lowerofcostormarket

Lower of cost or market is an accounting method used to value inventory by ensuring it is not carried at more than its recoverable amount. Under this rule, the carrying amount of inventory is compared with the lower of its cost and its market value, and the lower figure is recorded as the inventory balance. In practice, cost refers to the historical cost of acquiring or producing the inventory, including freight and handling. Market is typically defined as the current replacement cost, but it is limited by a ceiling and a floor to prevent overstatement of assets: the ceiling is the net realizable value (NRV), and the floor is NRV minus a normal profit margin. NRV is the estimated selling price less reasonably predictable costs of completion and disposal.

If the replacement cost (the market) falls below cost, an write-down is required to bring the inventory to the lower amount. The write-down generally reduces reported earnings in the period of the decline and lowers the inventory value on the balance sheet. Under many accounting frameworks, once a write-down is recorded, it cannot be reversed in later periods (at least under U.S. GAAP in some contexts), though reversals may be permitted under other standards.

Differences exist between frameworks. In U.S. GAAP, the traditional lower of cost or market approach uses replacement cost with the ceiling and floor to cap or floor the measurement. Internationally, IFRS uses lower of cost and net realizable value (LCNRV), focusing on NRV rather than replacement cost and allowing reversals in some circumstances if NRV recovers. The basic goal of both approaches is to prevent inventory from being overstated when market conditions decline.