I'll give it a shot. Once it clicks, you'll be able to truck though any LCM question on the exam in 30 seconds or less. At the end of this, I'll put a brief explanation that might help more than the long version.
Ok, so LCM for US GAAP. The first issue is one that a professor I had did a great job of making sure we understood. The “market value” you are getting for the problem is NOT MARKET VALUE. It is just called that for the problem. Our professor always hammered home the point that we should call it “Lower of cost or designated market value” instead of “lower of cost or market”. I think that makes the problem make more sense from the get go. Now onto the actual process…
The problem will give you the info to calculate…
1. the NRV (ceiling)
2.the cost to replace the inventory (the “middle” number)
3. the profit margin to calculate NRV – normal profit margin (floor).
I imagine your issue is the relationship between those three numbers and the issues that arise when the cost to replace the inventory is above the ceiling or below the floor. Here's an example of how I would write the calculations to down to make it clear what you are to do.
First, calculate the ceiling (NRV) by taking the selling price of the inventory and subtracting the costs that will be necessary to complete the sale. Put this number at the top of your calculations.
Next, calculate the floor (NRV – normal profit margin) doing the following: (selling price) – (costs to complete sale) – (profit margin % x the original selling price). So if the selling price was 50, the costs to complete the sale were 10, and the normal profit margin is 10% it would be…. 50 – 10 – 5 = 35. The 5 you subtract is the profit margin on the $50 selling price. Put this number below the NRV from the first calculation with a space to fit another number in between the two (in between floor and ceiling).
So now you have it set up like this:
50
35
If the replacement cost of the inventory is below the floor, then you compare the FLOOR number to the cost of the inventory on the books because you can't use a number below the floor. Conversely, if the replacement cost is above the ceiling, you use the CEILING to compare to the cost of the inventory on the books because you can't use a number above the ceiling. The trick is really knowing that if the replacement cost is between the floor and ceiling, use THAT number (replacement cost) to compare to the cost of the inventory on the books. If the replacement cost falls outside our ceiling to floor range, then that's a problem. That forces us to substitute the floor or ceiling in for the replacement cost as the number to be compared to the inventory cost on the books.
In essence, calculate the floor, ceiling, and the replacement cost. write those down in order of largest to smallest, and whichever number is the middle number is the one that you compare to cost of inventory on the books. That “middle” number is the DESIGNATED market value.
.