May 13, 2022/ Steven Bragg
The lower of cost or market rule states that a business must record the cost of inventory at whichever cost is lower – the original cost or its current market price. This situation typically arises when inventory has deteriorated, or has become obsolete, or market
prices have declined. The rule is more likely to be applicable when a business has held inventory for a long time, since the passage of time can bring about the preceding conditions. The rule is set forth under the Generally Accepted Accounting Principles accounting framework. The “current market price” is defined as the current replacement cost of the inventory, as long as the market price does not exceed net realizable value; also, the market price shall not be less than the net
realizable value, less the normal profit margin. Net realizable value is defined as the estimated selling price, minus estimated costs of completion and disposal. Additional factors to consider when applying the lower of cost or market rule are:
A recent update to the rule simplifies matters somewhat, but only if a business is not using the last in, first out method or the retail method. The variation states that the measurement can be restricted to just the lower of cost and net realizable value. Example of the Lower of Cost or MarginMulligan Imports resells five major brands of golf clubs, which are noted in the following table. At the end of its reporting year, Mulligan calculates the lower of its cost or net realizable value in the following table:
Based on the table, the market value is lower than cost on the Hi-Flight and Iridescent product lines. Consequently, Mulligan recognizes a loss on the Hi-Flight product line of $3,000 ($27,000 - $24,000), as well as a loss of $144,000 ($336,000 - $192,000) on the Iridescent product line. Accounting for the Lower of Cost or MarginIf the amount of a write-down caused by the lower of cost or market analysis is immaterial, then charge the expense to the cost of goods sold; this is usually the case. If the loss is material, then you may want to track it in a separate account (especially if such losses are recurring), such as “Loss on LCM adjustment,” in order to separately report on this information. To use the information in the preceding example, the journal entry would be:
What is the purpose of the lowerWhat Is the Meaning of Lower of Cost or Market Method? The lower of cost or market method is used to value inventory by comparing the original cost and the current market price, and recording the cost of inventory by whichever is lower.
What is the rationale behind the ceiling when applying the lowerWhat is the rationale behind the ceiling when applying the lower-of-cost-or-market method to inventory? Prevents overstatement of the value of obsolete or damaged inventories.
When applying the lowerThe lower of cost or market rule states that a business must record the cost of inventory at whichever cost is lower – the original cost or its current market price. This situation typically arises when inventory has deteriorated, or has become obsolete, or market prices have declined.
When applying the lowerd) $17. What is the rationale behind the ceiling when applying the lower-of-cost-or-market method to inventory? a) Prevents overstatement of the value of obsolete or damaged inventories.
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