Question

5. What is the lower-of-cost-or-market (LCM) basis of accounting for inventories? Describe the application of LCM.

6. What is the inventory turnover ratio? How is it computed? How is it used by external users and management?

7. What is the LIFO reserve? Explain its importance for comparing results of different companies.

Answer 1

5) Lower of cost, also known as LCM states that inventory need to be recorded at original cost or market/replacement values whichever is lower. This method was considered to be fair because assets are valued on a going-concern basis, instead of the price at which these assets are purchased. Under this method, the items of inventory are written down to market value when the market value, is less in comparison to item's cost. The rule of MCM is applicable to inventory on inventory class basis, individual items basis, or to entire inventory

6) Inventory turnover measures how fast an organisation sells the inventory; and is calculated as cost of goods sold during a defined time frame divided by average inventory. It reflects the firm's efficiency in managing its stock of goods. It is a good indicator of whether the inventory's quality is obsolete or not. This ratio acts as tool to evaluate the liquidity of firm’s inventory to external users and management and provides a link to determine the performance of the warehouse, sale, and purchasing department. Usually, the firms prefer a higher inventory turnover ratio as compared to industry standards

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