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Inventory is normally recorded at cost. Sometimes, however, it loses value. It may become obsolete, or see an increase in competitive offerings, or may enjoy less demand in the marketplace.
When the value of inventory goes down, the value on its owners books also has to go down.
The lower of cost or net realizable value is one such method. Do note, however it cannot be used for LIFO or retail inventory method systems.
The net realizable value is the expected selling price minus the costs to complete the sale (such as sales commissions).
There are two methods for recording a writedown via journal entries:
- COGS method - "Hides" the loss as part of cost of goods sold, obscuring what happened.
- Loss method - "Shows" the loss as its own line item, clarifying what happened.