Testing the inventory reserve
Inventory is carried at the lower of cost and net realizable value (ASC 330-10-35-1B). Two procedures cover most of the risk: a pricing test comparing unit cost with recent selling prices less costs to sell, and an evaluation of excess and obsolete stock using an aging or movement report. Both are estimates, so the auditor tests the data (aging report completeness and accuracy), the method and the assumptions (reserve percentages against history and subsequent sales).
Keep the two halves separate so the same cost is not reserved twice: items written down to NRV come out of the aging buckets. A difference from the recorded reserve is usually a judgmental misstatement; carry it to the summary of uncorrected misstatements.
Common questions
How is an inventory obsolescence reserve calculated?
A common method ages inventory by time since last movement or sale, then applies a reserve percentage to each bucket based on history, product life cycles and expected sales. Reserve = Σ bucket cost × reserve %.
What is net realizable value?
The estimated selling price in the ordinary course of business less reasonably predictable costs of completion, disposal and transportation (ASC 330-10-20).
Does lower of cost and net realizable value apply to all inventory?
It applies to inventory measured using FIFO or average cost (ASC 330-10-35-1B). Inventory measured using LIFO or the retail inventory method stays on lower of cost or market (330-10-35-1C).
Can an inventory write-down be reversed?
Not in annual financial statements. A write-down to NRV creates a new cost basis that is not marked back up if prices recover (ASC 330-10-35-14). Interim periods have a narrow exception.
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