FAR · Select balance sheet accounts · 6 practice questions
FIFO Lower of Cost and NRV: Finished Goods and Raw Materials
FIFO and average-cost inventory use lower of cost and NRV, but raw materials stay at cost when related finished goods recover their total cost. Below: a worked raw-material calculation and free practice on finished goods and materials.
Try one first
Hint
Recall which 'lower-of' test applies to FIFO and what NRV (net realizable value) represents.
Answer A. Under US GAAP for FIFO, inventory is measured at the lower of cost and net realizable value (NRV). NRV = estimated selling price ($130) less costs to complete and sell ($20) = $110. Because NRV ($110) is lower than cost ($120), the inventory is written down to $110 per unit.
Why not B: This choice is tempting because historical cost is the item's original carrying amount, but for FIFO GAAP requires comparing cost to NRV. NRV (130 − 20 = 110) is below cost, so reporting $120 would ignore the required write-down.
Why not C: Candidates often confuse the 'market' concept (replacement cost) that is used in some LIFO/retail lower-of-cost-or-market frameworks with FIFO treatment. For FIFO the correct comparison is cost versus NRV, so replacement cost is not the applicable measure here.
Why not D: This distractor appeals because it is the gross selling price, but it ignores costs to complete and sell. NRV = 130 − 20 = 110, so the selling price alone overstates the realizable value.
Worked example
Cedar Co. uses FIFO and holds one raw-material lot costing $36,000. Replacement cost has fallen to $27,000. The finished product will cost $90,000 to produce, including these materials, and sell for $100,000. Selling costs are $15,000. The materials have no alternative use.
| 1 | Finished product NRV$100,000 - $15,000 | $85,000 |
| 2 | Finished product shortfall$90,000 - $85,000 | $5,000, so materials need a write-down |
| 3 | Raw-material carrying amountLower of $36,000 cost and $27,000 replacement cost | $27,000 |
| 4 | Raw-material write-down loss$36,000 - $27,000 | $9,000 |
Cedar reports the raw-material lot at $27,000 and recognizes a $9,000 write-down loss.
Check: The finished product's $5,000 shortfall triggers the write-down; the raw-material loss is $36,000 - $27,000 = $9,000.
Key points
- At the stated testing level, compare cost with NRV before adding amounts. Item-level testing prevents offsetting losses with other items' gains.
- Damage and obsolescence require the same cost-versus-NRV test; include necessary repair and disposal costs.
- Do not subtract a normal profit margin when computing NRV for FIFO or average-cost inventory.
How the exam traps you
- Using replacement cost for finished goods under FIFO. Compare finished goods' cost with NRV, not replacement cost.
- Ignoring completion, repair, or disposal costs. Subtract necessary completion and selling costs from expected selling price.
- Writing down raw materials solely because replacement cost fell. First test the related finished product: no raw-material write-down if its NRV equals or exceeds total cost.
Question 2
| # | Item | Cost | Est. Selling Price | Costs to Dispose |
|---|---|---|---|---|
| 1 | Finished good A | $180 | $172 | $7 |
| # | Raw Material | Cost | Replacement Cost | Used In | Product Total Cost | Product Selling Price | Product Costs to Complete & Dispose |
|---|---|---|---|---|---|---|---|
| 2 | Material B | $60 | $48 | Product B-F | $130 | $136 | $4 |
| 3 | Material C (no alternative use; decline not temporary) | $50 | $37 | Product C-F | $120 | $111 | $3 |
Hint
Separate the finished good from the raw materials. For raw materials, first determine whether the related finished goods are expected to be sold at or above cost.
Answer B. Finished good A is written down from cost of $180 to NRV of $165 ($172 - $7), producing a $15 loss. Raw material B is not written down because the related finished product's NRV is $132 ($136 - $4), which exceeds its total cost of $130. Raw material C must be written down because the related finished product would be sold below cost; C is written down from $50 to replacement cost of $37, producing a $13 loss. Total write-down loss = $15 + $13 = $28.
Why not A: This answer reflects writing down only finished good A to NRV and ignoring the raw-material exception. It overlooks that raw material C must be written down because its related finished product would be sold below cost and C has no alternative use.
Why not C: This usually results from correctly writing down A by $15 and recognizing C needs a write-down, but measuring C's loss incorrectly (for example, using the finished-good shortfall rather than the raw material's replacement-cost decline). The correct write-down for C is $50 − $37 = $13, not $12.
Why not D: This is a result of writing down any raw material whose replacement cost is below cost without considering whether the related finished goods will be sold at or above cost. Raw material B does not require a write-down because B-F's NRV exceeds its total cost.
Question 3
Hint
Under FIFO, focus on the lower of cost and net realizable value. Be careful about what amount the completion and disposal costs reduce.
