Accounting rules, issued as far back as the 1940s and 1950s in Accounting Research Bulletins, describe how to measure inventory at the “lower of cost or market.” The concept of “lower of cost or market,” which has been with us since our college accounting classes, actually has roots that reach back to accounting practices in the 19th century, well before the rules were even codified. If you own a company that holds inventory or you work in some capacity with inventory, you have likely been faced with “lower of cost or market” considerations.
Accounting Changes to “Lower of Cost or Market”
As of 2017, this principle has changed and could impact inventory valuations at your Company. The “lower of cost or market” concept is now obsolete and has been officially replaced with a new accounting principle known as “lower of cost and net realizable value” (NRV). This new accounting standard was issued to simplify the complexities of measuring inventory and to reduce the costs of arriving at the proper measurement values.
Lower of Cost and Net Realizable Value is Now in Effect
The NRV Accounting Standards Codification amendment is ASU 2015-11 – Inventory – Simplifying the Measurement of Inventory and is effective in fiscal years beginning after December 15, 2016. The amendment in this update should be applied prospectively and does not apply to inventories measured using LIFO or the retail inventory method. Under current U.S. GAAP, the requirements of inventory measurement can be complicated, and it can be difficult to determine an appropriate “market” value. The new accounting guidance eliminates the need to determine replacement cost and evaluate whether it is above the ceiling (NRV) or below the floor (NRV less a normal profit margin). The new guidance simply requires the derivation of the NRV which is defined as the “estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.”
How DHJJ Can Help
A company’s holding inventory will need to apply this new accounting principle in the current year. If you have any questions in the application of this new accounting principle, contact DHJJ at 630-420-1360.
