Question

Under IFRS, how do firms determine lower-of-cost-or-market rule adjustments?

Answer 1

Companies usually record the inventory at its cost value. But due to some situations, its market value may decrease beyond its cost value. In this case, companies record the inventory at its market value to record the loss. Hence the principle is to record the inventory at its cost or market value, whichever is low. Thus we can say that lower- of-cost-or-market is conservative approach of valuation. In this cost refers to acquisition value of the inventor calculated one of the historical cost methods. Market refers to cost of replacement through purchase or reproduction. Another concept used in this is ceiling and floor limits to market value to prevent over or undervaluation of the inventory. Ceiling is the Net Realizable Value (NRV) of the inventory calculated by subtracting cost of completion and disposal from selling price. Floor is the MTV less normal profit margin. For lower-of- cost-or-market, designated market value is considered as middle of cost of replacement, ceiling limit and floor limit. But in IFRS, market value is always considered to be equal to net realizable value. Hence, Lower-of-cost-or-market approach in IFRS can also be called as Lower-of-cost-or-net- realizable-value approach.