIFO taxpayers must take inventory at cost regardless of market value (26 CFR 1.472-2(b)).
Goods that are unsalable at normal prices because of damage, imperfections, shop wear, changes of style or similar causes can be valued at bona fide selling prices less direct cost of disposition, but the taxpayer must show an actual offering of the goods within 30 days after the inventory date. A reserve for price changes or an estimated depreciation in value is listed as a method not in accord with the regulations (26 CFR 1.471-2(c) and (f)). A book allowance like the $12,400 above therefore usually becomes a deferred tax item.
Common mistakes
- Using replacement cost for FIFO or average cost items. Since ASU 2015-11, replacement cost matters only for LIFO and retail method inventory.
- Forgetting costs to complete and sell. NRV for WIP and raw materials must deduct conversion costs, commissions and outbound freight, as Item C shows.
- Writing inventory back up. Releasing an allowance because prices recovered violates the new cost basis principle in SAB Topic 5.BB.
- Not relieving the allowance when units are sold. The allowance then drifts away from the items it covers.
- Testing in aggregate by default. As the example shows, offsetting healthy items against impaired ones can hide most of the loss.
- Ignoring slow-moving stock. Excess and obsolete items are an NRV problem too; NRV may be scrap value.
How to report the write-down
AccountingTools states that the write-down loss appears within the cost of goods sold line item (AccountingTools, July 27, 2026). Inventory appears on the balance sheet net of any allowance. Your accounting policy note should state the cost method and that inventory is carried at the lower of cost and NRV (or LCM for LIFO). Describe large or unusual write-downs in the notes, and keep the test workbook and post-period sales evidence with the close file for audit.
How ERP and inventory systems support the analysis
Most ERP systems will hold the cost layers and post a revaluation, but few calculate NRV for you. The common pattern is to export on-hand quantity and cost by item, add price and selling-cost data, run the comparison in a spreadsheet or reporting tool, and post the result as a revaluation or a GL entry to the allowance. Build it into your ERP close process.
Microsoft Dynamics 365 Business Central uses a Revaluation Journal with a Calculate Inventory Value action; you enter Unit Cost (Revalued) or Inventory Value (Revalued) and posting creates revaluation value entries (Microsoft Learn, updated August 21, 2025). Average cost items can be revalued only when calculated per item and only at the end of an average cost period (Microsoft Learn, updated March 17, 2026).
Oracle NetSuite documents an Inventory Cost Revaluation transaction that sets a standard cost from an effective date and recalculates on-hand value at that cost (Oracle NetSuite Help, no date shown). For FIFO or average cost items, a journal entry to an allowance account is the usual route.
SAP ERP has long offered lowest value determination for balance sheet valuation, including a market price comparison (transaction MRN0) and a range-of-coverage devaluation based on consumption (transaction MRN1) that can update the material’s commercial and tax prices (SAP Help, no date shown). Its market price logic is closer to LCM, so you still deduct selling and completion costs.
Last sale price and days-on-hand reports flag at-risk items early; see ERP for inventory management.
How we researched this
We read the top-ranking pages for “lower of cost or net realizable value” in October 2026. Most define the term but give no item-level example, no allowance relief entry and no tax comparison. We relied on SEC staff guidance, the eCFR, the IFRS Foundation and vendor documentation, and we label sources that sell products or courses.
Related guides
- Excess and Obsolete Inventory: E&O Reserve Calculation
- Inventory Costing Methods: FIFO, Average, Standard, Specific
- Adjusting Journal Entries: 5 Types, Examples, Automation
Frequently asked questions
What is the difference between LCM and LCNRV?
LCNRV compares cost with net realizable value only. LCM compares cost with market, which is replacement cost bounded by a ceiling (NRV) and a floor (NRV less a normal profit margin). Since ASU 2015-11, US GAAP uses LCNRV for FIFO and average cost inventory and LCM for LIFO and retail method inventory.
Can you reverse an inventory write-down under GAAP?
No. Under US GAAP a write-down creates a new cost basis that cannot be marked up later, even if prices recover. IFRS is different and requires a reversal up to the original write-down when NRV recovers.
Is an inventory write-down deductible for tax?
Not always in the same year. Tax regulations allow lower of cost or market item by item for non-LIFO taxpayers and a lower value for goods unsalable at normal prices and actually offered for sale within 30 days, but they do not allow a general reserve. Book allowances therefore often create a temporary difference.
How often should you run the LCNRV test?
Run it at every balance sheet date you report on, which for most companies means each quarter or month as well as year end. Running it with each close keeps the allowance current.
Sources
- SEC, Staff Accounting Bulletins, Codification of Staff Accounting Bulletins, Topic 5.BB Inventory Valuation Allowances, document date December 1, 2017. sec.gov
- FASB, Accounting Standards Update 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory, July 2015, full text hosted by PwC Viewpoint. viewpoint.pwc.com
- Dean Dorton, Highlights of FASB’s ASU 2015-11, September 25, 2015. deandorton.com
- Becker, Lower of Cost or Market definition, no date shown (sells CPA exam review). becker.com
- IFRS Foundation, IAS 2 Inventories, no date shown. ifrs.org
- AnalystPrep, Measurement of Inventory at the Lower of Cost and Net Realisable Value, August 28, 2019 (sells exam prep). analystprep.com
- eCFR, 26 CFR 1.471-4 Inventories at cost or market, whichever is lower, up to date as of October 6, 2026. ecfr.gov
- eCFR, 26 CFR 1.471-2 Valuation of inventories, up to date as of October 6, 2026. ecfr.gov
- eCFR, 26 CFR 1.472-2 Requirements incident to adoption and use of LIFO inventory method, up to date as of October 6, 2026. ecfr.gov
- AccountingTools, Lower of cost or net realizable value, July 27, 2026. accountingtools.com
- Microsoft Learn, Revalue inventory (Business Central), updated August 21, 2025. learn.microsoft.com
- Microsoft Learn, Design details: Revaluation (Business Central), updated March 17, 2026. learn.microsoft.com
- Oracle NetSuite Help, Revalue Standard Cost Inventory, no date shown. docs.oracle.com
- SAP Help, Determining Lowest Value: Market Prices, no date shown. help.sap.com
- SAP Help, Determining Lowest Value: Range of Coverage, no date shown. help.sap.com
Sherman Hsieh
Independent analysis of enterprise software — ERP, CRM and more
