To Determine Lower of Cost or Market

First, Determine “Market”:

• Identify Replacement Cost of the Item

This is the amount you would pay to replace the item

• Identify the Net Realizable Value of the ItemThis is the amount you could reasonably sell the item for in course of business, minus completion and sales costs.

• Compute Net Realizable Value minus normal profit margin

This is a floor that is computed to prevent understatement of inventory.

“Market” is the middle of these three values.

To Determine Lower of Cost or Market

Next, Determine New Inventory Value:

Compare “market” to historical cost value

Select the lower value of these two

This can be done at the individual item level, the inventorycategory level, or at the total inventory level.

Lower of Cost or Market Example

Paterno Motors has the following in inventory:

1 Ford Explorer 1 Toyota Forerunner

1 Dodge Caravan 1 4x4 tire

1 4x4 foglight kit

They also have a 20% normal profit margin above historical cost.

Item-by-Item Method

Item Historical

Cost

Replace-ment

Cost

Net

Realizable

Value

NRV - (.20 x HC)

“Floor”

“Market”

Value

Final

Inventory

Value

Vehicle Inventory

Explorer 22,000 20,500 19,500 15,100

Forerunner 21,000 21,750 27,500 23,300

Caravan 14,000 11,250 14,250 11,450

Vehicle Total

Supplies Inventory

Tire 50 65 90 80

Foglight 80 45 55 39

Supplies

Total

Totals

Assume these numbers are already known. These must be computed.

Item Historical

Cost

Replace-ment

Cost

Net

Realizable

Value

NRV - (.20 x HC)

“Floor”

“Market”

Value

Final

Inventory

Value

Vehicle Inventory

Explorer 22,000 20,500 19,500 15,100 19,500

Forerunner 21,000 21,750 27,500 23,300

Caravan 14,000 11,250 14,250 11,450

Vehicle Total

Supplies Inventory

Tire 50 65 90 80

Foglight 80 45 55 39

Supplies

Total

Totals

Item-by-Item Method

First, determine “market” by taking middle value.

Item Historical

Cost

Replace-ment

Cost

Net

Realizable

Value

NRV - (.20 x HC)

“Floor”

“Market”

Value

Final

Inventory

Value

Vehicle Inventory

Explorer 22,000 20,500 19,500 15,100 19,500 19,500

Forerunner 21,000 21,750 27,500 23,300

Caravan 14,000 11,250 14,250 11,450

Vehicle Total

Supplies Inventory

Tire 50 65 90 80

Foglight 80 45 55 39

Supplies

Total

Totals

Item-by-Item Method

Next, choose lower of historical cost or “market.”

Item Historical

Cost

Replace-ment

Cost

Net

Realizable

Value

NRV - (.20 x HC)

“Floor”

“Market”

Value

Final

Inventory

Value

Vehicle Inventory

Explorer 22,000 20,500 19,500 15,100 19,500 19,500

Forerunner 21,000 21,750 27,500 23,300 23,300

Caravan 14,000 11,250 14,250 11,450

Vehicle Total

Supplies Inventory

Tire 50 65 90 80

Foglight 80 45 55 39

Supplies

Total

Totals

Item-by-Item Method

Do the same procedures, Item-by-Item.

Item Historical

Cost

Replace-ment

Cost

Net

Realizable

Value

NRV - (.20 x HC)

“Floor”

“Market”

Value

Final

Inventory

Value

Vehicle Inventory

Explorer 22,000 20,500 19,500 15,100 19,500 19,500

Forerunner 21,000 21,750 27,500 23,300 23,300 21,000

Caravan 14,000 11,250 14,250 11,450

Vehicle Total

Supplies Inventory

Tire 50 65 90 80

Foglight 80 45 55 39

Supplies

Total

Totals

Item-by-Item Method

Item Historical

Cost

Replace-ment

Cost

Net

Realizable

Value

NRV - (.20 x HC)

“Floor”

“Market”

Value

Final

Inventory

Value

Vehicle Inventory

Explorer 22,000 20,500 19,500 15,100 19,500 19,500

Forerunner 21,000 21,750 27,500 23,300 23,300 21,000

Caravan 14,000 11,250 14,250 11,450 11,450

Vehicle Total

Supplies Inventory

Tire 50 65 90 80

Foglight 80 45 55 39

Supplies

Total

Totals

Item-by-Item Method

Item Historical

Cost

Replace-ment

Cost

Net

Realizable

Value

NRV - (.20 x HC)

“Floor”

“Market”

