Exxon Mobil Corporation, the world's largest company, uses the LIFO inventory method for most of its inventories. Its inventory costs are heavily dependent on the cost of oil. In a recent year when the price of oil was down, Exxon Mobil, following the lower-of-cost-or-market (LCM) rule, wrote down its inventory by $325 million. In the next year, when the price of oil recovered, the company reported that market price exceeded the LIFO carrying values by $6.8 billion.
Explain why the LCM rule resulted in a write-down in the first year. What is the inconsistency between the first- and second-year treatments of the change in the price of oil? How does the accounting convention of conservatism explain the inconsistency? If the price of oil declined substantially in a third year, what would be the likely consequence?