 So far, we've learned how to determine the cost of inventory by using one of four methods, either specific unit costs, FIFO, LIFO, or average costs. When we report inventory on the balance sheet, however, we report it at the lower of its cost or its market value. And market value is defined as the current replacement cost of inventory. Estimating inventory at the lower of cost or market value follows the conservatism principle by not overstating the value of assets. Let's look at an example. The cost of inventory is $75,000. The market, which is determined by the inventory's current replacement value, is $80,000. So the lower of the two is cost. Therefore, inventory would be reported on the balance sheet at $75,000. However, if the replacement cost had been $65,000 instead of $80,000, then inventory would be reported at $65,000, which is lower than the cost of $75,000. If we have to write down our inventory value, then we would record an adjusting entry. In this case, we debit costs of goods sold in credit inventory for $10,000 in order to write the inventory down from $75,000 cost to a $65,000 market replacement value. Finally, the lower of cost or market rule can be applied to the entire inventory, as I did in these examples. It can also be applied to major inventory categories. When I worked in the dairy business, we applied this rule to categories like fluid milk, ice cream, yogurt, et cetera. And finally, it can be applied separately to each individual inventory item.