Accounting Study Guide

U.S. GAAP Codification IFRS International Standards Accounting Topics


Lower of Cost or Market(LCM)


U.S. GAAP CodificationAccounting Standards ASC,  
International Financial Reporting Standards (IFRS)
U.S. GAAP by TopicAccounting by Topic



Lower of Cost or Market (LCM)


GAAP

      Inventories are valued at cost or market, whichever is lower
      [ARB No. 43, Chapter 4, Para. 8

 

Market Value of Inventories [ARB No. 43, Chapter 4, Para. 9]

 
     
Market = Current replacement cost 

      Upper limit of Market
          = Net Realizable Value (NRV)
      Lower limit of Market
          = Net Realizable Value (NRV) - Normal Profit Margin

      Net Realizable Value (NRV)
          = Estimated Selling Price - Cost of Completion and Disposal

      Market = Current Replacement Cost

      If Current Replacement Cost > Net Realizable Value (NRV),
          then NRV is Market.

      If Current Replacement Cost < (NRV - Normal Profit Margin),
          then (NRV - Normal Profit Margin) is Market.



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Example 1 (Company A)


   Company has the following items as inventory as of December 31, 2010.  What is the value of inventory by applying Lower of Cost of Market?
 
Item Units Cost Current Replacement Cost Estimated Selling Price Completion & Disposal Cost
1 500 $65 $68 $80 $3
2 300 $80 $72 $102 $8
3 400 $90 $105 $112 $10
4 700 $38 $42 $40 $4
5 900 $20 $21 $30 $2
6 600 $55 $45 $67 $2

   For all inventory items, Normal Profit Margin is 30% of cost.

   Determine the Market
 
     Points
      Market = Current Replacement Cost
      If Current Replacement Cost > Net Realizable Value (NRV),
          then NRV is Market.
      If Current Replacement Cost < (NRV - Normal Profit Margin),
          then (NRV - Normal Profit Margin) is Market.

      Rank the following three values, then the one in the middle is Market.
          NRV
          Current Replacement Cost
          NRV - Normal Profit Margin

      Net Realizable Value (NRV)
          = Estimated Selling Price - Cost of Completion and Disposal
      In this example, normal profit margin = 30% of cost.

  (A) (B) (C) Middle value among (A), (B) and (C)
Item Current Replacement Cost NRV Normal - Normal Profit Margin Market
1 $68 $77 $57.5 $68
2 $72 $94 $70 $72
3 $105 $102 $75 $102
4 $42 $36 $24.6 $36
5 $21 $28 $22 $22
6 $45 $65 $48.5 $48.5

   Compare the Cost and Market
 
Item Cost Market Lower of Cost or Market (LCM) Units LCM Inventory
1 $65 $68 $65 500 $32,500
2 $80 $72 $72 300 $21,600
3 $90 $102 $90 400 $36,000
4 $38 $36 $36 700 $25,200
5 $20 $22 $20 900 $18,000
6 $55 $48.5 $48.5 600 $29,100
 Total         $162,400

   Inventory valuation at Cost, Market and LCM
 
Item Units Inventory at Cost   Inventory at Market   Inventory at LCM
1 500 $32,500 < $34,000   $32,500
2 300 $24,000 > $21,600   $21,600
3 400 $36,000 < $40,800   $36,000
4 700 $26,600 > $25,200   $25,200
5 900 $18,000 < $19,800   $18,000
6 600 $33,000 > $29,100   $29,100
 Total    $170,100 <  $170,500   $162,400

   LCM applied to each inventory item
          --> Inventory at LCM = $162,400

   LCM applied to all inventories as one pool
         --> Total inventory at cost < Total inventory at market
         --> Inventory at LCM = $170,100

 
Click here for solutions to LCM Example 1 in pdf file
 







Example 2 (Company B)


   Company has the following items as inventory as of December 31, 2010.  What is the value of inventory by applying Lower of Cost of Market?
 
Item Units Cost Current Replacement Cost Estimated Selling Price Completion & Disposal Cost
1 800 $220 $250 $280 $15
2 600 $190 $175 $240 $11
3 350 $310 $370 $390 $23
4 500 $180 $185 $185 $8
5 750 $205 $210 $320 $14
6 900 $150 $110 $170 $7

   For all inventory items, Normal Profit Margin is 30% of cost.

   Determine the Market
 
  (A) (B) (C) Middle value among (A), (B) and (C)
Item Current Replacement Cost NRV Normal - Normal Profit Margin Market
1 $250 $265 $199 $250
2 $175 $229 $172 $175
3 $370 $367 $274 $367
4 $185 $177 $123 $177
5 $210 $306 $244.5 $244.5
6 $110 $163 $118 $118

   Compare the Cost and Market
 
Item Cost Market Lower of Cost or Market (LCM) Units LCM Inventory
1 $220 $250 $220 800 $176,000
2 $190 $175 $175 600 $105,000
3 $310 $367 $310 350 $108,500
4 180 $177 $177 500 $88,500
5 $205 $244.5 $205 750 $153,700
6 $150 $118 $118 900 $106,200
 Total         $737,950

  Inventory valuation at Cost, Market and LCM
 
Item Units Inventory at Cost   Inventory at Market   Inventory at LCM
1 800 $176,000 < $200,000   $176,000
2 600 $114,000 > $105,000   $105,000
3 350 $108,500 < $128,450   $108,500
4 500 $90,000 > $88,500   $88,500
5 750 $153,750 < $183,375   $153,700
6 900 $135,000 > $106,200   $106,200
 Total    $777,250 <  $811,525   $737,950

   LCM applied to each inventory item
          --> Inventory at LCM = $737,950

   LCM applied to all inventories as one pool
         --> Total inventory at cost < Total inventory at market
         --> Inventory at LCM = $777,250

 
Click here for solutions to LCM Example 2 in pdf file
 
Overview of Inventories

Lower of Cost or Market (LCM) Example 1 in pdf file
Lower of Cost or Market (LCM) Example 2 in pdf file








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