Value

Final

Inventory

Value

Vehicle Inventory

Explorer 22,000 20,500 19,500 15,100 19,500 19,500

Forerunner 21,000 21,750 27,500 23,300 23,300 21,000

Caravan 14,000 11,250 14,250 11,450 11,450 11,450

Vehicle Total

Supplies Inventory

Tire 50 65 90 80

Foglight 80 45 55 39

Supplies

Total

Totals

Item-by-Item Method

Item Historical

Cost

Replace-ment

Cost

Net

Realizable

Value

NRV - (.20 x HC)

“Floor”

“Market”

Value

Final

Inventory

Value

Vehicle Inventory

Explorer 22,000 20,500 19,500 15,100 19,500 19,500

Forerunner 21,000 21,750 27,500 23,300 23,300 21,000

Caravan 14,000 11,250 14,250 11,450 11,450 11,450

Vehicle Total

51,950

Supplies Inventory

Tire 50 65 90 80 80

Foglight 80 45 55 39

Supplies

Total

Totals

Item-by-Item Method

Item Historical

Cost

Replace-ment

Cost

Net

Realizable

Value

NRV - (.20 x HC)

“Floor”

“Market”

Value

Final

Inventory

Value

Vehicle Inventory

Explorer 22,000 20,500 19,500 15,100 19,500 19,500

Forerunner 21,000 21,750 27,500 23,300 23,300 21,000

Caravan 14,000 11,250 14,250 11,450 11,450 11,450

Vehicle Total

51,950

Supplies Inventory

Tire 50 65 90 80 80 50

Foglight 80 45 55 39

Supplies

Total

Totals

Item-by-Item Method

Item Historical

Cost

Replace-ment

Cost

Net

Realizable

Value

NRV - (.20 x HC)

“Floor”

“Market”

Value

Final

Inventory

Value

Vehicle Inventory

Explorer 22,000 20,500 19,500 15,100 19,500 19,500

Forerunner 21,000 21,750 27,500 23,300 23,300 21,000

Caravan 14,000 11,250 14,250 11,450 11,450 11,450

Vehicle Total

51,950

Supplies Inventory

Tire 50 65 90 80 80 50

Foglight 80 45 55 39 45

Supplies

Total

Totals

Item-by-Item Method

Item Historical

Cost

Replace-ment

Cost

Net

Realizable

Value

NRV - (.20 x HC)

“Floor”

“Market”

Value

Final

Inventory

Value

Vehicle Inventory

Explorer 22,000 20,500 19,500 15,100 19,500 19,500

Forerunner 21,000 21,750 27,500 23,300 23,300 21,000

Caravan 14,000 11,250 14,250 11,450 11,450 11,450

Vehicle Total

51,950

Supplies Inventory

Tire 50 65 90 80 80 50

Foglight 80 45 55 39 45 45

Supplies

Total

Totals

Item-by-Item Method

Item-by-Item Method

Item Historical

Cost

Replace-ment

Cost

Net

Realizable

Value

NRV - (.20 x HC)

“Floor”

“Market”

Value

Final

Inventory

Value

Vehicle Inventory

Explorer 22,000 20,500 19,500 15,100 19,500 19,500

Forerunner 21,000 21,750 27,500 23,300 23,300 21,000

Caravan 14,000 11,250 14,250 11,450 11,450 11,450

Vehicle Total

51,950

Supplies Inventory

Tire 50 65 90 80 80 50

Foglight 80 45 55 39 45 45

Supplies

Total

95

Totals 52,045

Category Method

Item Historical

Cost

Replace-ment

Cost

Net

Realizable

Value

NRV - (.20 x HC)

“Floor”

“Market”

Value

Final

Inventory

Value

Vehicle Inventory

Explorer 22,000 20,500 19,500 15,100

Forerunner 21,000 21,750 27,500 23,300

Caravan 14,000 11,250 14,250 11,450

Vehicle Total

57,000 53,500 61,250 49,850 53,500

Supplies Inventory

Tire 50 65 90 80

Foglight 80 45 55 39

Supplies

Total

Totals

Total up each column within Category. Then apply the same method.

