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CandleFocus Glossary Editor
The lower of cost or market (LCM) method is an accounting technique used to determine the market or replacement value of inventory when it is lower than the recorded amount in a company’s balance sheet. This method is used when the net realizable value of an item is less than the cost of the same item recorded in the books. When the cost of the item is lower than its market value, the lower of cost or market method allows the company to reassign the value of the item to the current market value for the sake of accuracy.
Under the LCM method, a company would record an inventory item at the lower of its two values: Cost or Market Value. The cost is the original price the company paid for the item– the purchase price or the production cost. Market value is the current value the item can be sold at in the market. When the current market value is lower than the purchase price or production cost, the item is recorded at the lower, current market value. This allows the company’s inventory to be accurately represented on its balance sheet. The difference between cost and market value is recorded as a reduction in profit.
The application of the lower of cost or market method helps companies recognize a large drop in the sale price of an inventory item for the purpose of accuracy in financial reporting. Moreover, it helps companies plan for their current and future inventory needs, as prices can be expected to change from time to time. It also acts as an internal control, as material losses and inventory items can be identified and monitored as time passes.
The lower of cost or market method is a generally accepted accounting principle (GAAP) used by companies worldwide and is a common way of properly recognizing the value of inventory from a financial statements perspective. However, when using this method, it’s important that all estimates be supported by market evidence, a comparison of similar items, or an assessment of prices in the market. This way, the company’s financial statements are free from exaggeration and will reflect the true value of the company’s assets.
Under the LCM method, a company would record an inventory item at the lower of its two values: Cost or Market Value. The cost is the original price the company paid for the item– the purchase price or the production cost. Market value is the current value the item can be sold at in the market. When the current market value is lower than the purchase price or production cost, the item is recorded at the lower, current market value. This allows the company’s inventory to be accurately represented on its balance sheet. The difference between cost and market value is recorded as a reduction in profit.
The application of the lower of cost or market method helps companies recognize a large drop in the sale price of an inventory item for the purpose of accuracy in financial reporting. Moreover, it helps companies plan for their current and future inventory needs, as prices can be expected to change from time to time. It also acts as an internal control, as material losses and inventory items can be identified and monitored as time passes.
The lower of cost or market method is a generally accepted accounting principle (GAAP) used by companies worldwide and is a common way of properly recognizing the value of inventory from a financial statements perspective. However, when using this method, it’s important that all estimates be supported by market evidence, a comparison of similar items, or an assessment of prices in the market. This way, the company’s financial statements are free from exaggeration and will reflect the true value of the company’s assets.