What is lower of cost or market

Lower of cost or market is a particular method of calculating the value of a specific item, or a method of valuation.

This valuation method determines the inventory value of an item by doing the following: first of all, you have to calculate the market value of the item as of that inventory date. Second, you have to compare the actual cost of the item with the market value that you have just calculated. The lower number is used as the inventory value of the item-the lower of cost or market [value].

To state lower of cost or market another way, it can be described as an accounting valuation approach that shows the lower of either the amount it would cost to replace an item or its historical cost (what you originally paid for the item) as a reflection of an unrealized loss.

Lower of cost or market can be used to describe inventory either on an individual item basis, or a group basis (you group items of a category together), or the total basis of the inventory.

Remember when using lower of cost or market that no matter what, the market value that you determine can't be greater than the ceiling placed on the item. Ceiling is the net realizable value of an item, a situation where it costs less to sell an item than to complete and dispose of that item. It's also important to keep in mind that the market value can't be less than the floor value of the item, the floor value being the net realizable value minus the normal profit margin of the item.

Unrealized gain is the opposite of lower of cost or market. Unrealized gain doesn't receive any recognition in the accounting of costs and value.

You can use lower of cost or market to determine the value of a number of different types of goods. Some examples are any goods that are purchased and on hand at the time. Lower of cost or market can also be used for the different parts of work in process, and parts of finished goods. Examples of these are the direct labor, direct materials, and some indirect costs.
When can't you use lower of cost or market? Lower of cost or market can't be applied to any LIFO evaluated and calculated inventory. Lower of cost or market also can't be used to determine the value of any goods that are being produced at an already determined price under a decided and fixed contract that is made for goods to be delivered at a certain date. For both of these examples, you are going to have to use the value at cost of the items.

Let's illustrate lower of cost or market by an example. Let's say that you own a used car lot. You want to determine the value of all of the Honda Accords that you have on hand right now. You go through your cars and see that you have three Honda Accords.

1. You determine the cost of each of the cars. Car 1 has a cost of $6,000. Car 2 has a cost of $4,500. Car 3 has a cost of $9,000. The total cost is 19,500.
2. The next step is to determine the market value of each car. Car 1 has a market value of $7,200. Car 2 has a market value of $3,000. Car 3 has a market value of $10,050. The total comes to $20,250.
3. The third step is to determine the lower of cost or market. Taking the lower of cost or market gets you the following results. Car 1: 6,000. Car 2: 3,000. Car 3: 9,000. The total comes to $18,000. This is your lower of cost or market.

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Categories: Finance,

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