accounting Accounting, also known as accountancy, is the process of recording and processing information about economic entity, economic entities, such as businesses and corporations. Accounting measures the results of an organization's economic activit ...

, lower of cost or market (LCM or LOCOM) is a

conservative Conservatism is a cultural, social, and political philosophy and ideology that seeks to promote and preserve traditional institutions, customs, and values. The central tenets of conservatism may vary in relation to the culture and civiliza ...

approach to valuing and reporting

inventory Inventory (British English) or stock (American English) is a quantity of the goods and materials that a business holds for the ultimate goal of resale, production or utilisation. Inventory management is a discipline primarily about specifying ...

. Normally, ending inventory is stated at

historical cost The historical cost of an asset at the time it is acquired or created is the value of the costs incurred in acquiring or creating the asset, comprising the consideration paid to acquire or create the asset plus transaction costs. Historical cost ...

. However, there are times when the original cost of the ending inventory is greater than the

net realizable value Net realizable value (NRV) is a measure of a fixed or current asset's worth when held in inventory, in the field of accounting. NRV is part of the Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS ...

, and thus the inventory has lost value. If the inventory has decreased in value below historical cost, then its carrying value is reduced and reported on the

balance sheet In financial accounting, a balance sheet (also known as statement of financial position or statement of financial condition) is a summary of the financial balances of an individual or organization, whether it be a sole proprietorship, a business ...

. The criterion for reporting this is the current

market value Market value or OMV (open market valuation) is the price at which an asset would trade in a competitive auction setting. Market value is often used interchangeably with ''open market value'', ''fair value'' or '' fair market value'', although t ...

. Any loss resulting from the decline in the value of inventory is charged to "

cost of goods sold Cost of goods sold (COGS) (also cost of products sold (COPS), or cost of sales) is the carrying value of goods sold during a particular period. Costs are associated with particular goods using one of the several formulas, including specific iden ...

" (COGS) if non-material, or "loss on the reduction of inventory to LCM" if material.

History

The lower of cost or market concept first became part of normal accounting practices in England during the nineteenth century. Lower of cost or market was considered fair because assets were valued on a going-concern basis, rather than the price at which the assets were purchased. During the nineteenth century, lower of cost or market was not common practice for valuation of factory inventory in the United States. The concept was not easy for the Academic Accountants to accept due to its lack of logic. Despite the criticism, lower of cost or market quickly caught on in practice and by the early twentieth century was described as the most commonly accepted method for inventory valuation according to the Report of the Special Committee on Co-operation with Stock Exchanges. Although it lacked accounting logic, lower of cost or market survived because of its conservative approach to valuation and because it addressed opposing principles of cost and value. Its conservatism allowed users to value the inventory at the price for which the inventory could be sold.

Challenges

Three possible values can represent the market value: the replacement cost of the inventory, the net realizable value (also known as the "ceiling"), and the "floor" (the difference between the net realizable value and the normal profit).Wampler, Bruce; Holt, Travis (January 2013)."Valuing Inventory at the Lower of Cost or Market." ''CPA Journal''. 83: 34–9.

ISSN An International Standard Serial Number (ISSN) is an eight-digit to uniquely identify a periodical publication (periodical), such as a magazine. The ISSN is especially helpful in distinguishing between serials with the same title. ISSNs a ...

br>0732-8435
/ref> In the lower of cost or market approach, companies must determine these three values and find the median of the values. The companies then compare the median value, which is called the designated market value, to the inventory cost that is recorded. The lower of these two values is subsequently reported on the balance sheet. Because the lower of cost or market approach requires companies to use three possible market values, the companies' financial statements can be difficult to compare.

Contemporary usage

The term "lower of cost or market" is now obsolete and is officially replaced by "lower of cost and net realizable value". According to the FASB Accounting Standards Update, This FASB update makes usage consistent with the IFRS wording and removes the use of "or" in a context where "and" was always the correct one.FASB Accounting Standards Update, No. 2015-11, July 2015, p. 1. However, the update does not apply to all companies. Companies that use the FIFO (first-in, first-out) and average-cost methods of inventory valuation are required to implement the changes, whereas companies that use the LIFO (last-in, first-out) and retail inventory methods are not affected by the update.

References

{{Reflist Inventory

History

Challenges

Contemporary usage

See also

References