Should inventories be reported at their cost or at their selling prices?

Generally inventories are reported at their cost. A merchant's inventory would be reported at the merchant's cost to purchase the items. A manufacturer's inventory would be at its cost to produce the items (the cost of direct materials, direct labor, and manufacturing overhead).

However, if the net realizable value (NRV) of the inventory is less than the cost, the NRV will usually need to be reported on the balance sheet instead of the cost. Net realizable value is defined as the expected selling price in the ordinary course of business minus any costs of completion, disposal, and transportation. When the cost of the inventory is written down to its NRV, the amount of the write down is reported on the income statement. (In a few industries, such as gold mining and meatpacking, it is accepted practice to report the inventory at its net realizable value.)

Since the unit cost of items in inventory is likely to be changing (think inflation), the costs used for inventory reporting will be based on a cost flow assumption. For example, the FIFO cost flow assumption will result in the inventory being reported at the more recent costs, since the first costs are assumed to have been the first costs out of inventory. Under the LIFO cost flow assumption, the inventory will be valued at the older costs, since the more recent costs are assumed to be the first costs to flow out of inventory.

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