Lower of Cost or Market vs Net Realizable Value
Lesson:
Sometimes the value of inventory drops below its original cost. Consider a cellphone. It could be worth quite a bit upon release, but a couple of years later? It will be worth a tiny fraction of its original cost, because newer, better things are available. Similarly, other items expire. Consider a pallet of fresh food. The longer it's in inventory, the less desirable (and valuable) it becomes.
So how do we adjust the value of inventory to adjust for these changes? We have two popular systems to choose from: Lower of Cost or Net Realizable Value.
The rule of thumb is that LCM is the default option, unless it's a US company that uses the LIFO or the retail inventory method.
You're a consultant with expertise in inventory management. One of your clients needs your help to determine which method to use for tracking inventory.
Here are the relevant facts:
- The firm uses LIFO for inventory management.
Which should be used, NRV or LCM?
Answer:
- The firm should use Lower of Cost or Market.
Explanation:
-
Firms that use LIFO should be using the lower of Cost and Market (LCM).