SELF-PACED LEARNING MODULE

COLLEGE DEPARTMENT

MODULE 12
Subject:

INTERMEDIATE ACCOUNTING 1 (AE15-IA1)

AISAT COLLEGE – DASMARIÑAS, INC.

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INFORMATION SHEET PR-12.1.1

 Unit Intermediate Accounting 1
Module LOWER COST AND NET REALIZABLE VALUE
AE15 – IA1 Intermediate Accounting 1 Units: 3 Page |2

“LOWER COST AND NET REALIZABLE VALUE”

Measurement of inventory

PAS 2, paragraph 9, provides that inventories shall be measured at the lower of cost and net realizable
value.

The measurement of inventory at the lower of cost and net realizable value is now known as LCNRV.

Net realizable value

Net realizable value or NRV is the estimated selling price in the ordinary course of business less the
estimated cost of completion and the estimated cost of disposal.

The cost of inventories may not be recoverable under the following circumstances:

a. The inventories are damaged.

b. The inventories have become wholly or partially obsolete.
c. The selling prices have declined.
d. The estimated cost of completion or the estimated cost of disposal has increased.

The practice of writing inventories down below cost to net realizable value is consistent with the view
that assets shall not be carried in excess of amounts expected from their sale or use.

Accounting for inventory write-down

If the cost is lower than net realizable value, there is no accounting problem because the inventory is
measured at cost and the increase in value is not recognized.

If the net realizable value is lower than cost, the inventory is measured at net realizable value and the
decrease in value is recognized.

Methods of accounting for the inventory write-down

a. Direct method or cost of goods sold method

b. Allowance method or loss method

SUBJECT TEACHER: APPROVED FOR

12th IMPLEMENTATION:
MODULE
MIDTERM MS. MARY JOY F. LABAJO
12 Meeting
Subject Teacher MR. WILBERT A. MAÑUSCA
School Director
 Unit Intermediate Accounting 1
Module LOWER COST AND NET REALIZABLE VALUE
AE15 – IA1 Intermediate Accounting 1 Units: 3 Page |3

Direct method

The inventory is recorded at the lower of cost OF net realizable value.

This method is also known as "cost of goods sold method” because any loss on inventory write-down or
gain on reversal of inventory write-down is not accounted for separately but “buried” in the cost of
goods sold.

Allowance method

The inventory is recorded at cost and any loss on inventory write-down is accounted for separately.

‘This method is also known as “loss method" because a loss account “loss on inventory write-down” is
debited and a valuation account “allowance for inventory write-down" is credited.

In subsequent years, this allowance account is adjusted upward or downward depending on the
difference between the cost and net realizable value of the inventory at year-end,

If the required allowance increases, an additional loss is recognized

If the required allowance decreases, a gain on reversal of inventory writedown is recorded.

However, the gain is limited only to the extent of the allowance balance.

Preferably, the allowance method is used in order that the effects of write-down and reversal of write-
down can be clearly identified.

As a matter of fact, PAS 2, paragraph 36, requires disclosure of the amount of any inventory writedown
and the amount of any reversal of inventory write-down.

SUBJECT TEACHER: APPROVED FOR

12th IMPLEMENTATION:
MODULE
MIDTERM MS. MARY JOY F. LABAJO
12 Meeting
Subject Teacher MR. WILBERT A. MAÑUSCA
School Director
 Unit Intermediate Accounting 1
Module LOWER COST AND NET REALIZABLE VALUE
AE15 – IA1 Intermediate Accounting 1 Units: 3 Page |4

SUBJECT TEACHER: APPROVED FOR

12th IMPLEMENTATION:
MODULE
MIDTERM MS. MARY JOY F. LABAJO
12 Meeting
Subject Teacher MR. WILBERT A. MAÑUSCA
School Director
 Unit Intermediate Accounting 1
Module LOWER COST AND NET REALIZABLE VALUE
AE15 – IA1 Intermediate Accounting 1 Units: 3 Page |5

SUBJECT TEACHER: APPROVED FOR

12th IMPLEMENTATION:
MODULE
MIDTERM MS. MARY JOY F. LABAJO
12 Meeting
Subject Teacher MR. WILBERT A. MAÑUSCA
School Director
 Unit Intermediate Accounting 1
Module LOWER COST AND NET REALIZABLE VALUE
AE15 – IA1 Intermediate Accounting 1 Units: 3 Page |6

PAS 2,

paragraph 34, provides that the amount of any reversal of any write-down of inventory arising from
SUBJECT TEACHER: APPROVED FOR
12th IMPLEMENTATION:
MODULE
MIDTERM MS. MARY JOY F. LABAJO
12 Meeting
Subject Teacher MR. WILBERT A. MAÑUSCA
School Director
 Unit Intermediate Accounting 1
Module LOWER COST AND NET REALIZABLE VALUE
AE15 – IA1 Intermediate Accounting 1 Units: 3 Page |7

an increase in net realizable value shall be recognized as reduction in the amount of inventory
recognized as an expense in the period in which the reversal occurs.

