What is the rule for valuing inventory?

Inventory must be valued at the lower of cost or net realizable value (NRV), a principle that applies under both GAAP and USPAP-compliant appraisal practice.

This rule prevents businesses from overstating assets on financial statements. "Cost" means what was paid to acquire or produce the inventory, including purchase price, freight, and direct labor. "Net realizable value" is the estimated selling price in the ordinary course of business, less any costs to complete or sell the goods. Whichever figure is lower becomes the carrying value.

In retail settings, businesses often use the retail inventory method to approximate cost without tracking every item individually. The process involves two steps:

• Calculate a cost-to-retail ratio by comparing total inventory and purchases at cost versus their retail price.
• Apply that ratio to the retail value of ending inventory to estimate cost.

The result is then compared against NRV, and the lower figure governs. This approach is acceptable under GAAP as long as it is applied consistently and supported by accurate records. For tax purposes, consistency between financial reporting and tax filings is equally important. You can explore how GAAP shapes these requirements in more detail at What does GAAP require of inventory valuation?, and for a deeper look at the cost-flow methods that feed into this calculation, see What is FIFO vs. LIFO vs. FEFO?.

When an inventory valuation is needed for financial reporting, asset-backed lending, or a charitable donation, a professional inventory appraisal ensures the methodology is defensible and prepared in accordance with USPAP.