Adjusting Journal Entries for Net Realizable Value

Learning Outcomes

  • Create journal entries to adjust inventory to NRV

Let’s recap the effect of the different methods of applying COGS, gross profit, and ultimately, net income, assuming that total selling, general, and administrative expenses of Geyer Co. are $735,000.

Geyer, Co.
Income statements
For the year ended December 31, 20XX
Description by total by individual item by class
Beginning Inventory $              0 $             0 $              0
Net purchases and freight in 1,522,453 1,522,453 1,522,453
Ending Inventory, LCNRV (238,687) (186,872) (227,952)
Cost of good sold Single Line$1,741,663Double Line Single Line$1,793,478Double Line Single Line$1,752,398Double Line
Net sales $2,548,959 $2,548,959 $2,548,959
Cost of goods sold 1,741,663 1,793,478 1,752,398
Gross Profit Single Line807,296 Single Line755,481 Single Line796,561
Operating Expenses 735,000 735,000 735,000
Net income Single Line$72,296Double Line Single Line$20,481Double Line Single Line$61,561Double Line

 

Applying LCNRV to total inventory gave us a NRV of $274,610 (see Inventory List in prior reading) which was higher than total cost, so there would be no adjustment necessary. We just left each inventory item listed at cost, even though some of the items had an NRV less than cost (first column).

However, when we applied the LCNRV rule to each individual item, we found that we had to adjust some inventory downward, such as the Rel 5 HQ Speakers that are listed at FIFO at $110 each, but only have an NRV of $50 each. Overall, we calculated that the NRV of inventory assessing each item individually was only $186,872. Recognizing that loss in the year incurred (rather than waiting for them to sell, if ever) brought gross profit down from $807,296 to $755,481, and of course that reduced net income by the same amount (second column).

Assessing LCNRV by class also reduced ending inventory, which reduced gross profit and net income (third column).

If the amount of a write-down caused by the LCNRV analysis is minor, we could charge the expense to the COGS. If the loss is material, then we might want to track it in a separate account (especially if such losses are recurring), such as “Loss on LCNRV adjustment.”

In addition, instead of adjusting the merchandise inventory account, which would involve adjusting the cost of each individual item in the subsidiary ledger, you may want to post the adjustment to a contra-asset account called something like “Allowance to Reduce Inventory to NRV.”

So, we end up with four possible combinations (using the “by item” analysis):

  1. Post the adjustment to inventory and COGS.
  2. Post the adjustment to inventory and a loss account.
  3. Post the adjustment to a contra-asset account and COGS.
  4. Post the adjustment to a contra-asset account and a loss account.

Step 1

Post the adjustment to inventory and COGS.

JournalPage 101
Date Description Post. Ref. Debit Credit
20–
Dec 31 COGS 51,815.00
Dec 31       Merchandise Inventory 51,815.00
Dec 31 To adjust year end inventory to net realizable value

Which results in the following:

Selected accounts related to COGS

Two T accounts side by side. On the left is an intentory chart. On the debit side, there is an unadjusted balance (FIFO) entry of 238,687 dollars. There is a credit entry of 51,815 dollars. There is a debit total of 186,862 dollars. On the right side is an allowance chart. This T account does not have any entries.

Two T accounts side by side. On the left is a cost of goods sold chart. On the debit side, there is an unadjusted balance (FIFO) entry of 1,741,663 dollars. There is a debit entry of 51,815 dollars. There is a debit total of 1,793,478 dollars. On the right side is a loss of NRV chart. This T account does not have any entries.

Step 2

Post the adjustment to inventory and a loss account.

JournalPage 101
Date Description Post. Ref. Debit Credit
20–
Dec 31 Loss on LCNRV Adjustment 51,815.00
Dec 31       Merchandise Inventory 51,815.00
Dec 31 To adjust year end inventory to NRV
Selected accounts related to cost of goods sold

Two T accounts side by side. On the left is an intentory chart. On the debit side, there is an unadjusted balance (FIFO) entry of 238,687 dollars. There is a credit entry of 51,815 dollars. There is a debit total of 186,862 dollars. On the right side is an allowance chart. This T account does not have any entries.

