In accounting, the lower of cost or market (LCM) method is used to determine the value of inventory on a company's balance sheet. Under this method, the cost of inventory is compared to its current market value, and the lower of the two is used as the reported value. This is because inventory is required to be reported at the market value of replacing it when the market value is lower than the cost.
There are three ways in which the LCM method can be applied: to individual items, to major categories of items, or to the whole of the inventory. Companies are more likely to apply the LCM method to individual items when the items making up the inventory are less similar, and advances in technology have further encouraged the application of the method to individual items.
The LCM method is used in situations where it is impossible to take a physical inventory or maintain perpetual inventory records, such as when monthly income statements are needed or when a catastrophe has destroyed the inventory. In these cases, estimates of the cost of inventory must be made using methods such as the retail method or the gross profit method.