Net realizable value write-downs

Carrying inventory above what it can realistically be sold for overstates both assets and profit, and reverses into a sudden, often large write-off later - a red flag for auditors, lenders and investors. Perishable food products, expiry dating and fast-moving packaging/SKU changes make this a recurring, material issue for regional manufacturers, directly affecting reported gross margin, loan covenant ratios based on inventory/working capital, and taxable income, so a disciplined SKU-level NRV process is essential to avoid both overstatement (misleading stakeholders) and excessive, poorly evidenced provisioning (understating profit).

Is NRV tested item by item (or by similar SKU group) rather than as a blanket provision? What objective evidence (post-year-end sales, discount agreements, aging by SKU) supports the estimated selling price for near-expiry or slow-moving stock? Has a write-down already occurred that needs re-testing this period?

1. Segment inventory into individual items or groups of similar/related items (e.g. by SKU or product line); do not apply a single blanket provision across dissimilar categories such as raw materials versus finished goods.
2. For each item/group, estimate the net realizable value (NRV): estimated selling price in the ordinary course of business, less estimated costs to complete and estimated costs necessary to make the sale.
3. Compare NRV to carrying cost item by item; where NRV is lower, write the item down to NRV and recognize the write-down as an expense (typically within cost of sales) in the period it occurs.
4. For raw materials and other production inputs, do not write down below cost if the finished products they will be used in are still expected to sell at or above cost; if the finished product is itself impaired, the raw material's replacement cost is often the best evidence of NRV decline.
5. At each subsequent reporting date, reassess NRV; if circumstances that previously caused the write-down no longer exist or there is clear evidence of an increase in NRV, reverse the write-down (limited to the amount of the original write-down, i.e. new carrying amount cannot exceed original cost).
6. Recognize the reversal as a reduction in the inventory expense (cost of sales) of the period in which the reversal occurs.
7. Maintain aging/expiry analysis by SKU as the evidentiary basis for both the write-down and any later reversal - do not rely on informal judgment alone.

Measurement basis: inventories are carried at the lower of cost and net realizable value, assessed item by item (or by group of similar items) at each reporting date. NRV = estimated selling price in the ordinary course of business, less estimated costs of completion (for WIP) and estimated costs necessary to make the sale (freight-out, commissions, discounts). Included in the NRV test: all inventory categories - raw materials, WIP and finished goods - but raw materials are only written down if the finished product they go into is itself expected to sell below cost; replacement cost of raw materials is often the best available evidence of an NRV decline. Re-measurement trigger: reassess NRV at every subsequent reporting date; a write-down is reversed (not to exceed original cost) when the circumstances that caused it no longer exist or there is clear new evidence of increased NRV - this is not optional and must be tested each period, not left as a one-off adjustment.

Disclose: the amount of any write-down of inventories recognized as an expense in the period; the amount of any reversal of a previous write-down and the event/circumstance that led to the reversal; the accounting policy for determining NRV and the basis of any provisioning methodology (item-by-item vs grouped); the total carrying amount of inventories carried at NRV (i.e. below original cost) at period end; circumstances or events that led to the reversal of a write-down, per the standard's specific disclosure requirement.

• Applying a blanket percentage provision (e.g. '
• write down all stock over 90 days by 20%'
• ) without genuine SKU-level aging or clearance-price evidence
• writing down raw materials automatically when finished-product prices dip slightly, ignoring that the finished product may still sell above total cost
• never reversing write-downs when clearance prices recover, leaving inventory permanently understated
• omitting costs to complete and costs to sell from the NRV calculation, understating the write-down for WIP
• using year-end spot selling prices instead of realistic, evidence-based expected selling prices (e.g. ignoring that near-expiry stock will only move through discount channels).