Question

Explain the (a) lower of cost or net realizable value (LCNRV) approach and the (b) lower of cost or market (LCM) approach to valuing inventory. please answer in your own words, do not use the outside resources

Answer 1

a) Lower of cost or net realizable value approach is a method of making inventory adjustments in the financial records where the price of the inventory noted should be less than its laid - down cost and the net realizable cost.

Laid - down cost is the total cost involved in the making of the inventory plus the transpotation costs. This includes custom costs, invoice costs, Freights,etc. The net realizable cost is the actual value of inventory which is calculated by subtracting various selling costs involved in the goods from the selling price of the goods.

This is done so as the inventory or the income from the inventory does not goes overstated in the income statements.

b) If we talk about lower of cost or market apriach, it is thevapproathused for evaluating the inventory either on the historical cost at which it was initially bought or on the basis of current market price of the inventory.

If the inventory is marked at its historical cost it becomes easy for accountans to evaluate their gain or profit after selling the inventory or goods and they also are having the proper records of price st which goods are being bought. If any problem occurs they can reveiw old records to recheck. It also does not require any regular basis of updating cost as historical costs remains same throught tte accounting.

While in market value, the value of goods changes with the change in the market price and according to that the price of goods needed to be changed or updated in accounting system. But one dan just by seeing the accounting can know how much profit is obtained from that particular inventory.

This is the explanation of the above mentioned two approaches.