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Lower-of-Cost-or-Market Rule (Method)

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Explain the reasoning behind the lower of cost or market rule being used to value inventory in everyday language.

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Solution Summary

This solution contains an explanation of the lower-of-cost-or market method (LCM). It also explains the reasoning behind as well as why the lower-of-cost-or-market rule is used to value inventory. An example of the journal entry to write down the inventory to LCM is shown and how this information is reported on the balance sheet.

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Lower-of-Cost-or-Market Rule

The lower-of- cost-or-market rule shows accounting conservatism in action. Although every attempt is made to prepare and present financial data that are free from bias, accountants do use a degree of conservatism. Conservatism means that accountants avoid overstatement of assets and income. Equally, liabilities would tend to be presented at higher amounts in the face of uncertainty. This is not a hardened rule, just a general principle of measurement. There are many accounting practices that are considered examples of accounting conservatism. One example of an accounting practice is the lower-of-cost-or-market method or LCM of costing inventory.
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