Question

Define the Lower of Cost or market (LCM) method. Is it more or less applicable in 2020? Explain.

Answer 1

1a,  

Generally, companies should use historical cost to value inventories and cost of goods sold. However, some circumstances justify departures from historical cost. One of these circumstances is when the utility or value of inventory items is less than their cost. A decline in the selling price of the goods or their replacement cost may indicate such a loss of utility. This section explains how accountants handle some of these departures from the cost basis of inventory measurement.

The lower-of-cost-or-market (LCM) method is an inventory costing method that values inventory at the lower of its historical cost or its current market (replacement) cost. The term cost refers to historical cost of inventory as determined under the specific identification, FIFO, LIFO, or weighted-average inventory method. Market generally refers to a merchandise item’s replacement cost in the quantity usually purchased. The basic assumption of the LCM method is that if the purchase price of an item has fallen, its selling price also has fallen or will fall. The LCM method has long been accepted in accounting.

Under LCM, inventory items are written down to market value when the market value is less than the cost of the items. For example, assume that the market value of the inventory is $39,600 and its cost is $40,000. Then, the company would record a $ 400 loss because the inventory has lost some of its revenue-generating ability. The company must recognize the loss in the period the loss occurred.   The journal entry would be:

Cost of goods sold A/c Dr 400

To, Inventory A/c 400

LCM is more improtant in 2020,because that are helpful to this situation typically arises when inventory has deteriorated, or has become obsolete, or market prices have declined.

The “current market price” is defined as the current replacement cost of the inventory, as long as the market price does not exceed net realizable value; also, the market price shall not be less than the net realizable value, less the normal profit margin. Net realizable value is defined as the estimated selling price, minus estimated costs of completion and disposal.So, LCM is applicable to pandemic times so that are useful 2020 financial year.

Thank You........