 In this presentation we will discuss the concept of lower of cost or market. We will define this concept first and then see it and talk about how it would apply to inventory. The definition of lower of cost or market according to fundamental accounting principles while the 22nd edition is required method to report inventory at market replacement cost when that market cost is lower than recorded cost so what we're saying here is we have we're talking about the inventory of course and we're saying that we have to record it at the replacement cost when that replacement cost that market cost is lower than the recorded cost what we actually purchased it for so this looks like a confusing type of definition however it's pretty straightforward what we're applying here is going to be the conservative principle meaning that if our inventory has declined in value we have to record it at the lower cost we don't want to be overstating our inventory obviously regulations are very concerned about us overstating something when we're talking about an asset and making the financial statements look better than they would rather than under stating it and therefore what we want what we want to default to for this concept would be under recording the inventory rather than overstating the inventory and therefore we want to record it at the lower of the cost or the market value to apply that if you see problems such as this of course they're going to give you basically two numbers that we'll have to be able to compare and it's as easy as basically picking the smaller number so if we bought it at cost this is our inventory this isn't a piece of merchandise this is not a piece of equipment that we're selling if we buy and sell forklifts and they are our inventory then and if we bought that forklift for the 15 000 but the replacement cost is only 12 000 then we're saying that it went down in value and we shouldn't be keeping the inventory on the books at 15 000 which would be the general rule the default rule meaning we keep the inventory on the books at cost if the replacement cost has gone down to 12 000 it's important to note here that we're not talking about the sales price so we're not saying that the cost is what we're selling it for we're not selling our inventory in this case the forklift for 15 we would have marked it up for something of the sales price we're talking about the cost of it what it's on our books for and we're saying that well if it costs 15 and we can buy the same inventory for 12 then we should be putting that inventory on our books for a lower amount and if we were to sell it of course it's probably the case that there would be a relationship to the sales price the sales price probably is something that would have to be lower than the original sales price that we would have had when we had bought the merchandise at 15 000 but this problem once again has to do with how much we're reporting our assets on the books for which is not the same thing as the sales price it has to do typically with what we bought it for that's going to be the default but if we're saying it went down in value given the fact that we bought this inventory specifically for selling it if the purchase price went down then you would think that the inventory has declined in value and therefore we should not be holding it on the books overstating our assets by keeping them at cost at 15 but putting them on the replacement cost what the inventory what the same inventory the same forklift in this case would cost if we purchased it at this time to make that decrease of course would make the financial statements look a bit worse we would have to decrease the inventory lowering the amount of assets that we have on the books and record some kind of loss lowering the net income come at the point in time that it is determined that the replacement cost is less than the cost that we pay for the inventory