Purchase Value

Question: When applying the lower-of-cost-or-market approach to inventory, how does the owner of the

merchandise ascertain market value?

Answer: The practical problem in applying this rule arises from the difficulty in ascertaining an appropriate

market value. There are several plausible ways to view the worth of any asset. For inventory, there is both a

“purchase value” (replacement cost—the amount needed to acquire the same item again at the present time) and a

“sales value” (net realizable value—the amount of cash expected from an eventual sale). When preparing financial

statements, if either of these amounts is impaired, recognition of a loss is likely. Thus, the accountant must watch

both values and be alert to any potential problems.