Cost is the amount you paid to the supplier when you purchased the inventory. Suppose you paid $500 to purchase some inventory, this is the cost of the inventory.
Net realisable Value is the value that you’d get for the inventory when you sell it in the market. You have to incur some selling charges for selling the inventory or making that inventory saleable and those charges shall be deducted from the sales price. Suppose you can sell your inventory for $700 and the expenses you have to incur are $30, so net net you get $670 for the inventory.
Now as per IFRS you have to report the lower of cost or the NRV in the balance sheet and if the CARRYING VALUE (BALANCE SHEET VALUE) is greater than the NRV, you write down the inventory to make it equal to the NRV and a loss is recognised in the Income statement.
Under US GAAP, the cost is the same as it is under IFRS. The difference comes when they talk about the Market or Replacement cost. Market is generally equal to the replacement cost but there’s a criteria to measure the replacement cost. Also
Try it this way. Draw a vertical line on a paper and mark the replacement cost in the middile of that line. Now on the upper part of that line mark NRV and on the lower part mark NRV-Normal profit margin. This will help you remember that the Replacement cost CANNOT EXCEED the NRV, i.e now the replacement cost (OR MARKET) is equal to the NRV if it exceeds the marked NRV and the Replacement cost CANNOT BE LESS than NRV-Normal profit Margin, so when comapring these two, the Replacement cost will be NRV-Normal profit margin if it is below NRV-Normal Profit margin. You will see that the range lies between NRV and NRV-Normal profit Margin.
Hope this makes sense. It will be clearer if you do some numericals on this.
NRV is, as you say, pretty straightforward: the price at which you can sell the inventory, less any costs incurred (either selling costs, or costs to get the inventory ready to sell).
Market is also pretty straightforward: replacement cost, presumably a wholesale price, not the retail price at which you can sell the inventory.
The complication in US GAAP (have you noticed that US GAAP likes to complicate things a lot more than IFRS does?) is that there are limits: you use replacement cost generally, but it cannot be higher than NRV and it cannot be lower than NRV less a normal profit margin. However, there’s an easy way to make sure that you choose the correct value for US GAAP: list those three numbers – replacement cost, NRV, NRV less a normal profit – from smallest to largest, then pick the middle number; it’s always the correct one.
Here’s an example:
Original cost: $100
Replacement cost: $70
Selling price: $90
Selling costs: $5
Normal profit: $10
So, NRV = $90 – $5 = $85. Under IFRS, you’d write the inventory down to $85.
NRV less a normal profit is $85 – $10 = $75. Under US GAAP, market = replacement cost = $70, but you cannot use a number higher than NRV ($85), nor a number less than NRV less a normal profit ($75), so you write the inventory down to $75. If you list replacement cost, NRV, and NRV less a normal profit, from smallest to largest, you get:
$70, $75, $85
Choosing the middle one gives you $75, as required.
Here’s an illustration about the difference between COST and MARKET:
Let’s say that it is October 2004, and the Yankees are playing the Red Sox in the ALCS. The Yankees have a 3-0 lead in the series.
Let’s also say that you are a maker of baseball caps. You make 100,000 hats (at a cost to you of $5 each) that say “NY Yankees–2004 ALCS Champions!!!” This inventory has a COST of $500,000.
Four days later, the Yankees blow a three game lead and lose the ALCS 4-3. How much is your inventory worth now? That is, what is the MARKET value of the inventory?
Whatever NRV is, they’ll give it to you (or give you the selling price and cost of sales so you can calculate it). It’s probably not zero, so “market” is not zero; it’ll likely be NRV (because that’s likely less that $500,000).
As far as I know, they’ll give you the normal profit amount.
