CFA Level I Exam · Analysis of Inventories

Inventory Cost Measurement and Valuation for CFA Level 1

Updated 7 October 2026 · Fact-checked

Inventory is recorded at cost: purchase costs, conversion costs and other costs of bringing it to its present location and condition. It is then carried at the lower of cost and net realisable value (NRV). To solve questions, build cost, compute NRV, compare them, and apply the IFRS or US GAAP reversal rule.

Understand Inventory Cost Measurement and Valuation

Inventory is a current asset held for sale, in production for sale, or to be used in making goods. How you measure it affects both the balance sheet (inventory) and the income statement (cost of goods sold, or COGS).

Start with cost. Under IFRS (IAS 2) cost has three parts. Purchase costs are the purchase price, import duties, non-recoverable taxes, transport and handling, less trade discounts and rebates. Conversion costs are direct labour plus a systematic share of production overhead. Other costs are those needed to bring the inventory to its present location and condition. US GAAP follows the same broad idea.

Some costs are never part of inventory. They are expensed when incurred: abnormal waste, storage costs (unless needed in the production process before a further stage), administrative overheads that do not help bring inventory to its condition and location, and selling costs. Fixed production overhead is allocated using normal capacity. If production is abnormally low, the unallocated overhead is expensed, not loaded into unit cost.

Next, compare cost with net realisable value (NRV). NRV = estimated selling price − estimated costs of completion − estimated costs necessary to make the sale. Inventory is carried at the lower of the two. If NRV is below cost, you write the inventory down and the loss goes to the income statement, usually in COGS.

IFRS and US GAAP differ in details. Under IFRS, all inventory is at the lower of cost and NRV, LIFO is not allowed, and a write-down can be reversed if NRV recovers, up to the amount of the original write-down. Under US GAAP, inventory using LIFO or the retail method is measured at the lower of cost and market, while FIFO and average cost inventory use the lower of cost and NRV. US GAAP does not allow reversals of write-downs.

Key formulas to remember

Cost of inventory (IAS 2): Cost = purchase costs + conversion costs + other costs to bring to present location and condition; Purchase costs are net of trade discounts and rebates. Exclude abnormal waste, selling costs, general administration and most storage costs.
Purchase cost: Purchase cost = invoice price − trade discounts and rebates + import duties and non-recoverable taxes + freight-in and handling; Recoverable taxes, such as recoverable VAT, are not included in cost.
Net realisable value: NRV = estimated selling price − estimated costs of completion − estimated costs to make the sale; For finished goods there are no completion costs, so only selling costs are deducted.
Carrying amount: Carrying amount = lower of cost and NRV; Write-down = cost − NRV when NRV is lower. It is recognised in profit or loss.
Reversal rule: IFRS: reverse up to the original write-down (carrying amount cannot exceed cost). US GAAP: no reversal.; The reversal reduces COGS under IFRS. Under US GAAP, the written-down amount becomes the new cost basis.
US GAAP market (LIFO and retail method): Market = replacement cost, limited to a ceiling of NRV and a floor of NRV − normal profit margin; Carry at the lower of cost and market. FIFO and average cost use the lower of cost and NRV.

How to solve Inventory Cost Measurement and Valuation questions

Use this order for any question on inventory cost or valuation. It keeps the cost build-up separate from the valuation test.

1Read which framework applies. Financial reporting questions use IFRS unless the question says US GAAP.
2List every cost item given. Sort each into: include (purchase, conversion, bringing to location and condition) or expense now (abnormal waste, selling, general administration, unneeded storage).
3Subtract trade discounts and rebates from the purchase price. Add import duties, non-recoverable taxes, freight-in and handling.
4Add conversion costs: direct labour and production overhead allocated on normal capacity.
5Compute NRV: estimated selling price − costs to complete − costs to sell.
6Compare cost with NRV. Carry at the lower. The write-down is cost − NRV.
7If NRV later recovers, check the framework. IFRS allows reversal up to the original write-down. US GAAP does not.
8Check which line the amount hits. Write-downs and reversals go through the income statement, normally within COGS.

Quickest way: Include or expense, then lower of two

When to use it: Use this for multiple-choice questions with a list of costs followed by a value or carrying amount.

Cross out selling, administration, abnormal waste and unneeded storage items at once.
Sum the rest, after deducting trade discounts.
Compute NRV in one line: price − completion − selling.
Pick the smaller figure. Eliminate options that use selling price or add selling costs to cost.
For reversal questions, cap the new carrying amount at original cost. Under US GAAP, keep the written-down amount.

