Definition
The financial accounting term lower of cost or market refers to an inventory valuation rule that states items should be valued at their original cost or their current market cost, whichever is lower.
Explanation
Also known as the LCM technique, the lower of cost or market approach to valuing inventory was developed in reaction to FASB No. 33, which states that companies have to disclose the affects of inflation on their inventory values.
The lower of cost or market initially helped ease creditor worries about the accuracy of a company's balance sheet, since using this approach results in a conservative estimate of the company's assets. As focus shifted to the income statement, LCM was criticized for its potentially fictitious impact on the income statement. An inventory could be written down in one accounting period (lowering profits) then sold at a normal profit in the next (inflating profits).
This concern resulted in a modification to this rule that now states the lower of cost or market approach does not apply if the items in inventory can be sold at a normal profit. Furthermore, the value of inventory cannot be greater than the item's anticipated selling price minus sales expense.
Related Terms
Also known as a statement of financial position, the balance sheet is used to show the financial health of a company at a particular point in time. The balance sheet consists of assets, liabilities, and owner's equity in the company. It is one of the four key financial statements issued by public companies.
Moneyzine EditorNovember 6th, 2024
The financial accounting term inventory is used to describe the balance sheet line item that includes the value of raw materials, work in process, finished goods ready for sale, and returned goods that can be resold.Moneyzine EditorNovember 6th, 2024- The sales expense to sales ratio allows analysts to understand how efficient a particular sales channel is at generating revenues. Calculating its sales expense to sales ratio allows a company to direct resources to the most effective channels. Companies can also track this metric over time, looking for movements that might indicate a change in consumer purchasing behavior.Moneyzine EditorSeptember 21st, 2023
The financial accounting term first-in, first-out refers to one of several approaches to inventory valuation. The first-in, first-out method assumes the oldest items held in inventory are the first items to be sold when determining the value of inventory appearing on a company's balance sheet.Moneyzine EditorJanuary 18th, 2024
The financial accounting term last-in, first-out refers to one of several acceptable approaches to inventory valuation. The last-in, first-out method assumes the newest items held in inventory are the first items to be sold when determining the value of this asset as it appears on a company's balance sheet.Moneyzine EditorNovember 6th, 2024
The financial accounting term gross profit method refers to an approach to valuing ending inventory which is based on an assumption the gross profit ratio on the items held in inventory remains consistent from one accounting period to the next.Moneyzine EditorJanuary 19th, 2024
The financial accounting term average cost refers to one of several acceptable approaches to inventory valuation. The average cost method uses a weighted average approach to determine the value of inventory appearing on the company's balance sheet.Moneyzine EditorJanuary 8th, 2024- The financial accounting term retail method refers to an approach to valuing inventory in a retail business setting. The retail method assumes the relationship between the cost of goods in stores and their retail price is consistent in the current period.Moneyzine EditorNovember 6th, 2024
- The financial accounting term prudent cost concept refers to a process that allows accountants to place a value on an asset that is different than historical cost. The prudent cost concept applies when a company is unaware of the asset's true value and the acquisition price is too high. When this occurs, the recommended course of action is to charge a loss in the current period.Moneyzine EditorSeptember 21st, 2023
The term excess of cost over fair market value of net assets refers to the difference between the price paid for a bundle of assets and their net value as determined through a professional appraisal. Determining the excess of cost over fair market value is typically required when one business buys another, with the excess cost being applied to goodwill on the balance sheet.Moneyzine EditorSeptember 20th, 2023- The term revenue from investments in stock refers to an approach companies can use to determine when to record income generated by their investments in common stock. There are several methods a company can use to account for these long and short-term investments. Each method has a slightly different approach to account for a stock's change in value or dividends received.Moneyzine EditorNovember 6th, 2024
