CHAPTER 9 NOTES

Inventories: Additional Valuation Issues

I. Lower-of-Cost-or-Market (LCM)

General Rule:

When the market value of inventory falls below its cost, a company:

1. Reports the difference between the cost basis and the market-
based measure as a loss on the income statement (indirect
method) or an increase to cost of goods sold (direct method).
2. Carries the inventory at the lower amount on the balance sheet.

What is cost?

What you get from the LIFO/FIFO/Avg Cost.

What is market?

A. Under FIFO or Weighted Average Inventory Methods

Net Realizable value(Ceiling) = Estimated selling Price Cost of

disposal/completion

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 Instructions: Find the net realizable value (NRV) and lower-of-cost-or-market value for
ending inventory, assuming the company uses FIFO to compute inventory costs.

Cost under FIFO Estimated Selling Cost to Complete NRV LCM

Price
1 100 120 0

2 95 120 5

3 100 110 20

B. Under LIFO Inventory Method

Use the MIDDLE value of:

1. Current Replacement Cost the cost to replace the item by

purchase or production

2. Net Realizable Value (ceiling) Estimated selling price less the

costs of completion / disposal

3. Net Realizable Value reduced by a normal profit margin (floor)

See FASB Accounting Standards Update No. 2015-11 - Simplifying the

Measurement of Inventory

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 Instructions: Find the ceiling (NRV), floor, and lower-of-cost-or-market value for ending
inventory, assuming the company uses LIFO to compute inventory costs.

Cost Estimated Cost to Normal Current Ceiling Floor Market LCM

under Selling Complete Profit Replacemen (NRV)
LIFO Price Margin $$ t Cost
1 100 120 0 30 110

2 95 120 5 25 90

3 100 110 20 20 95

4 100 140 20 25 90

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 II. Recording Market Declines in Inventory

Indirect Method

Balance Sheet Presentation:

Inventory (at cost) $610,000

- Allowance to reduce inventory to market (40,000)
Inventory (at market) $570,000

Clearly displays the loss from market decline in the income

statement

The balance sheet reports both the cost and market values of the
inventory

Preferable method

Direct Method

The market value of inventory is shown in both the balance sheet

and the cost of goods sold section of the income statement.

The market decline (loss) is buried in cost of goods sold

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Example: Grant Wood Company manufactures desks. At December
31, 2015, the following finished desk appears in the companys
inventory.

Finished Desks Desk A

Inventory Cost under FIFO $450
Est. Cost to manufacture 440
Commissions and disposal 60
costs
Catalog selling price 500

Instructions: At what amount should Desk A appear in the companys

December 31, 2015 inventory, assuming that the company has
adopted a lower-of-cost-or-market approach for valuation of inventories
on an individual-item basis? Inventory cost is determined using FIFO.

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