Inventory is traditionally reported on a company’s balance sheet at its historical cost. However, reductions can be made based on applying the conservative lower-of-cost-or-market approach. In some cases, purchase value is in question if the item’s replacement cost has dropped since the date of acquisition. For other inventory items, net realizable value (expected sales price less any costs necessary to sale) may become less than cost because of changes in fads or technology or possibly as a result of damage. Consequently, the reported inventory figure should be reduced if either of these market values is below cost.
1In applying the lower-of-cost-or-market to inventory, the comparison can be made on an item-by-item basis. For
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example, XY-7 can be valued based on cost and market value and then, separately, a similar determination can
be made for AB-9. A company can also group its inventory (all bicycles, for example, might comprise one group
that is separate from all motorcycles) and report the lower amount determined for each of these groups. A third
possibility is to sum the cost of all inventory and make a single comparison of that figure to the total of all market
values. U.S. GAAP does not specify a mechanical approach to use in applying lower-of-cost-or-market value.