When is the lower of cost or market rule typically applied in inventory reporting?

The lower of cost or market rule is typically applied when inventory prices are expected to decline to ensure that the value of the inventory reported on the balance sheet reflects potential losses in market value. This rule is a conservative accounting approach that mandates reporting inventory at the lower of its historical cost or current market value. If the market value of the inventory falls below its cost due to expected price declines, reporting the lower value adheres to the principle of conservatism in accounting, which requires that losses be recognized when they are anticipated, rather than waiting for them to be realized.

Applying this rule helps businesses avoid overvaluing their inventory, which can distort financial statements and provide a misleading view of their financial health. By adjusting inventory values down to the market price, businesses maintain more accurate financial reporting and provide stakeholders with a clearer picture of the company's current assets, thus aiding in more informed decision-making processes.