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 U.S. GAAP Codification Accounting Topics

 Lower of Cost or Market(LCM)

 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.

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

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