FAR · Select balance sheet accounts · 11 practice questions
Inventory Write-Downs: Reversals and Subsequent Events
For FIFO inventory, record year-end declines below cost in income, never reverse a write-down, and adjust for later evidence only when the condition existed at year-end. Below, compare the same lot with only NRV or timing changed.
Try one first
Hint
First determine the measurement basis for FIFO inventory (lower of cost and NRV) and then decide whether U.S. GAAP permits reversing a previous inventory write-down.
Answer C. Under U.S. GAAP, inventories are measured at the lower of cost and net realizable value when applicable, and a write-down recorded in a prior period is not reversed if NRV later recovers. Toga's inventory was written down from $500 to $420 in Year 1, so the carrying amount remains $420 at December 31, Year 2 and no gain is recognized. (IFRS, by contrast, permits reversal up to original cost.)
Why not A: Candidates may think that because NRV now exceeds cost the inventory should be written up to $550. That is incorrect: inventories are not carried above original cost, and U.S. GAAP also prohibits reversing a prior write-down to report inventory at a higher NRV.
Why not B: This is tempting because IFRS allows reversing a prior inventory write-down up to the original cost, which would restore the carrying amount to $500. It is incorrect under U.S. GAAP because GAAP does not permit reversing inventory write-downs when NRV later increases.
Why not D: This appeals to those who treat the Year 1 write-down as an error requiring a prior-period correction. However, the Year 1 write-down was a proper valuation adjustment based on conditions then and is not an error; therefore it is not corrected as a prior-period adjustment, and no recovery is recognized under U.S. GAAP.
Same scenario, one fact changes
Base case
Toga uses FIFO. An unsold inventory lot costs $500. Its NRV is $550 before a market change in December, Year 1 and $420 afterward. Toga learns of the change immediately. NRV stays unchanged through January 25, Year 2, before Year 1 statements are issued. What inventory amount and loss should Toga report for Year 1?
Answer: Report inventory at $420 and recognize an $80 Year 1 loss.
The decline existed at year-end. NRV of $420 is below cost of $500, so the $80 difference reduces inventory and current-period income.
Before you open each one, predict the answer.
Change 1NRV after the market change is $550 instead of $420.
Answer: Report inventory at $500. Recognize no Year 1 write-down or gain.
Cost of $500 is below NRV of $550. Lower of cost and NRV does not permit a write-up above cost.
Change 2NRV recovers to $550 on January 25, Year 2, instead of staying at $420.
Answer: Report $420 inventory and an $80 Year 1 loss. No recovery gain is allowed. Disclose the recovery if material.
The recovery changes nothing: it arose after year-end, and U.S. GAAP does not reverse the write-down.
Change 3The market change occurs January 10, Year 2, instead of December, Year 1.
Answer: Report inventory at $500 with no Year 1 loss. Disclose the January decline if material.
Year-end NRV was $550. The new January condition is a nonrecognized subsequent event for Year 1.
Change 4Toga discovers the December decline on January 25, Year 2, rather than immediately.
Answer: Report $420 inventory and an $80 Year 1 loss. Adjust Year 1 before issuance.
Learning later changes nothing: the January evidence confirms a December condition, so the loss belongs in Year 1.
Key points
- Remember: The condition's date controls the loss; the discovery date does not, and later recovery never reverses it.
- NRV equals estimated selling price less reasonably predictable completion, disposal, and transportation costs.
- A write-down lowers inventory, net income, retained earnings, and the current ratio, ignoring income taxes.
- New post-year-end conditions do not adjust year-end balances; disclose their nature and estimated financial effect if material.
How the exam traps you
- Restoring inventory to original cost when NRV recovers. U.S. GAAP prohibits reversing the write-down through income, retained earnings, or OCI.
- Using every price change before issuance to adjust year-end inventory. Ask when the underlying condition arose, not when management learned about it.
- Waiting until the inventory is sold to recognize the loss. Recognize the write-down in current-period income when year-end NRV is below cost.
Now the same facts as questions
Each question changes one fact from the one before. Watch which change flips the answer.