The amount of inventory recognized as an expense of the period is actually the cost of goods sold
during the period.

SUBJECT TEACHER: APPROVED FOR

12th IMPLEMENTATION:
MODULE
MIDTERM MS. MARY JOY F. LABAJO
12 Meeting
Subject Teacher MR. WILBERT A. MAÑUSCA
School Director
 Unit Intermediate Accounting 1
Module LOWER COST AND NET REALIZABLE VALUE
AE15 – IA1 Intermediate Accounting 1 Units: 3 Page |8

Purchase commitments

Purchase commitments are obligations of the entity to acquire certain goods sometime in the future at a
fixed price and fixed quantity.

Actually, a purchase contract has already been made for future delivery of goods fixed in price and in
quantity.

Where the purchase commitments are significant or unusual, disclosure is required in the accompanying
notes to financial statements.

Any losses which are expected to arise from firm and noncancelable commitments shall recognized.

If there is a decline in purchase price after a purchase commitment has been made, a loss is recorded in
the period of the price decline.

Note that a purchase commitment must be noncancelable in order that a loss purchase commitment
can be recognized.

Thus, if at the end of the reporting period, the purchase price falls below the agreed price the difference
is accounted for as debit to loss on purchase commitments and a credit to an estimated liability.

SUBJECT TEACHER: APPROVED FOR

12th IMPLEMENTATION:
MODULE
MIDTERM MS. MARY JOY F. LABAJO
12 Meeting
Subject Teacher MR. WILBERT A. MAÑUSCA
School Director
 Unit Intermediate Accounting 1
Module LOWER COST AND NET REALIZABLE VALUE
AE15 – IA1 Intermediate Accounting 1 Units: 3 Page |9

LCNRV Adaptation

Actually, the recognition of a loss on purchase commitment is adaptation of the measurement at the
lower of cost or net realizable value.

Accordingly, if the market price rises by the time the entity makes the purchase, a gain on purchase
commitment would be recorded.

However, the amount of gain to be recognized is limited to the loss on purchase ‘commitment
previously recorded.

Thus, in the preceding illustration, if the replacement cost of the purchase commitment is P600,000
when the actual purchase is made, the journal entry to record the actual purchase is:

Purchases 500,000
Estimated liability for purchase commitment 50,000
Accounts payable 500,000
Gain on purchase commitment 50,000

The purchase is recorded at P500,000 because the purchase commitment of P500,000 is lower than the
replacement cost of 600,000.

The gain on purchase commitment is classified as other income.

If the replacement cost of the purchase commitment is P480,000 when the actual purchase is made, the
journal entry to record the actual purchase is:

Purchases 480,000
Estimated liability for purchase commitment 60,000
Accounts payable 500,000
Gain on purchase commitment 30,000

The purchase is recorded at P480,000 only because the replacement cost is lower than the purchase
commitment of P500,000.

The gain on purchase commitment is the increase in market price from P450,000 at year-end to
P480,000 on the date of actual purchase.

SUBJECT TEACHER: APPROVED FOR

12th IMPLEMENTATION:
MODULE
MIDTERM MS. MARY JOY F. LABAJO
12 Meeting
Subject Teacher MR. WILBERT A. MAÑUSCA
School Director
 Unit Intermediate Accounting 1
Module LOWER COST AND NET REALIZABLE VALUE
AE15 – IA1 Intermediate Accounting 1 Units: 3 P a g e | 10

Disclosures

With respect to inventories, the financial statements shall disclose the following:

a. The accounting policies adopted in measuring inventories including the cost for, measuring
inventories, including the cost formula used.

b. The total carrying amount of inventories and the carrying amount in classifications appropriate
to the entity.

Common classifications of inventories are merchandise, production supplies, goods in process

and finished goods.

c. The carrying amount of inventories carried at fair value less cost of disposal.

d. The amount of inventories recognized as an expense during the period.

e. The amount of any write-down of inventories recognized as an expense during the period.

f. The amount of reversal of write-down that is recognized as income.

g. The circumstances or events that led to reversal of a write-down of inventories.

h. The carrying amount of inventories pledged as security for liabilities.

Agricultural, forest and mineral Products

PAS 2, paragraph 4, provides that the inventories of agricultural, forest and mineral products are
measured at net realizable value at certain stages of production.

Accordingly, agricultural crops that have been harvested or mineral products that have been extracted
are measured at net realizable value:

a. When a sale is assured under a forward contract or government guarantee.

b. When a homogeneous market exists and there is a negligible risk of failure to sell.

