Final answer:
In inventory valuation, 'market' refers to the current replacement cost, used in the 'lower of cost or market' method when market value falls below inventory's original cost. Market prices are influenced by demand and supply. An excess supply can drive market prices below the cost of production.
Step-by-step explanation:
In applying the lower of cost or market method to inventory valuation, market is defined as the current replacement cost. This method of inventory valuation requires companies to write down the value of their inventory to the market value when it falls below its original cost. It operates under the conservative principle that inventory should not be reported at an amount higher than the benefits it can provide.
The market price is influenced by the demand and supply, rather than the historical cost of production. For instance, if there's an excess supply that's driving the market price down, such as in a going-out-of-business sale or in a saturated market for products like steel or computer chips, the inventory may need to be valued at this lower market price.