Question 1
Answer B. Year-end NRV is $80 below cost, requiring inventory of $420 and a current-period loss.
Why not A: The write-down is required at year-end, even though the lot remains unsold.
Why not C: The loss goes through current-period income, not directly to retained earnings.
Why not D: Inventory cannot be written above cost; year-end NRV is also only $420.
Question 2
Answer C. Cost of $500 is lower than NRV of $550.
Why not A: NRV above cost does not permit an inventory write-up or gain.
Why not B: NRV is now $550, so the $80 write-down is not required.
Why not D: Inventory cannot exceed cost merely because no gain is recognized.
Question 3
Answer A. The post-year-end recovery does not change Year 1 measurement, and U.S. GAAP prohibits reversal.
Why not B: The write-down cannot be reversed, even up to original cost.
Why not C: U.S. GAAP prohibits reversing the write-down or carrying inventory above original cost.
Why not D: A later recovery is not an error correction or a direct retained earnings adjustment.
Question 4
Answer D. Year-end NRV is $550; the new January decline is nonrecognized for Year 1.
Why not A: The January decline does not reflect a condition existing on December 31.
Why not B: Material nonrecognized subsequent events still require disclosure.
Why not C: Year-end NRV above cost does not permit a write-up.
Question 5
Answer B. January evidence confirms year-end NRV of $420, requiring an $80 Year 1 loss.
Why not A: The condition existed in December, regardless of when Toga discovered it.
Why not C: Disclosure alone cannot replace recognition of a year-end decline.
Why not D: The loss goes through current-period income, not directly to retained earnings.
Question 2
Hint
Decide where inventory write-downs and any recoveries are reported under U.S. GAAP and whether GAAP allows reversing a prior write-down when NRV rises.
Answer A. ASC 330 requires write-downs of inventory to be charged to earnings when recognized, reducing the carrying amount and retained earnings. U.S. GAAP does not permit reversing a previously recognized inventory write-down when NRV later recovers, so the lot remains at the written-down $350 and the Year 2 loss stays reflected in retained earnings.
Why not B: This answer is attractive because IFRS allows reversing a prior inventory write-down up to original cost; candidates who conflate IFRS with U.S. GAAP may choose it. It is incorrect under U.S. GAAP (ASC 330), which generally forbids reversing inventory write-downs.
Why not C: This choice appeals to those who mistake the write-down for an accounting error or think a prior-period adjustment can restore retained earnings. A write-down to NRV is a period-of-change valuation adjustment, not an error; you cannot reinstate retained earnings in Year 3 as a prior-period correction under ASC 330.
Why not D: This distractor tempts candidates who confuse where valuation changes are reported. Inventory valuation changes (and any reversals where allowed) affect profit or loss, not OCI, and in any case U.S. GAAP does not permit reversing an inventory write-down into OCI.
Question 3
Hint
Consider (1) how an inventory write-down affects current assets and equity when the loss is recorded (ignore taxes), and (2) whether US GAAP allows reversing an inventory write-down if NRV later increases.
Answer D. The Year 2 write-down reduces the carrying amount of inventory (a current asset) and is recorded as a loss, which lowers net income and retained earnings; therefore the current ratio falls. Under US GAAP (ASC 330), reversals of inventory write-downs when NRV later increases are not permitted, so the later NRV recovery does not increase inventory, retained earnings, or the current ratio.
Why not A: This is tempting because IFRS (IAS 2) allows reversing an inventory write-down when NRV recovers, which would restore inventory and increase income/retained earnings. It is incorrect for a US GAAP question: GAAP does not permit reversals of inventory write-downs.
Why not B: This option is misleading about mechanics: if reversals were permitted (per IFRS) they would flow through income (affecting retained earnings), not be booked solely to inventory. Under US GAAP, reversals are not permitted at all.
Why not C: Some may think the write-down only affects equity, but the carrying amount of inventory (a current asset) is reduced and the loss reduces net income and retained earnings, so the current ratio falls. Also, under US GAAP a later NRV increase does not reverse the prior write-down.
