Recording Inventory on the Balance sheet under GAAP

[Alpha07]

Hi all,
I’m struggling to understand how inventory is valued on the balance sheet under GAAP. IFRS is simple enough as it’s just the lower of cost or net realizable value. GAAP though is more complex so can anyone try and explain it to me in laymens terms?
The quote from the schweser notes below…
“Under U.S. GAAP, inventory is reported on the balance sheet at the lower of cost or market. Market is usually equal to replacement cost, but cannot be greater than net realizable value (NRV) or less than NRV minus a normal profit margin. If replacement cost exceeds NRV, then market is NRV. If replacement cost is less than NRV minus a normal profit margin, then market is NRV minus a normal profit margin.”
First off what is the difference between cost and replacement cost? Secondly, if inventory is reported conservatively at the lowest value, then shouldn’t it just be the lower of cost or (NRV - profit margin)? Why is this ceiling/floor calculation neccessary?
Thanks in advance for any help on this

 

[Tartaglia]

There was a similar post just a couple days ago. Maybe that will answer your question:
http://www.analystforum.com/forums/cfa-forums/cfa-level-i-forum/91348503
Let us know us know if it doesn’t help.

 

[Flashback]

Alpha07 wrote:
First off what is the difference between cost and replacement cost?

Cost = historical cost of purchase of inventory
Replacement cost = cost of new inventory under current market price (assuming inflation it may be higher for certain but not for all kind of inventory)

Alpha07 wrote:
Secondly, if inventory is reported conservatively at the lowest value, then shouldn’t it just be the lower of cost or (NRV - profit margin)? Why is this ceiling/floor calculation neccessary?
Thanks in advance for any help on this

USGAAP unlike IFRS has “cap” and “floor” for determinig inventory price. Thus, price correction should be taken if market cost is lower than carrying cost (book value). Inventory will be corrected at middle value between “cap” and “floor” and those are replacement cost, NRV and (NRV - NPM). Target always the middle value of those 3.
Furthermore, unless at specific sectors (ex. commodities exploatation), USGAAP as well as IFRS does not permit correction inventory price to higher value of purchasing (historical) price. IFRS does permit reversal positive correction but within limit to historical purchasing value. USGAAP does not permit any inventory reversals.