What Is Cost or Market Value?

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Cost versus Market Value are terms used in inventory accounting by companies when preparing financial documents for shareholder reports. Generally accepted accounting principles (GAAP) are a uniform set of standards that strive to keep information provided to investors consistent.

GAAP LCM Accounting

According to GAAP, the lower of cost or market--LCM--is used so that companies' inventory reports accurately reflect any market declines in inventory values.

A) Cost

Cost is simply the expense incurred in producing goods. "Current replacement cost" (CRC) may vary, depending on changes in cost of materials, labor, marketing/delivery and product demand at the time of accounting.

B) Net Realizable Value

Also known as NRV, net realizable value is the targeted sales price minus the cost to complete and dispose of the product. (The difference is expected profit margin.)

C) Market

Market value is the current replacement cost and is determined by the following:

If CRC > NRV, then NRV is the market.

If CRC < (NRV minus profit margin), then (NRV minus profit margin) is the market.

Considerations

The three values--A, B and C--are ranked and the middle value becomes the "market" value. This market is, in turn, compared to the cost and the lower of the two is the unit value of that inventory item.

Total Inventory

The number of units in inventory is multiplied by the lower of market or cost, and this is reported as the total inventory at LCM.

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