Question 4
Hint
Decide whether the post‑year‑end change provides evidence about conditions existing at the balance sheet date and remember U.S. GAAP's rule on reversing inventory write‑downs.
Answer B. Under U.S. GAAP, inventory write‑downs to NRV are not reversed in a subsequent reporting period. The market recovery here followed a new development after the balance sheet date, so it is a nonadjusting subsequent event; Vireo should therefore report the inventory at $900 on the Year 1 statements and, if the effect is material, disclose the nature and estimated effect of the favorable event.
Why not A: This is tempting because the price rose before issuance, but GAAP does not permit reversing an inventory write‑down to recognize a gain in the period just issued; the recovery is a nonadjusting event and should be disclosed if material rather than used to increase Year 1 carrying amounts.
Why not C: While gains are generally recognized when realized, U.S. GAAP still prohibits reversing prior inventory write‑downs in a later period; any benefit from higher prices will be reflected when the inventory is sold, not by recording a reversal gain in Year 2.
Why not D: A prior‑period restatement corrects an error or applies a retrospective accounting change; a post‑balance‑sheet market recovery is not an error and does not justify a restatement.
Question 5
Hint
First compute NRV at the balance sheet date and compare to cost; then decide whether the Jan price drop is an adjusting event for Dec 31 or a nonrecognized subsequent event requiring disclosure.
Answer A. At December 31 NRV = $80 - $30 = $50, which exceeds cost ($48), so no write-down was required at the balance sheet date. The competitor's launch (and the resulting lower selling price) occurred after the reporting date and therefore is a nonrecognized subsequent event; under U.S. GAAP it should not change the recorded Dec 31 inventory amounts but should be disclosed in the notes if material.
Why not B: This is tempting because the post‑balance‑sheet selling price (Jan) implies a lower NRV, but adjusting entries are required only when events provide evidence of conditions that existed at the balance sheet date. The competitor's launch occurred after Dec 31 and does not change the Dec 31 measurement.
Why not C: While the decline is a post‑balance‑sheet event and does not change the carrying amount, materially significant nonrecognized subsequent events must still be disclosed (nature and estimated effect). Omitting disclosure when material is incorrect.
Why not D: Inventory valuation changes (when recognized) affect profit or loss, not OCI. In addition, this decline is a nonrecognized subsequent event and therefore should be disclosed rather than recorded in Year 1 equity.
Question 6
Hint
Decide which lower-of-cost test applies to FIFO and check whether NRV was below cost at the balance sheet date.
Answer B. Under ASC 330, inventories measured under FIFO are reported at the lower of cost and net realizable value. At December 31, NRV ($420,000) is below cost ($500,000), so Company R must write the inventory down by $500,000 − $420,000 = $80,000 and recognize that loss in Year 2's income statement. The subsequent sale in January does not change the requirement to recognize the valuation loss in the period the decline occurred.
Why not A: Tempting because some think inventory losses are 'realized' only on sale, so they would defer recognition. It's wrong because GAAP requires recognition of a decline to NRV at the reporting date; deferring to the sale would omit the loss from the period when the decline was present (Year 2).
Why not C: Tempting because candidates may think only permanent declines should be written down and temporary dips disclosed. It's wrong because the lower-of-cost-and-NRV test requires a write-down whenever NRV is below cost at the balance sheet date, regardless of management's expectation of future recovery.
Why not D: Tempting if one confuses valuation adjustments with prior-period error corrections or equity-only adjustments. It's wrong because routine inventory write-downs are recognized as losses in the income statement in the period of the decline, not charged directly to retained earnings.
Common questions
Can inventory write-downs be reversed under U.S. GAAP?
No. A valid write-down establishes a new cost basis, so a later NRV increase creates no gain or increase in retained earnings.
Does a price drop after year-end require an inventory write-down?
Adjust year-end inventory if the later information confirms a condition that existed at year-end. A decline caused by a new post-year-end event is nonrecognized for the prior year and requires disclosure if material.
When do you record an inventory write-down under FIFO?
At the balance sheet date, compare cost with NRV. If NRV is lower, reduce inventory and recognize the difference in current-period income, even if the items remain unsold.
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