Inventory Valuation Method: Lower-of-Cost-or-Market Comparison
What is the cost amount that should be used in the lower-of-cost-or-market comparison?
Given the historical cost of product domino is $12, the selling price of product domino is $15, costs to sell product domino are $2, and the replacement cost for product domino is $11, what is the cost amount that should be used in the lower-of-cost-or-market comparison?
Answer:
The lower-of-cost-or-market (LCM) comparison is a method used to value inventory at its net realizable value. The LCM rule states that inventory should be valued at the lower of its cost or its replacement cost.
In this case, the cost amount that should be used in the LCM comparison is the lower of the historical cost and the replacement cost of the product domino. The historical cost of the product domino is $12, while the replacement cost is $11. Based on the LCM rule, we would use the replacement cost of $11, since it is lower than the historical cost.
To calculate the net realizable value of the product domino, we would deduct the costs to sell, which are $2, from the selling price of $15. This gives us a net realizable value of $13. Based on the normal profit margin of 20% of the sales price, the cost amount that should be used in the LCM comparison would be $10.40 ($13 x 80%). Therefore, the cost amount that should be used in the LCM comparison for product domino is $11, since it is lower than the historical cost of $12. This is based on the replacement cost of the product.