Common mistakes in Inventory Cost Measurement and Valuation

Including selling costs or storage costs in inventory cost.
Students think any cost linked to the goods is capitalised.
Fix: Only costs of bringing inventory to its present location and condition are included. Selling costs are expensed. Storage is included only if needed in the production process.
Forgetting to deduct selling costs when computing NRV.
Students compare cost directly with the selling price.
Fix: Always compute NRV = selling price − costs to complete − costs to sell before comparing.
Treating abnormal waste or abnormally low-production overhead as part of cost.
It feels like a real production cost.
Fix: Abnormal waste and unallocated overhead from abnormally low production are expensed in the period. Allocate fixed overhead on normal capacity.
Allowing a write-down reversal under US GAAP.
Students remember the IFRS rule and apply it everywhere.
Fix: IFRS allows reversal up to the original write-down. US GAAP does not allow reversal.
Reversing a write-down to the new NRV even when it exceeds cost.
Students forget the cap.
Fix: Under IFRS, the carrying amount after reversal is the lower of original cost and the new NRV.
Including trade discounts or recoverable taxes at the gross amount.
Students use the invoice figure without adjusting.
Fix: Deduct trade discounts and rebates. Exclude taxes the entity can recover from the tax authority.

Worked examples

Example 1

A manufacturer buys raw materials with an invoice price of $200,000. It receives a 10% trade discount. It also pays import duty of $8,000 and freight-in of $4,000. Other costs: storage before sale that is not part of production, $3,000; selling costs, $6,000; abnormal waste, $2,500. Under IAS 2, the cost of the inventory is closest to:
A. $188,000
B. $192,000
C. $212,000

Show the solution

Apply the trade discount: $200,000 × (1 − 0.10) = $180,000.
Add import duty: $180,000 + $8,000 = $188,000.
Add freight-in: $188,000 + $4,000 = $192,000.
Exclude storage not needed in production ($3,000), selling costs ($6,000) and abnormal waste ($2,500). All are expensed.
Option A omits freight-in. Option C ignores the discount and adds duty and freight.

Answer: B. $192,000

Example 2

Under IFRS, a company holds work in progress with a cost of €50,000. The estimated selling price of the completed goods is €58,000, estimated costs to complete are €6,000 and estimated selling costs are €5,000. At the next reporting date, the NRV of the same goods has risen to €52,000. The carrying amount after the reversal is closest to:
A. €47,000
B. €50,000
C. €52,000

Show the solution

First NRV = €58,000 − €6,000 − €5,000 = €47,000.
NRV is below cost (€50,000), so carry at €47,000. Write-down = €50,000 − €47,000 = €3,000, recognised in profit or loss.
NRV later rises to €52,000. IFRS allows reversal, but only up to the original write-down of €3,000.
Reversed carrying amount = lower of cost (€50,000) and new NRV (€52,000) = €50,000. Reversal = €3,000.
Option A would be right under US GAAP, where reversals are not allowed. Option C exceeds cost.

Answer: B. €50,000

Exam tips

Questions often hand you irrelevant costs. Scan for selling, administration, abnormal waste and storage first and ignore them.
When asked about IFRS vs US GAAP, think reversal of write-downs and LIFO. Both are the usual testing points.
For NRV, check whether goods are finished or still need completion. Subtract completion costs only for unfinished goods.
With three options, a number that uses selling price or omits freight is usually a distractor. Compute the exact figure rather than estimating.
Link write-downs to ratios: they lower inventory and profit, raise the COGS ratio and reduce current assets.

Practice questions from Analysis of Inventories

Inventory Cost Measurement and Valuation in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Inventory Cost Measurement and Valuation: frequently asked questions

What costs are included in inventory under IAS 2?

Purchase costs (net of trade discounts and rebates, plus non-recoverable duties and taxes, freight and handling), conversion costs (direct labour and systematic production overhead) and other costs needed to bring inventory to its present location and condition. Selling costs, abnormal waste and general administration are excluded.

What is the lower of cost and net realisable value?

It is the rule that inventory is carried at the smaller of its cost and its NRV. NRV is the estimated selling price less costs to complete and costs to sell. If NRV is lower, you write the inventory down and recognise the loss in profit or loss.

What is the difference between IFRS and US GAAP inventory valuation?

IFRS uses the lower of cost and NRV for all inventory, prohibits LIFO and allows write-down reversals up to the original write-down. US GAAP uses the lower of cost and market for LIFO and retail-method inventory, and the lower of cost and NRV for FIFO and average cost. US GAAP does not allow reversals.

Are storage costs part of inventory cost?

Generally no. Storage costs are expensed unless they are necessary in the production process before a further production stage. Storage of finished goods awaiting sale is normally expensed.