Occasionally, merchandisers find that the cost of replacing an inventory item is lower than what was originallypaid for the item. Conservatism requires the application of the lower-of-cost-or-market (LCM) ruleThe LCM rule states that a business must report inventory in the financial statements at whichever is lower, the historical cost or the market value, of each inventory item. If the replacement cost of inventory is less than its historical cost, a company writes down the inventory value by decreasing inventory and increasing cost of goods sold. This write-down means net income is decreased in the period in which the decrease in the market value of the inventory occurred.
WHAT INVENTORY COSTING METHODS ARE ALLOWED?(page 212)Finished Goods Inventory – inventory of goods ready to sellRaw materials Inventory –inventory items used in the production of goodsWork in process inventory –inventory of partially completed goodsSpecific-Identification –inventory costing method in which a business uses the specific cost of each unit of inventory; also called the specific-unit-costmethod(page 213)First-In, First-Out (FIFO) – inventory costing method in which the first inventory costs incurred are the first costs to be assigned to cost of goods sold; FIFO leaves in ending inventory the last, most recent costs incurredLast-In, First-Out (LIFO) – inventory costing method in which the last inventory costs incurred are the first costs to be assigned to cost of goods sold; LIFO leaves in ending inventory the first, oldest costs incurredAverage Cost – inventory costing method where, after each purchase of inventory, a new weighted average cost per unit is computed an is used to value ending inventory and cost of goods sold.