When using the LCM rule in Canada, the market value is most commonly
Select one:
A. replacement cost. B. net present value. C. selling price less profit margin. D. net realizable value.
The correct answer and explanation is:
The correct answer is D. net realizable value.
In Canada, under the lower of cost or market (LCM) rule, companies are required to value inventory at the lower of either the cost or the market value. The market value is defined as the net realizable value (NRV) of the inventory. This is the amount the company expects to receive from the sale of inventory, minus any costs to sell it. The net realizable value is essentially the estimated selling price in the ordinary course of business, less any direct costs to sell, such as shipping or commissions.
The purpose of applying the LCM rule is to ensure that inventory is not overstated on the balance sheet. If the market value of inventory drops below its cost, this indicates that the company is unlikely to recover the full cost of the inventory when it is sold. In this case, the inventory should be written down to its lower market value, which is the net realizable value. This approach aligns with the conservatism principle in accounting, which aims to avoid overestimating assets and profits.
Other options such as replacement cost, net present value, and selling price less profit margin are not typically used for determining market value under the LCM rule in Canada. Replacement cost is the cost to replace the inventory, but it is not the primary basis for market value under LCM. Net present value is more relevant to evaluating long-term investments or projects, and selling price less profit margin does not accurately reflect the expected realizable amount after considering the costs to sell.
By valuing inventory at the lower of cost or NRV, businesses can provide a more accurate representation of their assets and avoid overstating inventory values when market conditions change.