Lesson 9 of 26
International and U.S. accounting standards require companies to carry inventory on the balance sheet at the lower of cost or market (LCM).
With LCM an unrealized loss caused by a change that materially disconnects the in the fair market value of current inventory from the most recently reported book value of inventory must be immediately recognized.
This will lower the book value of assets on the balance sheet and reduce profit.
Example: The feature music file sharing device sold by an electronics chain has just become obsolete due to the advances offered by a new device that is not sold by this chain. Regardless of inventory accounting method, the electronics chain must write down its inventory and take a write down charge on its income statement to more accurately reflect true financial position and performance.
Internationally (IFRS-IAS), net realizable value represents the cost to finalize and sell inventory.
In the US (GAAP), market value is generally estimated as the present replacement cost of the inventory.