Answer B. Under U.S. GAAP (for FIFO inventory), inventory is measured at the lower of cost and net realizable value (NRV). NRV = estimated selling price ($80,000) less costs to complete and dispose ($6,000) = $74,000. Because NRV ($74,000) is below cost ($84,000), Alder should write the inventory down to $74,000 and recognize a $10,000 loss in 20X5.
Why not A: This is tempting because candidates often equate losses with realized sales. However, GAAP requires inventory to be written down in the period the decline in recoverable amount (NRV) occurs; no sale is required.
Why not C: This distractor uses the gross selling price as the comparison amount and ignores costs to complete and dispose. NRV is the selling price less those costs, so NRV is $74,000, not $80,000.
Why not D: This option reflects misapplication of the costs (e.g., subtracting them from cost). The completion and disposal costs reduce the amount realized from sale (the selling price), so they must be deducted from the $80,000 selling price to compute NRV.
Question 4
Hint
For FIFO inventory, compare cost with net realizable value, and be careful to include all expected completion and selling costs in NRV.
Answer C. Under U.S. GAAP, inventory is reported at the lower of cost or net realizable value (NRV). NRV = estimated selling price minus costs of completion and costs to sell = $500,000 - $70,000 - $40,000 = $390,000. Since NRV ($390,000) is less than cost ($420,000), Pine should report the inventory at $390,000.
Why not A: This equals $500,000 - $70,000 (completion only). It's tempting if a candidate subtracts completion costs but forgets to subtract selling/disposal costs; NRV requires both reductions.
Why not B: This is historical cost. It is tempting because candidates often default to cost, but when NRV is lower than cost the inventory must be written down to NRV.
Why not D: This equals $500,000 - $40,000 (selling costs only). It's tempting if a candidate subtracts selling costs but omits completion costs; both must be subtracted to compute NRV.
Question 5
Hint
First determine which lower-of-cost test applies to the stated cost flow method (FIFO vs LIFO/retail), then compare cost to the appropriate lower value and compute the write-down.
Answer D. Under US GAAP for inventories measured using FIFO (or average cost), inventory is valued at the lower of cost and net realizable value (LCNRV). Cost ($240,000) exceeds NRV ($210,000), so inventory must be written down immediately by $30,000 (240,000 − 210,000) with a loss recognized. The replacement-cost (LCM) approach with ceiling/floor limits applies to LIFO and the retail method, not to FIFO.
Why not A: Deferring recognition is incorrect: GAAP requires an immediate write-down of inventory to NRV when NRV is below cost. Using an allowance and delaying recognition would overstate inventory and improperly postpone the loss.
Why not B: This is tempting because replacement cost is the lowest single figure, but the LCM replacement-cost test (with ceiling/floor limits) applies only to LIFO and the retail method. For FIFO the comparison is cost versus NRV, so inventory is written down to NRV ($210,000), not replacement cost.
Why not C: This distractor confuses the LCM ceiling/floor mechanics with LCNRV. The floor concept is part of the LCM replacement-cost test for LIFO/retail, not the LCNRV comparison used for FIFO; since NRV ($210,000) is below cost, a write-down is required.
Question 6
Hint
Identify which measurement rule applies to finished goods versus raw materials, and then consider whether a prior inventory write-down can ever be increased later under U.S. GAAP.
Answer C. Alpha is finished goods under FIFO and is measured at the lower of cost and NRV: NRV = $392,000 − $8,000 = $384,000, so write down from $400,000 to $384,000. Beta is a raw material that will be incorporated into finished goods expected to sell above total cost (selling price $500,000 vs total production and selling costs $470,000), so the component's NRV in effect exceeds its cost and Beta remains at cost ($150,000). Gamma remains at its post‑write‑down carrying amount of $70,000 because U.S. GAAP does not permit reversing an inventory write‑down when NRV later recovers.
Why not A: Tempting because it applies a 'lower value' instinct to all items. It's wrong: Beta should not be written down here because the finished goods that will include Beta are expected to sell above total cost, and prior inventory write‑downs (Gamma) are not reversed under U.S. GAAP.
Why not B: This distractor incorrectly nets results across the inventory portfolio. The stem states item‑by‑item valuation is practicable, so Alpha must be compared separately to its NRV; also Gamma cannot be written back up above its written‑down basis.
Why not D: This misapplies the older lower‑of‑cost‑or‑market intuition by using replacement cost ($390,000) instead of NRV. For FIFO, finished goods are compared to NRV ($392,000 − $8,000 = $384,000), and Gamma still cannot be reversed upward.
Common questions
How do you calculate lower of cost and NRV for FIFO inventory?
NRV equals expected selling price minus costs to complete and sell. Report the lower of that amount and historical cost.
What does item-by-item lower of cost and NRV mean?
Compare cost with NRV separately for each item, then add the carrying amounts. Do not offset one item's write-down with another item's excess NRV.
When are raw materials written down to replacement cost?
If the related finished product's NRV is below its total cost and replacement cost has fallen, write down the materials to replacement cost. If the finished product's NRV equals or exceeds total cost, keep the materials at cost.
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