Lower of Cost or Market

Lesson:

Figuring out cost is easy. It's what a firm paid. Firms normally use cost as the value for inventory.

There's a problem though. Sometimes the value of items drop substantially. Think about a new computer. When it's first manufactured, it's worth a lot. A couple of years later, it's barely worth anything, because it's obsolete. Recording its value at its original cost no longer makes any sense.

When the cost drops below the market value, firms should downgrade its value to the market value (when using LIFO or retail inventory methods).

Unfortunately, figuring out what the market value is can be challenging. Firms first need to compute three values:

  • Replacement Cost - How much it would cost for the firm to buy
  • Net Realizable Value - How much it would sell for minus the cost to complete the sale (shipping and handling, commissions, etc.)
  • Net Realizable Value Minus Normal Profit

So if it could be one of the three, which one should be chosen to represent the market price?

The one in the middle (the median). Arrange the three values from least to greatest, and pick the one in the middle.

Llamas, LLC, the famed stool manufacturer, is looking at an item. The replacement cost is $168.00, the net realizable value is $186.00, the original cost was $210.00, and the net realizable value minus normal profit is $159.00.
What is the lower of cost and market?

Answer:

  • The lower of cost and market is $168.00.

Explanation:

  1. First, find the middle value
    MIDDLE VALUE = MIDDLE OF(REPLACEMENT COST, NET REALIZABLE VALUE, NET REALIZABLE VALUE MINUS PROFIT)
  2. Let's plug the numbers in
    $168.00 = MIDDLE OF($168.00, $186.00, $159.00)
  3. Next, pick the lower of the middle value and the original cost
    LOWER VALUE = SMALLEST(MIDDLE VALUE, ORIGINAL COST)
  4. Plug the numbers in
    $168.00 = SMALLEST($168.00, $210.00)
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