lower of cost or market

Imagine an electronics shop holding last year's phone model. It paid 500 a unit, but now, with a newer model out, those phones will fetch only 300. Pretending the inventory is still 'worth' 500 would be wishful thinking. Accounting refuses to let the books carry goods at a cost the market no longer supports — so it writes them down. That cautious rule is lower of cost or market.

Under this rule, inventory is reported at whichever is lower: its original cost, or its current market value. If cost is below market, you do nothing and keep cost. But if market value has fallen below cost, you write the inventory down to that lower value and record the drop as a loss now, even before the goods are sold. For the phones: cost 500, market 300, so they are reported at 300, and a 200-per-unit loss hits this period's income. Modern standards usually measure 'market' as net realizable value — the expected selling price minus costs to sell.

It matters as a clear example of the conservatism principle: accounting recognizes likely losses early but does not record gains until they are realized, so it never lets inventory look more valuable than buyers will actually pay. The one-way nature is the key caveat — you write down for declines, but you generally do not write inventory back up if its value later recovers (under IFRS a limited reversal is allowed; under US GAAP a write-down is usually permanent). Net realizable value gets its own dedicated entry.