How do you calculate the ceiling and floor in accounting?
The ceiling and floor are involved in the lower of cost or market rule for valuing inventory. The ceiling is the upper limit for the market amount. The floor is the lowest amount allowed for the market amount. This means that the market amount will be the replacement cost, but within the limitations of the ceiling and the floor.
The ceiling for the market value is the net realizable value. The net realizable value is calculated as the selling price in the ordinary course of business minus the cost of completion and disposal.
The floor for the market value is the net realizable value minus the normal profit. The floor is calculated as the selling price in the ordinary course of business minus the cost of completion and disposal and minus the normal profit.
The following is one illustration of the calculations. A company has an item with a cost of $10. Its replacement cost is $9, its net realizable value is $8, and its normal profit is $2. This means that the market amount for the lower of cost or market cannot be greater than the ceiling of $8 (the net realizable value). We also know that the market amount cannot be lower than the floor of $6 (the net realizable value of $8 minus the normal profit of $2). Since the replacement cost of $9 is greater than the ceiling, it cannot be used. As a result, the accountant will value the inventory item at the lower of (1) the cost of $10, or (2) the constrained replacement cost of $8. This makes the lower of cost or market amount $8.