University:
Grand Rapids Community College
Course:
Financial and Managerial Accounting: Information for Decisions - John J. Wild
Academic year:

2024
Views:

85

Pages:

3
Author:

stud_ice13

The Lower of Cost or Market (LCM) rule requires companies to report inventory at the lower value between its original cost and the current market value, ensuring that inventory is not overvalued on financial statements. This rule applies after a company has already calculated the cost of inventory using one of the four costing methods (FIFO, LIFO, weighted average, or specific identification). Here's how it works: Key Concepts of LCM: 1. Cost: The inventory's cost as determined by one of the costing methods (e.g., FIFO, LIFO). 2. Market Value: o For LIFO, market refers to replacement cost—the cost to replace the inventory item in the market. o For FIFO, weighted average, and specific identification, market refers to net realizable value (NRV)—the expected selling price minus any costs required to complete and sell the product. When market value falls below cost, an adjustment is required, and the lower value is used for reporting the inventory on the balance sheet. LCM Calculation: LCM can be applied in one of three ways: 1. To each individual item separately (most common due to technology). 2. To major categories of items. 3. To the entire inventory. Example of LCM Calculation (Exhibit 5.9): Assume a motorsports retailer has the following products in inventory: • • Roadster: Cost = $170,000, Market = $140,000 Sprint: Cost = $50,000, Market = $60,000 Using the LCM rule: • • For the Roadster, the lower value is $140,000 (market). For the Sprint, the lower value is $50,000 (cost). The total inventory reported would be the sum of these lower values: $140,000 (Roadster) + $50,000 (Sprint) = $190,000. Recording LCM Adjustments: If the market value of inventory is less than its recorded cost, an adjustment is made to reduce the inventory value. In the example: • • • The recorded inventory cost was $220,000. After applying LCM, the adjusted inventory value is $190,000. The company must record a $30,000 reduction in inventory (from $220,000 to $190,000) by making the following journal entry: plaintext Копировать код Debit: Loss on Inventory Write-Down $30,000 Credit: Merchandise Inventory $30,000 This adjustment reflects the loss due to the decline in market value, ensuring that the inventory is not overvalued on the balance sheet. Example Problem: A company has the following products in its ending inventory: Product Cost Market A $500 $480 B $300 $310 C $400 $390 1. Step 1: Apply LCM to each product: o For Product A: Lower of cost ($500) or market ($480) = $480 o For Product B: Lower of cost ($300) or market ($310) = $300 o For Product C: Lower of cost ($400) or market ($390) = $390 2. Step 2: Total LCM inventory: o $480 (A) + $300 (B) + $390 (C) = $1,170. 3. Step 3: If the recorded inventory cost is higher (say $1,200), the company needs to record an adjustment of $30 ($1,200 - $1,170) to reflect the lower value. The journal entry would be: plaintext Копировать код Debit: Loss on Inventory Write-Down $30 Credit: Merchandise Inventory $30 Summary: • LCM ensures that inventory is not overstated by adjusting it to the lower of cost or market. • • If market value declines below cost, companies must record a loss and reduce the inventory value. LCM adjustments are common and necessary to comply with conservative accounting principles.