FAR · Select balance sheet accounts · 8 practice questions
LIFO and Retail Inventory: Lower of Cost or Market
LIFO and retail-method inventories use lower of cost or market, with replacement cost constrained by a ceiling and floor. Below: a worked example and free practice show how to find market before comparing it with cost.
Try one first
Hint
First confirm which valuation rule applies to LIFO (LCM) versus FIFO (LCNRV). For LCM, identify 'market' by comparing replacement cost to the ceiling (NRV) and floor (NRV − normal profit) before comparing market to historical cost.
Answer A. For LIFO under U.S. GAAP use lower of cost or market (LCM). Market is replacement cost ($46) bounded by ceiling (NRV = $48) and floor (NRV − normal profit = $42); $46 lies between $42 and $48 so market = $46. Lower of cost ($50) and market ($46) yields $46 per unit → 5,000 × $46 = $230,000; write-down = ($50 − $46) × 5,000 = $20,000, recognized in income.
Why not B: Tempting if a candidate applies LCNRV (used for FIFO/average-cost) and compares cost to NRV ($48). That approach is incorrect for LIFO, which requires LCM where 'market' is replacement cost bounded by ceiling and floor.
Why not C: Reflects the mistaken belief that inventory stays at historical cost. It's wrong because historical cost ($50) exceeds market ($46), so ASC 330 requires a write-down to market and recognition of the loss.
Why not D: Would result from incorrectly selecting the floor (NRV − normal profit = $42) as market even though replacement cost ($46) is between the ceiling and floor. When replacement cost is within the bounds, market equals replacement cost ($46), not the floor.
Worked example
Pine Co. uses LIFO and holds 300 units of one product at year-end. Per unit: cost $80, replacement cost $60, estimated selling price $100, costs to complete and sell $10, and normal profit $20. No prior write-down exists. Calculate ending inventory and the current-year write-down.
| 1 | NRV ceiling per unit$100 selling price - $10 completion and selling costs | $90 |
| 2 | Floor per unit$90 NRV - $20 normal profit | $70 |
| 3 | Bounded market per unit$60 replacement cost < $70 floor; use the floor | $70 |
| 4 | Lower of cost or market per unitLower of $80 cost and $70 market | $70 |
| 5 | Ending inventory300 units × $70 | $21,000 |
| 6 | Current-year write-down300 units × ($80 - $70) | $3,000 |
Pine reports ending inventory of $21,000 and recognizes a $3,000 write-down in current-year income.
Check: Market is the middle of $60, $70, and $90: $70; the $10 per-unit loss × 300 units = $3,000.
Key points
- FIFO and average-cost inventories use lower of cost and NRV, except retail-method inventories, which use LCM with ceiling and floor.
- Apply LCM at the stated level: individual item, inventory pool, or total inventory.
- Recognize a write-down in current earnings, not other comprehensive income.
How the exam traps you
- Comparing LIFO or retail-method inventory cost directly with NRV. First bound replacement cost by the NRV ceiling and NRV-minus-normal-profit floor; then compare market with cost.
- Using replacement cost without limits, or always choosing the floor. Use the ceiling above the range, the floor below it, and replacement cost inside it.
- Using gross selling price as the ceiling. Subtract costs to complete and sell to calculate NRV, the ceiling.
Question 2
| Product A | Product B | Product C | Product D | |
|---|---|---|---|---|
| Units | 400 | 250 | 150 | 600 |
| Cost per unit | $25 | $20 | $30 | $50 |
| Status | Shipped FOB shipping point 12/29; not yet received | Company K's goods at consignment outlets (K is consignor) | Consigned to K by Supplier Z (title remains with Z) | On hand in K's warehouse |
| Replacement cost per unit | , | , | , | $48 |
| Estimated selling price per unit | , | , | , | $60 |
| Cost of completion and selling per unit | , | , | , | $14 |
| Normal profit margin per unit | , | , | , | $6 |
Hint
First decide ownership (FOB terms and consignments) to determine which items to include; then apply the LIFO measurement rule, determine market (replacement cost bounded by NRV ceiling and NRV-less-normal-profit floor) and take the lower of cost or market for LIFO inventory.
Answer C. Include Product A (FOB shipping point) = 400 × $25 = $10,000 and Product B (Company K is consignor) = 250 × $20 = $5,000; exclude Product C (owned by Supplier Z). For Product D (LIFO), NRV = $60 − $14 = $46, floor = $46 − $6 = $40, replacement cost = $48, so market = the middle value = $46; lower of cost ($50) or market ($46) = $46 → 600 × $46 = $27,600. Total inventory = $10,000 + $5,000 + $27,600 = $42,600.
