CPA Exam - FAR (Financial Accounting and Reporting)Select TransactionsHard
A company uses the LIFO inventory costing method. Due to obsolescence, a specific inventory item, which originally cost $100, has a current replacement cost of $80 and an estimated selling price of $110. Selling costs are $15, and normal profit margin is $10. What is the value of this inventory item using the lower-of-cost-or-market (LCM) rule?
- A$100
- B$95
- C$90
- D$80
Show answer & explanationAnswer & explanation
Correct answer: C. $90
Under the LIFO/retail inventory methods, the lower-of-cost-or-market (LCM) rule applies. Market is defined as the middle value of replacement cost, net realizable value (ceiling), and net realizable value less normal profit (floor). The inventory is then valued at the lower of its cost or this determined market value.
Why the other options are wrong
- A. This is the original cost, which might be the LCM value if it's lower than market, but not in this case.
- B. This is the net realizable value (ceiling), which is one of the market components, but not the final LCM value.
- D. This is the replacement cost, which might be the market value, but not necessarily the final LCM value.
Lower-of-Cost-or-Market (LCM) Rule
An inventory valuation method used with LIFO/retail, where inventory is reported at the lower of its historical cost or its market value.
- Market value is constrained by a 'ceiling' (NRV) and a 'floor' (NRV minus normal profit).
- Market value is the middle of replacement cost, ceiling, and floor.
- If market is lower than cost, inventory is written down, and a loss is recognized.
Memory trick: LIFO's Low Cost Market Check.