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