Discuss the lower of Cost or Market (LCM) rule in the context of
inventory valuations.  What does the rule say?  What is the accounting
concept behind LCM?  Over which convention does it take precedence
over?

Hi Pearl!

“Lower of cost or market” refers to an accounting inventory valuation
method used for financial reporting purposes.  LCM is an exception to
the historical cost principle and used when the potential value of the
inventory is less than the historical cost to acquire the asset.  This
rule was established to account for the loss of potential inventory
value due to changes in price, deterioration, obsolescence, etc. 
Using this method will assist in fairly reporting income of the
period.  Note that this method is an application of conservatism.

LCM states the user must value the inventory at lower of cost or
market.

“Cost” refers to the original cost of the inventory.  

“Market” is defined as the replacement cost.  The replacement cost
must lie between a ceiling and floor.  The ceiling is the net
realizable value or selling price less disposal cost. The floor is net
realizable value minus a normal profit margin.  As a general rule,
market is the middle value of replacement cost, ceiling and floor.

This valuation method may be applied to individual items or category
or the entire inventory.  A consistent method must be used.

There are several useful sites that you may want to access for further
information including:

Slides prepared by Krish Ranganathan, Angelo State University, San
Angelo, Texas:
http://people.uis.edu/bmoe1/ch09.ppt

Chapter slides found on website for Jan Smith, CPA, Austin Community
College:
http://www2.austin.cc.tx.us/jasmith/chap9invmore/sld001.htm

Outline found for Professor David B. Smith’s (Professor of Accounting,
Iowa State University) Intermediate Accounting course:
http://www.bus.iastate.edu/smithdb/386/Chapter%209.doc

Simple explanation of LCM by Neal R. VanZante, Texas A & M University:
http://www.swcollege.com/vircomm/gita/gita15-2.html

Definitions of LCM:
Yahoo Tax Center:
http://taxes.yahoo.com/glossary/l.html

Xrefer – Web Reference Engine:
http://www.xrefer.com/entry/589027

Search terms used include:

Lower of cost or market
Inventory valuation lower of cost or market

Pearl, I hope you find this answer useful and good luck!

Is this a homework assignment?

Here's the Layman answer:

LCM relates to the accounting principle called "conservatism."  That
is to say that you would rather be conservative when you present your
financial statements (i.e. not to overstate assets on a Balance Sheet
or income on an Statement of Earnings).

Lets say you had a bunch of computer chips in inventory that were 5
years old.  By today's market, even though you paid a ton of money to
acquire (or produce them), today they'd be virtually worthless.

Hence, since there is no market for them, you would reduce the history
cost of this inventory (also called inventory write-down or reserve
for obsolesence) to the 'market' cost (hence, the lower of cost or
market).  This has the affect of 'flushing' the devaluation in
inventory through the P&L, thus stating your assets and earnings
'conservatively.'

Hope that helps a little.