commission and other selling costs, such as packaging and

freight costs. In these cases, net realizable value is the

estimated final selling price of the inventory minus the

estimated costs necessary to prepare the item for sale and to

sell it. As examples, consider agricultural products and

precious metals on hand at the close of an accounting

period. Firms often state these items at net realizable value,

a farmer may find estimating a market price less selling

costs easier than measuring the historical cost of a bushel of

apples harvested from an orchard.

For example, assume that damaged merchandise

costing L.E 100 can be sold for only L.E 800, and direct

selling expenses are estimated to be L.E 150. This

inventory should be valued at L.E 650 (L. E800 - L.E 150),

which is its net realizable value.

Valuation at Lower of Cost or Market:

If the cost of replacing an item in inventory is lower

than the original purchase cost, the lower-of-cost-or-market

method is used to value the inventory. Market, as used in

Chapter Four: Inventories and the cost of goods sold

182

the phrase lower of cost or market, is the cost to replace the

merchandise on the inventory date. This market value is

based on quantities normally purchased from the usual

source of supply.
The lower-of-cost-or-market method provides two

advantages. First, the gross profit (and net income) is

reduced in the period in which the decline occurred.

Second, an approximately normal gross profit will be

realized during the period in which the item is later sold.

To illustrate, assume that merchandise with a unit

cost of L.E 70 has sold at L.E 100 during the period,

yielding a gross profit of L.E 30 a unit, or 30% of sales.

Assume also that at the end of the year, there is a single

unit in the inventory and that its replacement cost has

declined to L.E 63. In such a case, it would be expected

that the selling price would also decline, if it has not

already done so. Assuming a reduction in the selling price

to L.E 90, the gross profit based on the replacement cost of

L.E 63 would be L.E 27, which is also 30% of the selling