Task Team of FUNdaMENTAL aCCOUNtIng School of Business. Sun Yat-sen University r ma GAAP require that inventory be reported at market value whenever market value is lower than cost.This is the lower-of-cost-or-market(LCm)rule The following points are essential to understand LCM; Y The cost of ending inventory is determined by using one of the four inventory pricing methods. On the balance sheet, inventory is reported at market value whenever market is lower than the cost reported under the chosen pricing method Y Cost is the price paid for an item. Market value is defined as net realizable value (NRV, which is sales price less additional costs to sell, or as replacement cost, which is the price that would have to be paid to purchase(replace)the item on the inventory date Y If the market value of inventory falls below its original cost, a holding loss occurs. It is likely that the sales price of inventory will also decrease. The holding loss should be recorded in the period during which the price declined. This is the basic concept of LCM Y LCM allocates holding losses to the period during which a firm holds inventory, and all remaining income to the period during which merchandise is sold Y LCM may be applied to the inventory as a whole, by major category, or separately to Estimating inventories Inventory estimation can be used in preparing interim financial statements to determine if the physical inventory count is reasonable or in determining the amount of inventory lost in a flood, destroyed in a fire, or stolen. The two common methods of inventory estimation are the gross profit method and the retail inventory method Retail inventory method The retail inventory method is used to estimate the amount of ending inventory based on a cost ratio, according to the following formula Cost ratio= Amount of goods for sale at markedselling price Using the retail method of inventory estimation, interim financial statements can be prepared monthly or quarterly without a physical inventory count. The ending inventory is estimated by converting retail prices(or the marked selling price)to cost amounts. Records must be kept at both cost and retail as follows At cost. Goods available for sale= beginning inventory+ Net purchases Ending inventory= Beginning inventory Net purchases -Net saleTask Team of FUNDAMENTAL ACCOUNTING School of Business, Sun Yat-sen University 4 Lower of cost or market GAAP require that inventory be reported at market value whenever market value is lower than cost. This is the lower-of-cost-or-market (LCM) rule. The following points are essential to understand LCM:  The cost of ending inventory is determined by using one of the four inventory pricing methods. On the balance sheet, inventory is reported at market value whenever market is lower than the cost reported under the chosen pricing method.  Cost is the price paid for an item. Market value is defined as net realizable value (NRV), which is sales price less additional costs to sell, or as replacement cost, which is the price that would have to be paid to purchase (replace) the item on the inventory date.  If the market value of inventory falls below its original cost, a holding loss occurs. It is likely that the sales price of inventory will also decrease. The holding loss should be recorded in the period during which the price declined. This is the basic concept of LCM.  LCM allocates holding losses to the period during which a firm holds inventory, and all remaining income to the period during which merchandise is sold.  LCM may be applied to the inventory as a whole, by major category, or separately to each product in the inventory. Estimating inventories Inventory estimation can be used in preparing interim financial statements to determine if the physical inventory count is reasonable or in determining the amount of inventory lost in a flood, destroyed in a fire, or stolen. The two common methods of inventory estimation are the gross profit method and the retail inventory method. Retail inventory method The retail inventory method is used to estimate the amount of ending inventory based on a cost ratio, according to the following formula: Cost ratio = Amount of goods for sale at markedsellingprice Amount of goods for sale at cost Using the retail method of inventory estimation, interim financial statements can be prepared monthly or quarterly without a physical inventory count. The ending inventory is estimated by converting retail prices (or the marked selling price) to cost amounts. Records must be kept at both cost and retail as follows: At cost: Goods available for sale = Beginning inventory + Net purchases At retail: Ending inventory = Beginning inventory + Net purchases – Net sales