ASC 330 Inventory Write-Downs: Lower of Cost and Net Realizable Value, Journal Entries and Audit Tests

An inventory balance is only as good as the price the goods will fetch. ASC 330 requires a write-down when that price falls below cost, and it makes the write-down permanent. For a CPA firm auditing a manufacturer, distributor or retailer, the write-down entry is usually small in form and large in judgment. This guide covers the measurement rule, the journal entries, the reserve question, the no-reversal rule and the audit tests. The cost flow methods themselves are covered in our guide to FIFO, average cost, LIFO and NRV.

Which inventory uses lower of cost and net realizable value?

Inventory measured with FIFO or average cost is measured at the lower of cost and net realizable value. Inventory measured with LIFO or the retail inventory method is outside that change and keeps the older lower-of-cost-or-market test. ASU 2015-11 made the change and applies prospectively. It was effective for public business entities for fiscal years beginning after December 15, 2016, including interim periods. For all other entities it was effective for fiscal years beginning after December 15, 2016, with interim periods in fiscal years beginning after December 15, 2017.

Net realizable value (NRV) is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. The old test measured market as replacement cost, NRV, or NRV less an approximately normal profit margin. The new test compares cost with one number.

When is a write-down recorded?

When evidence shows NRV is below cost, the difference is recognized as a loss in earnings in the period in which it occurs. Damage, obsolescence and price declines all qualify. The write-down is not deferred to the sale.

Obsolete finished goods and aged raw materials are the usual candidates, and each should be supported with its own NRV evidence.

The journal entry

Illustration only, with round numbers. A distributor carries 1,000 units of a product at FIFO cost of $400 each, or $400,000. A competitor price cut lowers the expected selling price to $360. Costs to sell are $20 per unit. NRV is $340 per unit, or $340,000. The write-down is $60,000.

Many entities post the credit to an inventory reserve, a contra asset, rather than to the inventory account directly. The balance sheet shows inventory net of the reserve either way.

When the units are sold or scrapped, the entry clears the reserve against inventory, so no second loss is booked:

Reserve or direct credit?

Both give the same net inventory. The difference is control. A reserve keeps the original cost visible and lets the preparer see cumulative write-downs by item. It also creates a risk: a reserve looks like a valuation allowance that can be released. Under ASC 330 it cannot be treated that way. The write-down creates a new cost basis for the inventory. The CPA Journal states that write-downs taken at year end are deemed a new cost prospectively and may not be restored in future years.

Can the write-down be reversed?

No, with one narrow exception for interim periods. Year-end write-downs are not restored. Under the interim reporting guidance in ASC 270, recoveries of an earlier interim loss on the same inventory in a later interim period of the same fiscal year are recognized as gains, not exceeding the losses previously recognized. A write-down taken for the annual period is final. When prices recover after year end, the entity records a higher margin on the sale and does not recognize the recovery earlier.

At adoption of the ASU, inventory already written down below cost under a method other than LIFO or the retail method kept that reduced amount as its cost.

Audit angle

The auditor tests whether NRV is measured, not just whether a reserve exists. Common procedures and evidence:

• Aging and movement. Obtain the inventory aging by item. Slow-moving and zero-movement items drive the exposure. Compare the reserve to the aging buckets and to prior-year write-offs.
• Subsequent sales and price lists. Trace a sample of items to sales after year end and to current price lists. Items selling below cost, or not selling, need NRV support.
• Costs to complete and sell. Recompute NRV for a sample, including freight out, commissions and rework cost. Preparers often omit these.
• Existence and condition. Use observation results to identify damaged or obsolete goods. See inventory observation audit procedures.
• Reserve roll-forward. Agree opening reserve, provisions, usage and closing reserve. Check that usage reflects physical disposal and that no reserve was released into income.
• Management's method. Inspect the reserve policy, how it was applied consistently and whether management overrides appear in late entries.

Common misstatements: a general percentage reserve with no item-level support, a reserve released after a price recovery, NRV computed without costs to sell, and write-downs recorded in the wrong period. The effect of an unsupported reserve on gross margin is direct, so it is often a point where management bias shows. See auditing estimates for bias.

Presentation

Entities commonly record the loss in cost of sales. ASC 330-10-50-2 says substantial and unusual losses from the subsequent measurement of inventory should be disclosed, and it is often desirable to show the amount as a separate charge in the income statement. Check that the notes state that inventory is measured at the lower of cost and NRV where that applies.

CORAA prepares ready-to-review audit files for US CPA firms from QuickBooks books; you review and sign. See /us.

Sources

• FASB, ASU 2015-11, Simplifying the Measurement of Inventory (scope, effective dates, transition, interim recoveries, disclosure of losses): https://storage.fasb.org/ASU%202015-11.pdf
• The CPA Journal, "Net Realizable Value Is the New Market": https://www.cpajournal.com/2018/06/26/net-realizable-value-is-the-new-market/

AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error