CPA Exam - FAR (Financial Accounting and Reporting)Select TransactionsHard
A company uses the LIFO inventory costing method. At year-end, the inventory records show the following: Product A has a cost of $50 per unit and a replacement cost of $45 per unit. The net realizable value (NRV) for Product A is $48 per unit, and the NRV less a normal profit margin is $43 per unit. What amount should Product A be reported at per unit, applying the lower-of-cost-or-market (LCM) rule under U.S. GAAP?
- A$45
- B$50
- C$43
- D$48
Show answer & explanationAnswer & explanation
Correct answer: A. $45
Under the LCM rule for LIFO (and retail inventory methods), inventory is valued at the lower of its cost or market. Market is determined by three values: replacement cost ($45), NRV ($48), and NRV less a normal profit margin ($43). Market is the middle value of these three, which is $45 (replacement cost). Then, the inventory is valued at the lower of its cost ($50) or market ($45). Therefore, Product A should be reported at $45 per unit.
Why the other options are wrong
- B. This is the cost, which is higher than the determined market value, so it cannot be the reporting value under LCM.
- C. This is NRV less a normal profit margin, which is the 'floor' for market, but not necessarily 'market' itself.
- D. This is the net realizable value (ceiling), which is an upper limit for 'market' but not necessarily 'market' itself.
Lower-of-Cost-or-Market (LCM) Rule
An inventory valuation rule used for LIFO and retail inventory methods, where inventory is reported at the lower of its historical cost or its 'market' value.
- Market is the middle value of: Replacement Cost, Net Realizable Value (Ceiling), and Net Realizable Value less a normal profit margin (Floor).
- Applied item by item, by category, or total inventory.
- Write-downs create a loss recognized in the period of the decline.
- NRV (Ceiling) = Selling price - costs to complete and sell.
- NRV - Normal Profit (Floor) = Ceiling - Normal Profit.
Memory trick: Cost vs. Market: Find the middle, then pick the lower fiddle.