Lower-of-Cost-or-Market (LCM) Valuation for Inventories

LCM Valuation for Inventories

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Question

When valuing inventories using the lower-of-cost-or market (LCM), which of the following is/are true?

I. The inventory value cannot exceed the net realizable value.

II. If the inventory is written down from cost, the value of the inventory cannot fall below the net realizable value.

III. Inventories can only be written back up to the original cost.

IV. Write-downs are charged directly to retained earnings account.

Answers

Explanations

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A. B. C. D.

A

US GAAP requires that inventory be valued at the lower of cost or market value. This means that if the inventory value falls below the cost (FIFO, LIFO, average cost, etc.) for reasons which include price changes, obsolescence, damage or theft, the loss in value must be recognized immediately. Specifically, the inventory must be "written-down" in value and the loss recognized on the income statement. In the application of this principle, "market value" is defined as current replacement cost, except that this value cannot exceed the net realizable value (NRV) or fall below NRV minus the normal profit margin.

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