The purpose of the lower-of-cost-or-market method includes the following. First, it provides a realistic, verifiable, and objective reporting. It recognizes losses on the income statement and reports the lower inventory valuation on the balance sheet (Heintz & Parry, 2014). Second, it serves to implement the matching principle. For instance, it ensures that loss of inventory value is reported in the same period as revenue derived from the sales of inventory. Third, it serves to implement the conservatism principle. In situations when accountants have two acceptable alternatives for reporting values, they should choose a method that results in a lower asset value.

A market entails the cost to replace the inventory. It is the price prevailing in the market and businesses use that to purchase the goods (Heintz & Parry, 2014). With market ceiling, the market amount cannot exceed the net realizable value (NRV). For instance, if the current replacement cost exceeds the net realizable value, then the net realizable value is used as the market amount. Floor for market implies that the market amount is the net realizable value less the normal profit. For instance, if the current replacement cost is the less than net realizable value minus normal profit, the market amount is taken as net realizable value minus normal profit.

Reference

Heintz, J. A., & Parry, R. W. (2014). College Accounting: Chapters 1-15. Mason, OH: South-Western, Cengage Learning.

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