Lower of Cost or Market

Lower of Cost or Market Definition

Lower of Cost or Market (LCM) is an accounting principle requiring inventory to be valued at the lower of its original cost or its current market replacement cost. If inventory can't be sold for more than it cost (due to obsolescence, damage, or market conditions), it must be written down to reflect the lower value. This conservative approach prevents overstatement of assets.

Lower of Cost or Market in Practice — Example

A electronics retailer bought 100 tablets at $200 each in January. By year-end, the same tablets wholesale for $150 due to newer models entering the market. Under LCM, the 30 remaining tablets must be valued at $150 each (market price), not $200 (original cost). The retailer records a $1,500 write-down ($50 × 30 units) as an inventory adjustment, reducing both the inventory asset and current period income.

Why Lower of Cost or Market Matters for Your Books

LCM prevents your Balance Sheet from showing inflated inventory values that don't reflect economic reality. If you paid $10,000 for inventory that now has a market value of $6,000, showing it at cost overstates your assets by $4,000. This misleads lenders, investors, and even yourself about the business's true financial position.

The principle also matches the decline in inventory value with the period it occurred, providing more accurate income measurement. Rather than waiting until the obsolete inventory is sold (which might be never), the write-down hits the income statement when the impairment happens.

For businesses with seasonal or technology products, LCM is particularly important. Fashion items, electronics, and holiday merchandise can lose value quickly. Regular LCM analysis prevents these losses from accumulating undetected in your books.

How Lower of Cost or Market Shows Up in QuickBooks

QBO doesn't have an automated LCM calculation, but you can implement it manually. Compare your inventory items' costs (from the Inventory Valuation Summary) with current replacement costs from suppliers. For items where market is lower than cost, create an inventory adjustment (+ New → Inventory Qty Adjustment) to reduce quantities or use a journal entry to write down value. The write-down typically goes to an expense account like "Inventory Shrinkage" or "Cost of Goods Sold." Document your analysis for audit purposes.

Common Mistakes

Only applying LCM at year-end: While annual application is common, apply LCM whenever you become aware of permanent declines in value. Don't wait for year-end to recognize obvious impairments.

Using selling price instead of replacement cost: LCM compares original cost to current wholesale/replacement cost, not the price you sell to customers. Replacement cost is what you'd pay to buy the same item today.

Not documenting the analysis: Keep records of how you determined market values and which items were written down. This documentation supports your accounting treatment during audits or reviews.

FAQ

Q: Can I write inventory back up if market value recovers?

A: Under U.S. GAAP, no. Once you write down inventory under LCM, you can't write it back up even if market conditions improve. The new lower cost becomes the new basis for future LCM comparisons.

Q: How often should I apply the LCM test?

A: Annually at minimum, but more frequently for fast-changing industries. Technology, fashion, and seasonal businesses should consider quarterly LCM reviews.

Related Terms

Inventory

Net Realizable Value

Impairment

FIFO

Cost of Goods Sold

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