Lower of Cost or Market (LCM)

We will use the information in the following table to calculate the net realizable value and the lower of cost or market for five products:

Product:	A	B	C	D	E
Cost	$ 6.00	$ 5.00	$ 8.00	$ 8.75	$ 2.00
Replacement cost	4.50	3.00	8.50	9.00	2.50
Expected selling price	10.00	4.50	12.00	10.00	4.00
Cost to complete & dispose	3.00	1.00	2.50	1.50	1.00
Normal profit*	2.00	0.90	2.40	2.00	0.80

  *We will assume a normal profit equal to 20% of the selling price

Recall the lower of cost or market (LCM) rule: LCM is the lower of cost or replacement cost, with the replacement cost being no higher than NRV and no lower than NRV minus the normal profit.

Since the replacement cost was given, we will begin by calculating the net realizable value (NRV) of each of the products. Recall that net realizable value is the expected selling price in the ordinary course of business minus the cost to complete and dispose. NRV will be the upper limit (the ceiling) for the replacement cost.

Net Realizable Value (NRV): The Ceiling in LCM

Product:	A	B	C	D	E
Expected selling price	10.00	4.50	12.00	10.00	4.00
Less: Cost to complete & dispose	3.00	1.00	2.50	1.50	1.00
Net realizable value = CEILING*	7.00	3.50	9.50	8.50	3.00

  *If the replacement cost is greater than this ceiling, use this ceiling as the market amount.

Next we will calculate the NRV minus the normal profit. This amount will be the lower limit (the floor) for the replacement cost.

NRV minus the Normal Profit: The Floor in LCM

Product:	A	B	C	D	E
Net realizable value = CEILING*	7.00	3.50	9.50	8.50	3.00
Less: normal profit (20% of selling price)	2.00	0.90	2.40	2.00	0.80
NRV - normal profit = FLOOR*	5.00	2.60	7.10	6.50	2.20

  *If the replacement cost is lower than this floor, use this floor as the market amount.

The following chart displays the four relevant amounts used in the lower of cost or market rule: (1) cost, (2) the upper limit, or ceiling, for the replacement cost, (3) replacement cost, and (4) the lower limit, or floor, for the replacement cost. The lower of cost or market amount appears in bold font:

Product:	A	B	C	D	E
Cost	$ 6.00	$ 5.00	$ 8.00	$ 8.75	$ 2.00
Market information:
NRV (ceiling)	7.00	3.50	9.50	8.50	3.00
Replacement cost	4.50	3.00	8.50	9.00	2.50
NRV - normal profit (floor)	5.00	2.60	7.10	6.50	2.20

Let's review the lower of cost or market for each of the five products shown in the above table:

Product A
Cost	vs.	Market
$6.00	vs.	$7.00	NRV (ceiling)
		$5.00	NRV - normal profit (floor)
		$4.50	Replacement cost
As you can see, the $4.50 replacement cost is less than the floor of $5.00. Because it is below the floor, the replacement cost cannot be used as the market amount. Instead, the floor of $5.00 is used as the market amount for Product A. The lower of cost or market is $5.00 (the lower of the $6.00 cost vs. the $5.00 market).

Product B
Cost	vs.	Market
$5.00	vs.	$3.50	NRV (ceiling)
		$3.00	Replacement cost
		$2.60	NRV - normal profit (floor)
The $3.00 replacement cost is between the floor of $2.60 and the ceiling of $3.50. As a result the $3.00 replacement cost is used as the market amount for Product B. The lower of cost or market is $3.00 (the lower of the $5.00 cost vs. the $3.00 market).

Product C
Cost	vs.	Market
$8.00	vs.	$9.50	NRV (ceiling)
		$8.50	Replacement cost
		$7.10	NRV - normal profit (floor)
The $8.50 replacement cost is between the ceiling of $9.50 and the floor of $7.10. This means the $8.50 replacement cost is the market amount for Product C. However, lower of cost or market is $8.00 (the lower of the $8.00 cost vs. $8.50 market).

Product D
Cost	vs.	Market
$8.75	vs.	$9.00	Replacement cost
		$8.50	NRV (ceiling)
		$6.50	NRV - normal profit (floor)
The $9.00 replacement cost is above the ceiling of $8.50. Because it is above the ceiling, the replacement cost cannot be used as the market amount. Instead, the ceiling of $8.50 is used as the market amount for Product D. The lower of cost or market is $8.50 (the lower of the $8.75 cost vs. the $8.50 market).

Product E
Cost	vs.	Market
$2.00	vs.	$3.00	NRV (ceiling)
		$2.50	Replacement cost
		$2.20	NRV - normal profit (floor)
Because the $2.50 replacement cost is between the ceiling of $3.00 and the floor of $2.20, the $2.50 replacement cost is used as the market amount for Product E. However, the lower of cost or market is $2.00 (the lower of the $2.00 cost vs. the $2.50 market).

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