Impact of Inventory Errors
An error in ending inventory affects both the balance sheet AND income statement. If ending inventory is OVERSTATED: COGS is understated, net income is overstated, and assets are overstated. The error reverses in the next period.
Lower of Cost or Market (LCM)
Inventory must be reported at the LOWER of its original cost or its current market value (net realizable value). If market value drops below cost, inventory is written down and a loss is recognized.
Conservatism
LCM reflects the conservatism principle: when in doubt, choose the method that results in lower assets and lower income. Losses are recognized immediately; gains wait until realized.