The correct answer is C) Cost or market price, whichever is lower.

Why “Cost or Market Price Whichever is Lower” is the Correct Answer:

Floating assets, also known as current assets, are valued at cost or market price, whichever is lower, in accordance with the lower of cost or market (LCM) accounting principle. This principle is applied to ensure that assets are not overstated on the balance sheet and that they are carried at a conservative and realistic value.

Here’s a detailed explanation of why “Cost or Market Price Whichever is Lower” is the correct choice:

1. Conservatism Principle:

The lower of cost or market principle is rooted in the conservatism principle of accounting. This principle dictates that when faced with uncertainty, accountants should err on the side of caution and choose methods that result in lower asset valuations and lower income recognition. It helps prevent overstatement of assets and income.

2. Cost Basis:

Initially, assets are recorded on the balance sheet at their historical cost. This cost includes all expenditures necessary to acquire and prepare the asset for its intended use. It is the most common basis for valuing assets, and it reflects the actual resources invested in acquiring the asset.

3. Market Price Basis:

Market price, on the other hand, represents the current fair market value of the asset. This is the amount that the asset could be sold for in the open market. Market price can fluctuate based on supply and demand, economic conditions, and other factors.

4. Comparing Cost and Market Price:

The lower of cost or market principle requires periodic comparison of the carrying amount (cost) of the asset on the balance sheet with its current market price.

If the market price is lower than the cost, the asset’s value on the balance sheet is adjusted downward to the market price, and a loss is recognized in the income statement. This adjustment reflects the conservatism principle by recognizing a reduction in value when the market value falls below historical cost.

5. Preventing Overvaluation:

This principle prevents assets from being overstated on the balance sheet, which is important for financial statement users, including investors, creditors, and management, to have an accurate picture of a company’s financial health. Overstating assets could lead to misleading financial statements.

Why the Other Options Are Not Correct:

A) Cost:

While the historical cost is the initial basis for valuing assets, valuing floating assets at cost alone may not reflect their current market value. Assets may appreciate or depreciate over time due to various factors, including changes in market conditions, technology, or demand. Therefore, valuing assets solely at cost could result in an overstatement of their value on the balance sheet.

B) Market Price:

Valuing floating assets at market price alone may not adhere to the principle of conservatism. Using market price without considering the historical cost could result in overstatement if the market price exceeds the historical cost. The lower of cost or market principle is designed to provide a more conservative and realistic valuation.

D) Cost Less Depreciation:

Valuing assets at cost less depreciation is commonly used for non-current assets like property, plant, and equipment. It reflects the historical cost minus accumulated depreciation, which accounts for the wear and tear of the asset over time.

However, this method is not typically applied to current assets, which are expected to be used or sold in the near term. Current assets, including floating assets, are more likely to be valued at the lower of cost or market price, as they are less subject to depreciation.

In summary, floating assets, or current assets, are valued at cost or market price, whichever is lower, in accordance with the lower of cost or market (LCM) accounting principle. This approach ensures that asset values on the balance sheet are conservative and realistic, preventing overstatement of asset values.

The LCM principle aligns with the conservatism principle in accounting and provides financial statement users with a more accurate representation of a company’s financial position.