Category Method

Item Historical

Cost

Replace-ment

Cost

Net

Realizable

Value

NRV - (.20 x HC)

“Floor”

“Market”

Value

Final

Inventory

Value

Vehicle Inventory

Explorer 22,000 20,500 19,500 15,100

Forerunner 21,000 21,750 27,500 23,300

Caravan 14,000 11,250 14,250 11,450

Vehicle Total

57,000 53,500 61,250 49,850 53,500 53,500

Supplies Inventory

Tire 50 65 90 80

Foglight 80 45 55 39

Supplies

Total

Totals

Category Method

Item Historical

Cost

Replace-ment

Cost

Net

Realizable

Value

NRV - (.20 x HC)

“Floor”

“Market”

Value

Final

Inventory

Value

Vehicle Inventory

Explorer 22,000 20,500 19,500 15,100

Forerunner 21,000 21,750 27,500 23,300

Caravan 14,000 11,250 14,250 11,450

Vehicle Total

57,000 53,500 61,250 49,850 53,500 53,500

Supplies Inventory

Tire 50 65 90 80

Foglight 80 45 55 39

Supplies

Total

130 110 145 119 119

Totals

Category Method

Item Historical

Cost

Replace-ment

Cost

Net

Realizable

Value

NRV - (.20 x HC)

“Floor”

“Market”

Value

Final

Inventory

Value

Vehicle Inventory

Explorer 22,000 20,500 19,500 15,100

Forerunner 21,000 21,750 27,500 23,300

Caravan 14,000 11,250 14,250 11,450

Vehicle Total

57,000 53,500 61,250 49,850 53,500 53,500

Supplies Inventory

Tire 50 65 90 80

Foglight 80 45 55 39

Supplies

Total

130 110 145 119 119 119

Totals

Item Historical

Cost

Replace-ment

Cost

Net

Realizable

Value

NRV - (.20 x HC)

“Floor”

“Market”

Value

Final

Inventory

Value

Vehicle Inventory

Explorer 22,000 20,500 19,500 15,100

Forerunner 21,000 21,750 27,500 23,300

Caravan 14,000 11,250 14,250 11,450

Vehicle Total

57,000 53,500 61,250 49,850 53,500 53,500

Supplies Inventory

Tire 50 65 90 80

Foglight 80 45 55 39

Supplies

Total

130 110 145 119 119 119

Totals 53,619

Category Method

Total Inventory Method

Item Historical

Cost

Replace-ment

Cost

Net

Realizable

Value

NRV - (.20 x HC)

“Floor”

“Market”

Value

Final

Inventory

Value

Vehicle Inventory

Explorer 22,000 20,500 19,500 15,100

Forerunner 21,000 21,750 27,500 23,300

Caravan 14,000 11,250 14,250 11,450

Vehicle Total

57,000 53,500 61,250 49,850

Supplies Inventory

Tire 50 65 90 80

Foglight 80 45 55 39

Supplies

Total

130 110 145 119

Totals 57,130 53,610 61,395 49,969 53,610

Total all columns then apply same method.

Total Inventory Method

Item Historical

Cost

Replace-ment

Cost

Net

Realizable

Value

NRV - (.20 x HC)

“Floor”

“Market”

Value

Final

Inventory

Value

Vehicle Inventory

Explorer 22,000 20,500 19,500 15,100

Forerunner 21,000 21,750 27,500 23,300

Caravan 14,000 11,250 14,250 11,450

Vehicle Total

57,000 53,500 61,250 49,850

Supplies Inventory

Tire 50 65 90 80

Foglight 80 45 55 39

Supplies

Total

130 110 145 116

Totals 57,130 53,610 61,395 49,969 53,610 53,610

Final Total Inventory Value

Method Total Inventory Value

Item-by-Item $52,045

Category $53,619

Total Inventory $53,610

Presenting the Markdown to Market

Assume Paterno chooses Total Inventory Method

(LCM yields ending balance of $53,610)

Need a journal entry to adjust inventory balance down from Historical Cost balance of $57,130 to LCM ending balance of $53,610 (a difference of $3,520).

Two methods of adjustment:

• Direct method: Adjust directly to Inventory and directly to Cost of Goods Sold

• Allowance method: Adjust to contra-asset allowance account and to Holding Loss account

Presenting the Markdown to Market

• Direct Method:

Cost of Goods Sold 3,520 Inventory 3,520

• Allowance Method:

Inventory Holding Loss 3,520Inventory LCM Allowance 3,520

Presenting the Markdown to Market

Direct Method Allowance Method

82,000 82,000

95,000 95,000

20,000 20,000

115,000 115,000

(53,610) (57,130)

(61,390) (57,870)

Sales

Beg Inv.

Purchs.

End Inv.

CoGAS

COGS

Gross Marg. 20,610 24,130

Holding Loss (3,520)

Adj. Gross Marg. 20,610

Stated at LCM Stated at Historical Cost