Definition: Lower of cost or market, often abbreviated LCM, is an accounting method for valuing inventory. It assigns a value to inventory at the lesser of the market replacement cost or the amount it was recorded at when it was initially purchased. This price is then used on the balance sheet at the end of an accounting period.
What Does Lower of Cost or Market Mean?
The lower of cost or market method is used to protect retailers and other businesses from fluctuations in inventory purchase prices. Since inventory is a significant number on a retailer’s balance sheet, a large fluctuation in the value of these assets could affect the company’s financial position.
For example, if a retailer purchases $100,000 worth of inventory and six months later it is only worth $10,000, the retailer actually lost money even though it didn’t sell the inventory yet. The FIFO, LIFO, and weighted average inventory systems would not recognize this loss because the inventory hasn’t been sold. The LCM method takes care of this.
Example
LCM adjusts the reported value of inventory based on the market and original cost prices. The market price is amount of money it would take to replace the inventory today. It’s the current market price. The cost is the price that the retailer originally paid for the merchandise.
The lower of cost or market method adjusts inventory to the lessor of the original cost or the current market price. In other earlier example, the recorded cost was $100,000, but the current market price was only $10,000. According to the LCM method, this $90,000 loss should be recorded by crediting the inventory account and debiting a loss account.
Here’s a simple rule of thumb when using the LCM. When the cost equals the market value, no gain or loss is recognized. When the cost is greater than the market value, a loss is recognized.