Why not A: Tempting because it uses replacement cost for Product D (600 × $48 = $28,800) without applying the NRV ceiling; since replacement cost ($48) exceeds the NRV ceiling ($46), market is limited to $46 and yields a lower valuation.
Why not B: Tempting because it leaves Product D at historical cost (600 × $50 = $30,000) instead of applying LIFO lower-of-cost-or-market; using cost gives 10,000 + 5,000 + 30,000 = $45,000, which overstates inventory under LIFO LCM rules.
Why not D: Tempting because it excludes the 250 units at third‑party retail outlets, but as consignor Company K retains title until sale and must include those units (250 × $20 = $5,000).
Question 3
Hint
First decide whether this inventory follows lower of cost and NRV or lower of cost or market. Then determine each item's market using the ceiling and floor before comparing to cost.
Answer A. Under U.S. GAAP LIFO inventory is measured using lower of cost or market (LCM); 'market' is replacement cost constrained by an NRV ceiling and an NRV-less-normal-profit floor, and the comparison is applied to each item individually. Item A: replacement cost (130) is capped at the NRV ceiling (128), so market = 128 and cost 120 is lower. Item B: replacement cost (80) lies between the floor (76) and ceiling (84), so market = 80 which is lower than cost 90. Item C: replacement cost (62) exceeds the NRV ceiling, so market = 60 which is lower than cost 70. Total ending inventory = 120 + 80 + 60 = 260 (thousands) = 260,000.
Why not B: This comes from applying the general lower-of-cost-and-NRV approach (compare cost to NRV) per item; that would carry Item B at NRV = 84 instead of the constrained market of 80. LIFO requires the LCM exception, so this is incorrect.
Why not C: This equals the sum of each item's constrained market (128 + 80 + 60 = 268) and reflects comparing aggregated market to total cost. The question specifies the test is applied on an individual-item basis, so aggregating markets and costs is incorrect.
Why not D: This results from using replacement cost of 62 for Item C without applying the NRV ceiling; under LCM market must be capped at the NRV ceiling (60), so carrying Item C at 62 is wrong.
Question 4
Hint
First determine which valuation model applies to this inventory method, then ask whether GAAP allows a previously recognized inventory loss to be reversed.
Answer A. Because Bray uses LIFO, this inventory category is measured under lower of cost or market (LCM), not lower of cost and NRV. At 12/31/X6, the designated market is replacement cost of $482,000 (it lies between the NRV ceiling of $492,000 and the NRV floor of $474,000). However, U.S. GAAP does not permit reversal of a previously recognized inventory write-down, so the carrying amount remains $468,000.
Why not B: This distractor catches candidates who apply lower of cost and NRV universally. LIFO inventory remains subject to lower of cost or market (LCM), not LCNRV; additionally, even if LCNRV applied the prior write-down still could not be reversed under U.S. GAAP.
Why not C: This is tempting because $482,000 is the correctly computed designated market for LIFO inventory (replacement cost between the NRV ceiling and floor). The error is assuming a previously recorded inventory loss can be reversed; under U.S. GAAP inventory write-downs are not reversed, so Bray cannot increase the carrying amount.
Why not D: This lures candidates who focus on the NRV floor ($474,000). While the floor constrains designated market, it does not create a requirement to write inventory back up to the floor after a prior write-down. Reversals of inventory write-downs are prohibited under U.S. GAAP.
Question 5
Hint
First determine which cost-flow method each division uses; compute NRV (selling price − costs to complete and sell) and the floor (NRV − normal profit). Then apply FIFO's lower-of-cost-and-NRV rule versus LIFO's lower-of-cost-or-market rule (market = replacement cost bounded by ceiling/floor).
Answer A. For FIFO use lower of cost and net realizable value: NRV = $70 − $10 = $60, which exceeds cost $50, so Division A (FIFO) is not written down. For LIFO use lower of cost or market, where market = replacement cost bounded by ceiling (NRV = $60) and floor (NRV − normal profit = $48). Replacement cost $44 is below the floor, so bounded market = $48; compare $50 (cost) to $48 (market) and write down to $48: $2 × 4,000 = $8,000 (LIFO reported at $192,000).
Why not B: Tempting because replacement cost is below historical cost, but FIFO is measured at the lower of cost and NRV (NRV = $60), so FIFO is not written down. For LIFO, 'market' must be bounded by the ceiling and floor before comparison, so LIFO is not written down to the unbounded replacement cost of $44.
