Final answer:
The lower-of-cost-or-market rule requires inventory to be valued at the lower of either the purchase cost or market value, which is influenced by supply, demand, and perceptions of quality, rather than the selling price.
Step-by-step explanation:
The question refers to the lower-of-cost-or-market rule in U.S. inventory valuation, where market value generally refers to the replacement cost of the inventory, not the selling price. In essence, this accounting principle requires companies to write down the value of their inventory to market value when the market value is lower than the cost of the inventory. This can occur in situations where demand decreases or supply increases, leading to a decrease in the market price, which can fall below the cost of production. An example cited is a going-out-of-business sale where goods can be sold below production cost. Similar situations might occur on a global scale, such as oversupplied commodities like steel, computer chips, or machine tools causing international companies to adjust downwards their inventory values.
Market prices can also influence buyer perception of quality. If a used car dealer cuts the prices to sell more cars, the lower price may lead consumers to infer that the cars are of low quality, paradoxically reducing demand instead of increasing it. This demonstrates that market dynamics can be complex and are not solely determined by cost but also by perceptions of value and quality among buyers.