SUBJECT TEACHER: APPROVED FOR

12th IMPLEMENTATION:
MODULE
MIDTERM MS. MARY JOY F. LABAJO
12 Meeting
Subject Teacher MR. WILBERT A. MAÑUSCA
School Director
 Unit Intermediate Accounting 1
Module LOWER COST AND NET REALIZABLE VALUE
AE15 – IA1 Intermediate Accounting 1 Units: 3 P a g e | 11

Commodities of broker-traders

PAS 2, paragraph 3, provides that commodities of broker-traders are measured at fair value less cost of
disposal.

PFRS 13, paragraph 9, defines fair value of an asset as the price that would be received to sell the asset
in an orderly transaction between market participants.

Broker-traders are those who buy and sell commodities for others or on their own account.

The inventories of broker-traders are principally acquired with the purpose of selling them in the near
future and generating a profit from fluctuations in price or broker-traders' margin.

References:

• Intermediate Accounting – 2020 Edition Volume 1

Author: Conrado T. Valix; Jose F. Peralta; Christian Aris M. Valix

SUBJECT TEACHER: APPROVED FOR

12th IMPLEMENTATION:
MODULE
MIDTERM MS. MARY JOY F. LABAJO
12 Meeting
Subject Teacher MR. WILBERT A. MAÑUSCA
School Director
 Unit Intermediate Accounting 1
Module LOWER COST AND NET REALIZABLE VALUE
AE15 – IA1 Intermediate Accounting 1 Units: 3 P a g e | 12

SELF-CHECK QUESTIONS PR-12.1.1

Directions:

A. Answer the following questions.

1. What is net realizable value?

2. Explain the two methods of accounting for inventory write-down.
3. What are purchase commitments?
4. Explain measurement of commodities of broker-traders.

SUBJECT TEACHER: APPROVED FOR

12th IMPLEMENTATION:
MODULE
MIDTERM MS. MARY JOY F. LABAJO
12 Meeting
Subject Teacher MR. WILBERT A. MAÑUSCA
School Director
 Unit Intermediate Accounting 1
Module LOWER COST AND NET REALIZABLE VALUE
AE15 – IA1 Intermediate Accounting 1 Units: 3 P a g e | 13

SELF-CHECK ANSWERS PR-11.11.1

Directions:

Answer the following questions.

1. What is net realizable value?

Net realizable value or NRV is the estimated selling price in the ordinary course of business
less the estimated cost of completion and the estimated cost of disposal.

2. Explain the two methods of accounting for inventory write-down.

Direct method
The inventory is recorded at the lower of cost OF net realizable value.
This method is also known as "cost of goods sold method” because any loss on inventory
write-down or gain on reversal of inventory write-down is not accounted for separately but
“buried” in the cost of goods sold.

Allowance method
The inventory is recorded at cost and any loss on inventory write-down is accounted for
separately.
This method is also known as “loss method" because a loss account “loss on inventory write-
down” is debited and a valuation account “allowance for inventory write-down" is credited.

3. What are purchase commitments?

Purchase commitments are obligations of the entity to acquire certain goods sometime in
the future at a fixed price and fixed quantity.

4. Explain measurement of commodities of broker-traders.

PAS 2, paragraph 3, provides that commodities of broker-traders are measured at fair value
less cost of
disposal.

PFRS 13, paragraph 9, defines fair value of an asset as the price that would be received to
sell the asset in an orderly transaction between market participants.

SUBJECT TEACHER: APPROVED FOR

12th IMPLEMENTATION:
MODULE
MIDTERM MS. MARY JOY F. LABAJO
12 Meeting
Subject Teacher MR. WILBERT A. MAÑUSCA
School Director
 Unit Intermediate Accounting 1
Module LOWER COST AND NET REALIZABLE VALUE
AE15 – IA1 Intermediate Accounting 1 Units: 3 P a g e | 14

STUDENT NAME: __________________________________ SECTION: __________________

PERFORMANCE TASK PR-12.7.1

PERFORMANCE TASK TITLE: : LOWER OF COST AND NET REALIZABLE VALUE

PERFORMANCE OBJECTIVE: After completing this performance task, you were being knowledgeable on
determination of lower of cost and net realizable value.
TOOLS AND MATERIALS: Modules

EQUIPMENT : none

ESTIMATED COST : none

PROCESS / PROCEDURE:

Required :
1. Tasks must be neat and presentable.
2. Show your computations and avoid erasures.

PRECAUTIONS : •Avoid copy and paste performance task of other

ASSESSMENT METHOD : Equivalent to 30points.

SUBJECT TEACHER: APPROVED FOR

12th IMPLEMENTATION:
MODULE
MIDTERM MS. MARY JOY F. LABAJO
12 Meeting
Subject Teacher MR. WILBERT A. MAÑUSCA
School Director