Lower of Cost or Market in 4 Steps

Under U.S. generally accepted accounting principles (GAAP), lower of cost or market (LCM) applies to inventory measured under last-in, first-out (LIFO) or the retail inventory method. Market is replacement cost, capped at net realizable value (NRV) as a ceiling, with NRV minus a normal profit margin as the floor. Report inventory at the lower of cost or market.

Suppose a supplier cuts its price just before year-end. The new quote tells you what another unit would cost today. Whether the company has a loss on the unit already on its shelf also depends on what that unit can earn when sold.

Video walkthrough of designated market

Start at 2:41 to calculate net realizable value, establish the floor, and choose the middle amount. Watch the segment on YouTube.

When does lower of cost or market apply?

Read the inventory method in the question before using the numbers. Under LIFO or the retail inventory method, use the market test below. For inventory measured by first-in, first-out (FIFO) or average cost, U.S. GAAP instead compares recorded cost directly with net realizable value (NRV). That simpler test is called lower of cost and net realizable value (LCNRV), and we walk through it in our LCNRV guide. The store’s line of business alone does not tell you which method it uses. A retailer can use FIFO.

On the CPA exam, inventory measurement is part of Financial Accounting and Reporting (FAR), Area II, Select Balance Sheet Accounts. Many questions hinge on this first step: identify the cost method, then choose LCM or LCNRV.

Why the split? When the Financial Accounting Standards Board (FASB) simplified inventory measurement in Accounting Standards Update (ASU) 2015-11, stakeholders warned that moving LIFO and retail-method inventory to LCNRV could bring significant transition costs that the benefits would not justify, because those methods are already complex. So the FASB left them under LCM.

The FASB draws this distinction in Accounting Standards Codification (ASC) 330-10-35-1A through 35-1C, and the LIFO and retail guidance continues through 35-7. Read ASU 2015-11 from the FASB (PDF).

How to apply lower of cost or market in four steps

Designated market is replacement cost after you apply both limits. In practice, it is the middle value of three numbers: the floor, replacement cost, and the ceiling.

The ceiling protects against carrying an item above the amount the company expects to recover from its sale. The floor addresses a different problem. An unusually cheap replacement quote could lead to an excessive loss today and an unusually large profit when the unit sells. The floor limits how far that quote can reduce designated market.

Lower of cost or market example: from supplier quote to journal entry

Suppose an audio-equipment distributor uses LIFO and tests items individually at year-end. It holds 40 identical portable speakers at a recorded cost of $89 each. Each speaker should sell for $100. Final testing and outbound shipping will cost $6 per unit in total. Its normal profit is 18% of selling price. A supplier now quotes $71 per speaker.

Ceiling and floor. The ceiling is $100 − $6 = $94. The normal profit allowance is 18% × $100 = $18. Subtract $18 from $94 to find the $76 floor. The three candidates in order are $71, $76, and $94. Designated market is $76 because the quote falls below the floor.

Carrying amount and loss. Compare $89 with $76. Inventory ends at 40 × $76 = $3,040. It previously stood at 40 × $89 = $3,560. The decline is $520, or $13 per speaker. Using the loss method, which records the decline in a separate loss account and credits Inventory directly, the distributor makes this year-end entry. Many companies debit Cost of Goods Sold instead, and some credit an allowance account rather than Inventory. Every version leaves inventory reported at $3,040.

Change only the supplier quote and you can see why each limit matters. At $83, the quote falls inside the range, so market is $83 and the loss is $6 per speaker. At $99, market is capped at $94. Recorded cost of $89 is already lower, so inventory stays at $89 per speaker.

Common calculation mistakes

Including historical cost in the middle-number test. Keep the original $89 to one side until step four. The first comparison determines market, and the second determines what goes on the balance sheet.

Applying a percentage to the wrong amount. In this example the margin is expressly stated as a percentage of selling price. Multiplying 18% by NRV would give $16.92. Check the stated base and convert the margin to dollars before subtracting it.

Mixing unit prices and total balances. Compare two per-unit amounts or two extended totals for the same stock. If several product lines appear, the point at which you add them can change the result. See how item, category, and total inventory comparisons change the write-down.

