Why might an inventory write-down to NRV be necessary, and what is its effect on financial statements?

• A. If market value falls below cost, NRV write-down reduces assets and increases expenses, lowering net income.
• B. If market value rises above cost, NRV write-down increases assets and increases revenue.
• C. NRV write-down increases assets and increases equity.
• D. NRV write-down has no effect on net income.

Answer: (A)

When inventory’s net realizable value (NRV) is less than its cost, you must write it down to NRV. NRV is the expected selling price minus costs to complete and sell. Carrying inventory at a higher cost than NRV inflates assets in error and ignores the loss you’ll incur to convert those goods into cash.

The write-down records a loss on the income statement, so it increases expenses in the period and reduces net income. Because that expense lowers earnings, retained earnings (a component of equity) also fall, so equity declines. It’s a non-cash adjustment—the effect shows up as a lower asset value on the balance sheet and a lower net income on the income statement, not as an immediate cash outlay.

This aligns with choosing the option that describes a write-down when market value falls below cost: assets are reduced and expenses rise, leading to lower net income. The other scenarios describe situations that don’t reflect how NRV write-downs work (no write-down when NRV is higher than cost; assets increasing or no net income effect).