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Lower of Cost or Market (LCM) Method:
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The Lower of Cost or Market (LCM) is a conservative inventory valuation method that requires businesses to report inventory at the lower of its historical cost or current market value. This approach ensures that inventory is not overstated on financial statements.
The calculator uses the LCM formula:
Where:
Explanation: The LCM method compares the historical cost of inventory with its current market value and records inventory at whichever value is lower, following the conservatism principle in accounting.
Details: Proper inventory valuation is crucial for accurate financial reporting, tax compliance, and business decision-making. LCM prevents overstatement of assets and ensures more realistic profit calculations.
Tips: Enter the original cost and current market value in currency units. Both values must be non-negative numbers. The calculator will automatically determine the lower value for inventory reporting.
Q1: Why use LCM instead of just cost?
A: LCM provides a more conservative approach by recognizing inventory losses when market prices decline, preventing overstatement of assets and income.
Q2: What is considered "market value" in LCM?
A: Market value typically means current replacement cost, but it should not exceed net realizable value or be less than net realizable value minus normal profit margin.
Q3: When should LCM be applied?
A: LCM should be applied at each reporting period end when preparing financial statements, especially when inventory values have declined significantly.
Q4: Are there limitations to LCM method?
A: LCM can result in inconsistent valuation if market prices fluctuate frequently and may not reflect true economic value in rapidly changing markets.
Q5: How does LCM affect financial statements?
A: When market value is lower than cost, LCM reduces inventory value on the balance sheet and creates a loss that reduces net income on the income statement.