Key takeaways

• Under U.S. GAAP, LCM applies only to inventory measured with LIFO or the retail inventory method. FIFO and average cost use LCNRV instead.
• The ceiling is NRV: the expected selling price minus reasonably predictable costs to complete, sell, and transport the goods.
• The floor is NRV minus a normal profit margin.
• Designated market is the middle of the floor, replacement cost, and the ceiling.
• Report the lower of cost and designated market. Under U.S. GAAP, the written-down amount becomes the new cost and is not written back up at a later year-end.

Practice questions with answers

1. When does replacement cost control?

A LIFO item costs $58. Its ceiling is $64, its floor is $50, and its replacement cost is $54. Answer: $54 carrying amount and a $4 loss. The quote lies within the limits. Compare that $54 with the $58 cost.

2. Can the carrying amount be below the floor?

An item costs $34. Its floor is $38, ceiling is $47, and replacement cost is $32. Answer: yes, inventory remains at $34. The floor makes designated market $38. The final comparison still selects the lower recorded cost.

3. Which amount would a FIFO company use?

An item costs $82, NRV is $79, and replacement cost is $70. Answer: $79. FIFO uses the direct cost-versus-NRV comparison under U.S. GAAP, which our LCNRV guide covers step by step. The $3 loss recognizes the shortfall in expected recovery.

Interactive lower of cost or market (LCM) quiz

Test your understanding of when LCM applies, how replacement cost relates to designated market, and how net realizable value and a normal profit margin set the ceiling and floor.

Frequently asked questions

How do I estimate a normal profit margin?

Use evidence about ordinary margins for comparable products. Recent selling prices, the product’s margin history, and changes in demand can help. A problem may supply a dollar amount directly. If so, subtract that dollar amount from NRV once.

Does international guidance use the same ceiling and floor?

For ordinary merchandise under International Accounting Standard 2, the comparison is cost versus NRV. The U.S. LIFO/retail ceiling-and-floor calculation belongs to a different measurement rule. See the IFRS Foundation’s IAS 2 summary.

What is the difference between LCM and LCNRV?

Both rules stop inventory from being carried above its value to the company, but they apply to different cost methods. LCM is for LIFO and retail-method inventory, and it compares cost with designated market, which is replacement cost held between a ceiling and a floor. LCNRV is for everything else, such as FIFO and average cost, and it compares cost directly with NRV. There is no floor and no replacement cost. See our lower of cost or net realizable value guide for a full example.

Can an inventory write-down be reversed later?

Not under U.S. GAAP at year-end. Once you write inventory down, the lower amount becomes its new cost, and you do not write it back up if prices recover (ASC 330-10-35-14). One narrow exception: a loss recorded on inventory in an earlier interim quarter can be recovered through an increase in the value of that same inventory in a later quarter of the same fiscal year, limited to the previously recognized loss (ASC 270-10-45-6(c)). IFRS is different. IAS 2 allows a reversal, limited to the amount of the original write-down.

Do you apply LCM item by item or to total inventory?

U.S. GAAP lets companies apply the test to individual items, to major categories, or to total inventory, using whichever approach most clearly reflects periodic income, and applying it consistently. Item by item usually produces the largest write-down, because a gain on one item cannot offset a loss on another. Our item, category, and total comparison runs one set of numbers all three ways.

How does LCM work with the retail inventory method?

Retailers using the conventional retail method usually do not run the ceiling-and-floor test item by item. Instead, they build the cost-to-retail ratio with net markups included and net markdowns left out. That lower ratio produces an ending inventory that approximates lower of cost or market. Learn the ratio step by step in our retail inventory method guide.

Can a LIFO company deduct an LCM write-down on its tax return?

No. For federal tax purposes, inventory valued under LIFO must be stated at cost, regardless of market (Treasury Regulation section 1.472-2(b)). So a LIFO company’s book write-down is not deductible when it is recorded, and it creates a temporary difference between book and tax inventory. That makes this a useful point for Enrolled Agent (EA) candidates as well as CPA candidates.

About the author

Mansour Farhat, CPA, CIA, DBA, teaches the accounting and CPA exam courses at Farhat Lectures, including Intermediate Accounting. Have a question about this example? Ask in the comments below.

Last reviewed against ASC 330: November 2026.

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