Inventory accounting isn’t just a back-office concern – it can make or break your business’s financial health. In 2025, with shifting supply chains and new tax compliance standards, the lower of cost or market (LCM) method is back in the spotlight for Australian businesses, big and small. Whether you run a retail chain, manage a manufacturing plant, or are just starting out, understanding the LCM method could save you from costly mistakes and keep you on the right side of the ATO.
What is the Lower of Cost or Market Method?
The LCM method is an inventory valuation rule requiring businesses to report inventory at either its original cost or its current market value—whichever is lower. This conservative approach prevents businesses from overstating assets or profits if the value of their inventory drops. For example, if you purchased widgets for $20,000 but, due to market changes, their resale value drops to $15,000, LCM dictates you record the inventory at $15,000 on your balance sheet.
- Cost: The original price paid for the inventory, including all costs to bring it to its current condition and location.
- Market value: The replacement cost, with upper and lower bounds (ceiling and floor) as defined by accounting standards.
LCM is rooted in the accounting principle of prudence, ensuring that businesses do not inflate their financial position. In Australia, the method aligns with AASB standards and is closely monitored by the ATO, especially when it comes to tax deductions and compliance.
Why LCM Matters More Than Ever in 2025
Several factors make the LCM method especially relevant in 2025:
- Global supply chain volatility: Ongoing disruptions have led to unpredictable swings in inventory values, from electronics to building materials.
- Tax scrutiny: The ATO has ramped up audits on inventory valuation, particularly for businesses in sectors like retail, wholesale, and manufacturing. Overstating inventory can lead to hefty penalties.
- Accounting standards update: The AASB’s 2024 amendments now require more granular disclosures on inventory write-downs, pushing businesses to adopt stricter LCM practices.
For example, an electronics retailer holding a large stock of smartphones faces a sudden price drop due to a new model release. By applying LCM, the retailer writes down inventory to the new market price, reflecting the realisable value and avoiding an inflated profit figure.
Applying LCM: Practical Steps and Real-World Examples
Here’s how you can implement the LCM method in your business:
- Determine cost: Calculate the original purchase cost, including shipping, handling, and any related expenses.
- Assess market value: Identify the current replacement cost. According to AASB 102, ensure this value is not higher than the net realisable value (ceiling) or lower than net realisable value minus a normal profit margin (floor).
- Compare and record: Report inventory at the lower of the two values. Any write-down is expensed on the profit and loss statement.
Example: An Australian clothing retailer bought winter coats at $120 each. Due to an unusually warm winter, demand slumps and the replacement cost falls to $90. With a net realisable value of $95, the inventory should be valued at $90 per coat, as it’s the lower figure.
2025 Policy Updates and Compliance Tips
The AASB’s 2024 update clarified that all material write-downs must be separately disclosed in annual reports, and businesses must justify the market values used. The ATO’s 2025 compliance program specifically targets aggressive write-downs or inconsistencies between tax and financial reporting.
- Keep detailed documentation for each inventory write-down.
- Ensure your accounting software is updated for the latest LCM calculation templates.
- Consult with a registered tax agent if you operate in volatile markets or have complex inventory structures.
Ignoring LCM or applying it inconsistently can trigger ATO reviews, delay tax returns, and erode investor confidence. Staying ahead of the rules helps your business remain resilient, transparent, and ready for growth.
