Question

Explain briefly the application of the LCM concept to the ending inventory and its effect on the income statement and balance sheet when market is lower than cost.

Answer 1

LCM/NRV is applied when the market value (often defined as current replacement cost) or net realizable value is lower than the cost of the available units. The LCM/NRV requirement to write down the closing inventory from cost to market/net realizable value has the immediate effect of reducing (a) net income and (b) the amount of inventory carried on the balance sheet.

Low or market price rules are typically applied to specific inventory items, but can also be applied to entire inventory categories. In the latter case, LCM adjustments can be avoided if there is a balance within the inventory category for items whose market value is below cost and above cost.

Low Cost or Market Value (often abbreviated as LCM) is an accounting method of valuing inventory. We assign a value to inventory at the cost of replacement in the market or the amount recorded when originally purchased, whichever is lower.

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