Different Meanings of 'Market Value'

Different meanings of 'market value'

Whilst most accountants would agree with the LCM rule, there seems to be little unanimity as to which market value is the most useful. According to one Publisher, the net realizable value interpretation of market value is most commonly accepted in the United Kingdom and Australia; in the United States, market value means replacement or reproduction cost; in Canada and most European countries, net realizable value is used for the valuation of finished goods and replacement cost is applied to the valuation of raw material inventories (Mueller. 2004).

The net realizable value concept is based on the theory that the usefulness of a measurement of inventory value is to be found in its function as an indicator of the recoverable value of the inventory concerned. So long as the expected net realizable value is equal to the costs which have been incurred, there is no possibility of an accounting loss occurring.

The replacement cost concept of market value is based on the idea of the 'utility' of inventory. According to the American Institute of Certified Public Accountants ( 2015), 'as a general guide, utility is indicated primarily by the current cost of replacement of the goods as they would be obtained by purchase or reproduction'. Hence, the notion of utility in this context is related to the ability to generate income, for at the time of acquisition, each unit of inventory is regarded as incorporating a gross income potential which is to be realized at the time of sale. The measure of the retained usefulness of inventory held at the end of the accounting period is to be found, therefore, in an assessment of the expenditure which would have to be incurred to produce or to purchase inventory having an equivalent gross profit potential. Where inventory may be replaced at a cost which is lower than the acquisition cost of currently held inventory, the fall in the replacement cost is regarded as indicating that the expected gross income potential of current inventory has decreased. For this reason, the lower of the cost of current inventories and their replacement cost is used in the United States to measure the residual income potential of inventories on hand, and to determine the amount of their acquisition cost which appropriately should be written off as having lost their usefulness for producing future income. As a result, subsequent revenues are not charged with the cost of acquiring inventories which is higher than current costs, and distortions are not introduced into the measurement of income.

The replacement cost concept of market value assumes that a decrease in the replacement cost will be accompanied by a corresponding decrease in the net realizable value of currently held inventories. Where there is no evidence to suggest that a fall in selling prices will take place, there is no likelihood of a failure to recover the cost of acquisition of existing inventories. Consequently, no loss of gross income potential is incurred. For this reason, A.I.C.P.A. Research Bulletin No. 43 recommended an upper and a lower limit for replacement cost as a definition of 'market' in the LCM rule. Therefore, no loss should be recognized if the fall in replacement cost does not reflect a similar fall in expected selling price, because a loss should not be recognized in the current accounting period, if it will result in the recognition of abnormal income in a later period.


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Read on: The 'Lower of Cost Or Market' (LCM) Rule

The 'lower of cost or market' (LCM) rule

The valuation of inventories at cost or market value, whichever is lower, is a rule which has long and widely been observed in financial accounting. The rule was originally justified in terms of the convention of conservatism, which as applied to the valuation of inventories meant that there should be no anticipation of profit and that all foreseeable losses should be provided for in the value reported to shareholders. Thus, if the cost value of an inventory item was £1.20 and the market value was £1.00, the end of year inventory valuation... see: The 'Lower of Cost Or Market' (LCM) Rule