7/26/2023 0 Comments Gaap cost principleThe amount by which the inventory item was written down is recorded under cost of goods sold on the balance sheet. This value may be reduced to market value, which is defined as the middle value when comparing the cost to replace the inventory, the difference between the net realizable value and the typical profit on the item, and the net realizable value of the item. The lower of cost or market (LCM) method lets companies record losses by writing down the value of the affected inventory items. Why Is the Lower of Cost or Market (LCM) Method Used? The LCM method is a tenet of generally accepted accounting principles (GAAP).Under this scenario, if the price at which the inventory may be sold dips below the net realizable value (NRV) of the item, which consequently results in a loss, then the LCM method can be employed to record the loss. The LCM method takes into account that the value of a good can fluctuate.Historical cost refers to the cost of inventory at the time it was originally purchased. The lower of cost or market (LCM) method relies on the fact that when investors value a company’s inventory, those assets shall be recorded on the balance sheet at either the market value or the historical cost.This flexibility in applying GAAP is why financially intelligent managers need to understand the estimates, bias, and assumptions behind these judgment calls, and how they affect the financials. But GAAP doesn’t spell out everything it allows for plenty of discretion and judgment calls. It helps to ensure the statements’ validity and reliability, and allows for easy comparison between companies and across industries. GAAP defines the standard for creating financial reports in the United States. (Excerpts from Financial Intelligence, Chapter 8 – Costs and Expenses) So long as a company’s logic is reasonable, and so long as that logic is applied consistently, whatever it wants to do in this instance is OK. The key to proper application of GAAP, as accountants like to say, is reasonableness and consistency. Companies take those guidelines and apply a logic that makes sense for their particular situations. For example, what about the salary of the person who manages the plant where the product is manufactured? What about the wages of the plant supervisors? You’d think GAAP would say, “The plant manager is out,” or “The supervisor is in.” No such luck GAAP only provides guidelines. Conversely, the cost of supplies used by the accounting department and the salary of the human resources manager are definitely in SG&A, not in COGS or COS.īut then there’s the gray area-and it’s enormous. Some of these decisions are easy: for example the wages of the people on the manufacturing line or the cost of materials used to make the product should definitely go in COGS or COS. The accounting department has to make decisions about what to include in COGS or COS and what to put somewhere else. Another category of operating expense is selling, general, and administrative expenses (SG&A). It includes all the costs directly involved in producing a product or delivering a service. GAAP specifications include definitions of concepts and principles, as well as industry-specific rules. Cost of goods sold or cost of services (also known as COGS and COS) is one category of business expenses. GAAP (generally accepted accounting principles) is a collection of commonly followed accounting rules and standards for financial reporting. For example, the same expense might be accounted for differently by two different companies, and both companies might still be in perfect compliance with GAAP. GAAP says that all operating expenses must be reflected on a company’s books however, it does not say how to categorize them specifically. One example of the way GAAP can be applied concerns how to account for operating expenses. When a company wants to change how they apply GAAP, they must publicly disclose the change. There are no separate guidelines regarding first-time adoption of Dutch GAAP although as a general principle retrospective. However, once they pick how they are going to apply GAAP, they must be consistent and use it on an on-going basis. GAAP runs for thousands of pages and spells out a lot of detailed rules. The Financial Accounting Standards Board (FASB) defines and amends GAAP. The cost principle is an accrual basis of accounting that mandates the documenting of equity investments, liabilities, and assets on business statements at. Securities and Exchange Commission (SEC) requires that GAAP be followed by all companies whose stock is publicly traded on the open market. GAAP stands for Generally Accepted Accounting Principles.
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