Why not C: This correctly prevents a write-down for FIFO (NRV > cost) but is wrong for LIFO. LIFO uses lower of cost or market (bounded replacement cost), and the bounded market ($48) is below cost, so LIFO requires a write-down.
Why not D: This assumes market equals replacement cost without applying the ceiling/floor bounds. Because replacement cost $44 is below the floor ($48), the bounded market is $48, not $44, so the correct LIFO write-down is $8,000, not $24,000.
Question 6
Hint
First confirm the inventory method (LIFO v. FIFO). If LIFO, compute 'market' as replacement cost constrained by ceiling (NRV) and floor (NRV − normal profit), then compare that market to cost.
Answer C. Under LIFO, use lower of cost or market (LCM). Market is replacement cost limited by the ceiling (NRV = $100,000) and the floor (NRV − normal profit = $85,000). Replacement cost $92,000 lies between those bounds, so market = $92,000, and the lower of cost ($95,000) and market ($92,000) is $92,000.
Why not A: Tempting because $95,000 is the item's cost and is lower than NRV; however, LIFO uses LCM where 'market' is replacement cost bounded by ceiling and floor. Here market is $92,000, which is lower than cost.
Why not B: Tempting because $100,000 is NRV (the ceiling). But for LIFO, 'market' is replacement cost subject to the ceiling and floor; since replacement cost ($92,000) is below the ceiling, market is $92,000, not $100,000.
Why not D: Tempting because $85,000 is the floor (NRV minus normal profit). The floor prevents market from being set too low, but replacement cost ($92,000) is above the floor, so market remains $92,000 and $85,000 is not reported.
Question 7
Hint
Do not stop at NRV. First determine whether this inventory method uses lower of cost and NRV or lower of cost or market, then apply any ceiling and floor limits.
Answer D. Because the item is accounted for under LIFO, the LIFO exception applies: use lower of cost or market (not lower of cost and NRV). NRV = $132 - $7 = $125; the floor = NRV - normal profit margin = $125 - $13 = $112. Replacement cost ($108) is below the floor, so market is constrained up to the floor ($112). Report the lower of cost ($120) or market ($112) = $112.
Why not A: Tempting because $125 is NRV ($132 - $7), and many recall GAAP generally uses LCNRV. However, for LIFO the correct rule is lower of cost or market (with ceiling/floor constraints), so NRV is the ceiling, not the carrying amount when market is constrained below the floor.
Why not B: This appeals to candidates who note NRV ($125) exceeds cost so no write-down seems necessary under LCNRV. But because LIFO uses lower of cost or market and constrained market is $112 (below cost), a write-down to $112 is required.
Why not C: Attractive if a candidate remembers that market starts with replacement cost. But under LCM, market is replacement cost constrained between the ceiling (NRV = $125) and the floor ($112). Since replacement cost ($108) is below the floor, market must be raised to the floor ($112), not left at $108.
Question 8
Hint
First determine which valuation rule applies to LIFO (LCM), then compute 'market' as replacement cost limited by NRV (ceiling) and NRV less profit (floor) before comparing to cost.
Answer B. For LIFO under U.S. GAAP, apply lower of cost or market (LCM). Market is replacement cost bounded above by the ceiling (NRV = $940,000) and below by the floor (NRV less normal profit = $800,000); replacement cost $870,000 falls between those bounds, so market = $870,000. Lower of cost ($1,000,000) and market ($870,000) is $870,000, so recognize a $130,000 write-down as a loss in net income; reversal of such write-downs is not permitted under U.S. GAAP.
Why not A: Tempting because some students apply LCNRV (lower of cost and NRV) across the board. It's incorrect for LIFO: LIFO uses lower of cost or market, where market is replacement cost bounded by a ceiling (NRV) and floor (NRV less profit), not direct LCNRV.
Why not C: Tempting if a student assumes the floor always applies. It's wrong because the replacement cost ($870,000) lies between the floor ($800,000) and ceiling ($940,000), so market equals replacement cost, not the floor.
Why not D: Tempting if a student confuses inventory write-downs with fair-value OCI treatments. It's incorrect because inventory write-downs are recognized as losses in net income under U.S. GAAP, not reported in OCI.
Common questions
How do you calculate market for LIFO inventory?
Calculate NRV and NRV minus normal profit first. Market is the middle of those two amounts and replacement cost; then report the lower of cost or market.
Does the retail inventory method use lower of cost or market?
Yes. Retail-method inventories use lower of cost or market with the ceiling-and-floor test, even when the cost flow assumption is FIFO or average cost.
Can you reverse a LIFO inventory write-down under U.S. GAAP?
No. A later recovery in market does not permit reversal of a prior inventory write-down.
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