Lower-of-Cost-or-Market Rule

1. Explain the need for reporting inventory at the lower-of-cost-or-market.

2. Differentiate between a problem caused by a drop in the purchase value of inventory and one coming from the sales value of the merchandise.

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3. Understand the difference in applying the lower-of-cost-or-market rule under U.S. GAAP and IFRS.

Question: In the example of Rider Inc., Model XY-7 bicycles have been bought and sold and one unit remains in

stock at the end of the year. The cost of this model has held steady at $260. However, its market value is likely to

differ from that figure.

Assume that, because of the sales made during the period, company officials believe that a buyer will eventually

be found to pay $440 for this last bicycle. Is inventory always reported on a balance sheet at historical cost or is

market (or fair) value ever taken into consideration? Should this bicycle be shown as an asset at $260, $440, or

some other pertinent figure?

Answer: Under normal conditions, market value is rarely relevant in the reporting of inventory. For Rider Inc. this

bicycle will most likely appear as an asset at its cost of $260 until sold. Value is such a subjective figure that it is

usually ignored in reporting inventory. The company has no reliable proof that the bicycle will bring in $440 until

a sale actually occurs. The conservative nature of accounting resists the temptation to inflate reported inventory

figures based purely on the anticipation of a profitable transaction at some point in the future.

An exception to this rule becomes relevant if the value of inventory falls below cost. Once again, the conservatism

inherent in financial accounting is easily seen. If market value remains greater than cost, no change is made in

the reported balance until a sale occurs. In contrast, if the value drops so that inventory is worth less than cost, a

loss is recognized immediately. Accountants often say that losses are anticipated but gains are not. As a note to the June 24, 2009, financial statements for Winn-Dixie Stores states, “Merchandise inventories are stated at the

lower-of-cost-or-market” (emphasis added). Whenever inventory appears to have lost value for any reason, the

accountant compares the cost of the item to its market value and the lower figure then appears on the balance


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