Chapter 3.3® - How Lower of Cost or Market Works - Acceptable Historical Cost Flow Method & Comparisons of Market versus Cost, US Designated Market Value

• Part 3.1 - Inventory Valuation & Estimation – Lower of Cost or Market, Example & Illustration of Net Realizable Value, Market Replacement Cost
• Part 3.2 - Example of Net Realizable Value less a Normal Profit Margin, Market equals = Net Realizable value or Market equals net realizable value minus a normal Profit Margin
• Part 3.3 - How Lower of Cost or Market Works - Acceptable Historical Cost Flow Method & Comparisons of Market versus Cost, US Designated Market Value
• Part 3.4 - Methods of Applying Lower of Cost and Market - Item by Item Basis, Category Basis & Total Inventory Basis
• Part 3.5 - Recording Inventory Valuation at Market instead of Cost - Direct & Indirect Methods assuming Periodic & Perpetual Inventory Systems
• Part 3.6 - Income Statement Presentation - Direct & Indirect Method and Advantages & Disadvantages of Using Lower of Cost and Market
• Part 3.7 - Gross Profit Method of Estimating Inventory - Using the Gross Margin Method, Annual Inventory Counts, Gross Profit on Selling Price Method
• Part 3.8 - Glossary of Important Inventory Valuation Terms

The lower of cost or market (LCM) rule requires that inventory be valued at cost unless market is lower than cost, in which case the inventory will be valued at ‘market.’ The application of this rule involves the following steps used in both Canadian and US accounting:

Usually under Canadian GAAP, the management of the company decides which of the three types of methods will be used to find the ‘market’ and the usual choice is the Net Realizable Value. Thus we will take the 2nd column from the above table (net realizable value) and compare the values with original costs of the inventories to find lower of cost or market. The table is shown below:

Under US GAAP, the accounting treatment of these 3 definitions of market is amalgamated together to find a ‘designated market value.’ In the table below, all 3 definitions including net realizable value, net realizable value minus profit margin and replacement cost are listed alongside the original purchasing cost. Then, the middle value of these 3 numbers is chosen as the ‘designated market value.’ For instance, if net realizable value was $110,000, and net realizable value less profit margin was $99,000 and the replacement cost was $105,000, then the designated market value would be the middle value which equals to the replacement cost of $105,000 in this case.