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Accounting Terms Dictionary |
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| Inventory measurement: Lower of Cost or Market |
| Inventory measurement: Lower of Cost or Market 1. Lower of Cost or Market (LCM) --> If market value of inventory is lower than the cost --> inventory is measured at market 2. Market = current replacement cost 3. Upper limit and lower limit Upper limit = net realizable value (NRV) Lower limit = net realizable value - normal profit margin 4. Net realizable value = (A) - (B) (A) Selling price (B) Estimated cost of completion and disposal 5. If Lower limit < Upper limit < Current replacement cost --> Market = upper limit = net realizable value 6. If Current replacement cost < Lower limit < Upper limit --> Market = lower limit = net realizable value - normal profit margin 7. If Lower limit < Current replacement cost < Upper limit --> Market = Current replacement cost Example 1 Cost of inventory = $5,000 Current replacement cost of inventory = $4,500 Selling price = $5,200 Cost of completion and disposal = $400 Normal profit margin = 20% of selling price 8. Net realizable value = selling price - cost of completion and disposal = $5,200 - $400 = $4,800 9. Upper limit = net realizable value = $4,800 10. Lower limit = net realizable value - normal profit margin = $4,800 - ($5,200 x 20%) = $4,800 - $1,040 = $3,760 11. Market = current replacement cost = $4,500 Because Current replacement cost = $4,500 --> is below upper limit ($4,800) --> and above lower limit (3,760) 12. Inventory is measured at market ($4,500) Because Market ($4,500) is lower than the cost ($5,000) --> Lower of cost or market |
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