Evaluation of the Lower-of-Cost-or-Market Rule

This is the third article on Lower of cost or market. In the first article on this topic, we give a good description on lower of cost market concept. On the second article, we highlighted some of  the Methods of Lower of Cost Or Market concept. Today we will learn about the evaluation of the lower of cost market concept.

  • There are some conceptual deficiencies in the rule of the lower-of-cost-or-market which often become constrains for the lower-of-cost-or-market. These lacking are as follows:  If a company applies the rule of the lower-of-cost-or-market then it recognizes decreases in the value of the asset and then charges to expense in that period in which the loss in utility occurs, the company does not charge in the period of sale. On the other hand, the company recognizes increases in the value of the asset only at the point of sale. This inconsistent performance or result can deform the income data of any company.
  • Application of the rule of the lower-of-cost-or-market sometimes results in inconsistency or irregularity .Because a company may value the inventory at cost in one year and at market in the next year.
  • Though the Lower-of-cost-or-market values the inventory in the balance sheet conventionally, but its effect on the income statement sometimes may not be conservative. Net income for the year in which a company takes the loss is definitely lower. Net income of the consequent period may be higher than normal if the expected decreases in sales price do not appear.
  • The appliance of the lower-of-cost-or-market rule by any company generally uses a “normal profit” in determining inventory values. Because some companies approximate the normal profit based on the past experience (which they may not attain in the future).this individual evaluation presents an opportunity for income manipulation.

Most of the users of financial statement generally appreciate the lower-of-cost-or-market rule, as the users aware that lower-of-cost-or-market could prevent overstatement of inventory as well, recognizing all losses but expecting no benefits generally results in lower income.