Lower of Cost or Market (LCM) inventory valuation worked example for the CPA Exam FAR section: this simulation walks through how to value inventory under the LCM rule using net realizable value, the floor, and replacement cost, then compares market value to historical cost. Ideal for CPA and CMA exam candidates, intermediate accounting students, and practitioners who need to master the lower of cost or market rule, the conservatism principle, and how to compute inventory write-downs.

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Video Timeline & Key Concepts:
0:00 Introduction to the Lower of Cost or Market (LCM) simulation
0:20 LCM overview and the principle of conservatism
2:41 Net Realizable Value (NRV): selling price minus costs to sell (ceiling)
3:26 Floor: NRV minus a normal profit margin
3:43 Replacement cost: current cost to purchase the inventory
4:34 Determining market value by selecting the middle of the three figures
5:45 Example Product A worked through
6:46 Example Product B worked through
7:36 Example Product C and the resulting loss
8:09 Example Product D and the resulting loss

Frequently Asked Questions:

What is the lower of cost or market rule?

The lower of cost or market (LCM) rule requires a company to report inventory at the lower of its historical cost or its market value. It reflects the principle of conservatism, ensuring inventory is not overstated on the balance sheet when its utility or value has declined.

How do you determine the market value under LCM?

You calculate three figures and select the middle one. The ceiling is net realizable value, which is the estimated selling price minus the costs to complete and sell. The floor is net realizable value minus a normal profit margin. Replacement cost is what it would cost to purchase the inventory today. The market value is the middle of these three amounts.

What are the steps to apply the LCM rule?

First, identify the historical cost of the item. Second, calculate net realizable value, the floor, and replacement cost. Third, choose the middle of those three figures as the market value. Finally, compare the historical cost to the market value and report the inventory at the lower of the two.

When does a company record a loss under LCM?

A company records a loss when the market value of the inventory is lower than its historical cost. The inventory is written down to the market value, and the difference between the original cost and the reduced value is recognized as a loss in the period.

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