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What approaches may be employed in applying the lower of cost or material procedure? Which approach is normally used and why?
The lower of cost or market rule implies that accountants cannot record the inventory costs at a higher cost, than the cost of replacing the item on the open market. They have to compare the costs of replacement and the cost of inventory to determine the cost that is lower. The lower of cost or market can be applied to individual items, the entire inventory or to categories of inventories. The least conservative approach involves applying the lower of cost or material method on the total inventory. The most conservative approach involves applying the lower of cost or material method on an item by item basis. Accountants normally look for the most conservative approach since means that they will not make any overstatements. They will often choose the method that will lead to a lesser profit. Accountants use conservatism to account for uncertainties and risks that may occur in future, since most businesses tend to be volatile. They have to deal with sudden increases or decreases in the price of different products. The three approaches used will give different answers. The most commonly used method is the item by item basis. This is because, other than the fact that it is the most conservative method, it ignores any additional value but identifies any declines in value. The other two approaches do not have this advantage. Instead, any decline in the value of the items is offset by the increase in value of some items. Accountants are free to choose whatever approach they want to use but they have to be consistent (Porter and Norton 272).
Works Cited
Porter, A. Gary and Norton, L. Curtis. Financial Accounting: The Impact on Decision Makers: The Impact on Decision Makers. Cengage Learning, 2010. Print