Two T accounts side by side. On the left is a cost of goods sold chart. On the debit side, there is an unadjusted balance (FIFO) entry of 1,741,663 dollars. There is a debit total of 1,741,663 dollars. On the right side is a loss of NRV chart. There is a debit entry of 51,815 dollars. There is a debit total of 51,815 dollars.

Step 3

Post the adjustment to a contra-asset account and COGS.

JournalPage 101
Date Description Post. Ref. Debit Credit
20–
Dec 31 COGS 51,815.00
Dec 31       Allowance to Reduce Inventory to NRV 51,815.00
Dec 31 To adjust year end inventory to NRV
Selected accounts related to COGS

Two T accounts side by side. On the left is an intentory chart. On the debit side, there is an unadjusted balance (FIFO) entry of 238,687 dollars.There is a debit total of 238,687 dollars. On the right side is an allowance chart. There is a credit entry of 51,815 dollars. There is a credit total of 51,815 dollars.

Two T accounts side by side. On the left is a cost of goods sold chart. On the debit side, there is an unadjusted balance (FIFO) entry of 1,741,663 dollars. There is a debit entry of 51,815 dollars. There is a debit total of 1,793,478 dollars. On the right side is a loss of NRV chart. This T account does not have any entries.

Step 4

Post the adjustment to a contra-asset account and a loss account.

JournalPage 101
Date Description Post. Ref. Debit Credit
20–
Dec 31 Loss on LCNRV Adjustment 51,815.00
Dec 31       Allowance to Reduce Inventory to NRV 51,815.00
Dec 31 To adjust year end inventory to NRV
Selected accounts related to COGS

Two T accounts side by side. On the left is an intentory chart. On the debit side, there is an unadjusted balance (FIFO) entry of 238,687 dollars.There is a debit total of 238,687 dollars. On the right side is an allowance chart. There is a credit entry of 51,815 dollars. There is a credit total of 51,815 dollars.

Two T accounts side by side. On the left is a cost of goods sold chart. On the debit side, there is an unadjusted balance (FIFO) entry of 1,741,663 dollars. There is a debit total of 1,741,663 dollars. On the right side is a loss of NRV chart. There is a debit entry of 51,815 dollars. There is a debit total of 51,815 dollars.

All of these methods of recording the adjustment are acceptable. It just depends on how you want to capture the data for your own internal and external reporting purposes.

For instance, Dynatronics Corporation shows on the balance sheet a line item called, “Inventories, net” and provides details in a footnote:

Note 3. Inventories

Inventories consist of the following as of June 30:

Inventories, net
2019 2018
Raw materials $5,830,140 $6,216,150
Work in process 706,128 625,830
Finished goods 5,129,806 4,604,264
Inventory Reserve (138,553) (458,389)
Single Line$11,527,521Double Line Single Line$10,987,855Double Line

Included in cost of goods sold for the years ended June 30, 2019, and 2018, are inventory write-offs of $0 and $692,000, respectively. The write-offs reflect inventories related to discontinued product lines, excess repair parts, product rejected for quality standards, and other non-performing inventories.

The company reports COGS (cost of sales) as a single line item, but may be posting inventory write-downs to a separate expense line item in order to capture the data for the note, and also includes this statement in its Summary of Significant Accounting Principles:

Inventories

Finished goods inventories are stated at the lower of standard cost, which approximates actual cost using the first-in, first-out method, or net realizable value. Raw materials are stated at the lower of cost (first-in, first-out method) or net realizable value. The Company periodically reviews the value of items in inventory and records write-downs or write-offs based on its assessment of slow moving or obsolete inventory. The Company maintains a reserve for obsolete inventory and generally makes inventory value adjustments against the reserve.

Next, we’ll look at how inventory is presented on the financial statements, along with disclosures and an analysis of what happens when inventory is under or overstated.

Practice Question