# Lower of Cost or Market (LCM) Method: Definition and Uses

![Lower of Cost or Market Method](https://www.investopedia.com/thmb/Q3f6YLhDnYeI8FUkLseJ0AX_yNc=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/Lowerofcostandmarketmethod_final-cba5b199f508448280cdcc05d4f8ebc8.png)

*— Michela Buttignol / Investopedia*

> **Definition**
>
> The lower of cost or market method is an accounting approach that values a company's inventory at the lesser of its historical cost or current market value.

## What Is the Lower of Cost or Market (LCM) Method?

The lower of cost or market (LCM) method is an [inventory](https://www.investopedia.com/terms/i/inventory.asp) valuation technique that ensures inventory is reported at the lower of its [historical purchase cost](https://www.investopedia.com/terms/h/historical-cost.asp) or its current market value, preventing overstatement of asset values.

This approach, required under generally accepted accounting principles (GAAP), promotes transparency in financial statements and is especially relevant when inventory faces declining market prices or becomes obsolete. Recent changes in accounting standards have refined their application to better reflect fair value and [net realizable value](https://www.investopedia.com/terms/n/nrv.asp) (NRV).

### Key Takeaways

*   The lower of cost or market (LCM) method ensures inventory is valued accurately and conservatively, avoiding overstated asset values.
*   LCM is a GAAP requirement and helps record losses by writing down inventory values to prevent overstating profits.
*   Companies using LIFO or average cost must adhere to LCM, aligning with international financial standards.
*   This method is crucial for products that might become obsolete or see declining market prices.
*   LCM adjustments can be mitigated through strategies like hedge accounting or anticipating market recovery.

## The Importance of the Lower of Cost or Market (LCM) Method

The lower of cost or market (LCM) method lets companies record losses by writing down the value of the affected inventory items. This value may be reduced to market value, which is defined as the middle value when comparing the cost to replace the inventory, the difference between the net realizable value and the typical profit on the item, and the net realizable value of the item. The amount by which the inventory item was written down is recorded under [cost of goods sold](https://www.investopedia.com/terms/c/cogs.asp) on the balance sheet.

The LCM method is part of [generally accepted accounting principles (GAAP)](https://www.investopedia.com/terms/g/gaap.asp) used in the United States and in international commerce. Almost all [assets](https://www.investopedia.com/terms/a/asset.asp) enter the [accounting](https://www.investopedia.com/terms/a/accounting.asp) system with a value equal to acquisition cost. GAAP prescribes many different methods for adjusting asset values in subsequent reporting periods.

In 2017, the [Financial Accounting Standards Board (FASB)](https://www.investopedia.com/terms/f/fasb.asp) issued an update to its code and standards that affect companies that use the [average cost](https://www.investopedia.com/terms/a/averagecostmethod.asp) and [last in, first out (LIFO)](https://www.investopedia.com/terms/l/lifo.asp) methods of inventory accounting. Companies that use these two methods of inventory accounting must now use the lower of cost or net realizable value method, which is more consistent with [International Financial Reporting Standards (IFRS)](https://www.investopedia.com/terms/i/ifrs.asp).

## How Businesses Implement the Lower of Cost or Market (LCM) Rule

The lower of cost or market (LCM) rule traditionally applies to companies with products that become obsolete. The rule also applies to products losing value due to a lower market price, defined as the cost of replacing outdated inventory, as long as it isn’t higher or lower than the net realizable value—selling price minus disposal fees.

### Considerations When Applying the Lower of Cost or Market (LCM) Rule

*   **Category analysis**: Although the lower of cost or market (LCM) rule is typically linked to a single product, it may also relate to a broad swath of related products.
*   **Hedges**: In cases where inventory is hedged by a [fair value hedge](https://www.investopedia.com/terms/h/hedge-accounting.asp#:~:text=A%20fair%20value%20hedge%20is,affect%20the%20company's%20reported%20earnings.), the [hedge](https://www.investopedia.com/terms/h/hedge.asp)’s effects should be added to the inventory’s cost, which may obliterate the need for LCM adjustments.
*   **Last in, first out (LIFO) layer recovery**: One may sidestep a write-down to the LCM during interim periods when evidence suggests that inventory will be restored by year’s end.
*   **Raw materials**: One shouldn’t write down [raw material](https://www.investopedia.com/terms/r/rawmaterials.asp) costs, if the finished products are projected to sell at or above their costs.
*   **Recovery**: A [write-down](https://www.investopedia.com/terms/c/capital-recovery.asp) can be avoided if there's enough evidence that market prices will rise before selling the inventory.
*   **Sales incentives**: Potential LCM problems may exist with specific items where yet-to-be expired sales incentives are still in play.

Recent changes to the LCM rule simplify things for businesses not using the retail or LIFO methods. Under the new guidelines, the measurement can be solely restricted to the lower of cost or net realizable value.

## Is the Lower of Cost or Market (LCM) Method Required by Generally Accepted Accounting Principles (GAAP)?

Yes, the LCM method is required under GAAP. This method became required as of 2017.

## What Is the Meaning of the Lower of Cost or Market (LCM) Method?

The lower of cost or market (LCM) method is used to value inventory by comparing the original cost and the current market price, and recording the cost of inventory by whichever is lower. This method is typically applicable to companies that hold inventories for extended periods, when inventory has declined in cost, or if inventory has gone obsolete.

## What Inventory Costing Methods Are Allowed by GAAP?

Along with the lower of cost or market (LCM) method being required by GAAP reporting, other inventory costing methods allowed by GAAP are:

*   [First in, first out (FIFO)](https://www.investopedia.com/terms/f/fifo.asp)
*   Last in, first out (LIFO)
*   [Weighted average valuation](https://www.investopedia.com/ask/answers/09/weighted-average-fifo-lilo-accounting.asp#:~:text=Weighted%20average%20cost%20accounting%20calculates,the%20value%20of%20ending%20inventory.)

## The Bottom Line

The lower of cost or market (LCM) method helps ensure that inventory is not overstated on financial statements, presenting a fair and accurate financial position in line with GAAP requirements. It's especially useful when market values decline or inventory becomes obsolete, helping companies account for potential losses.

Following the 2017 FASB update, firms using average cost or LIFO methods must now follow the lower of cost or net realizable value rule, aligning with IFRS and reinforcing transparency in reporting.