Steel Company, a wholesaler that has been in business for two years, purchases its inventories from various suppliers. During the two years, each purchase has been at a lower price than the previous purchase.

Steel uses the lower of FIFO cost or market method to value inventories. The original cost of the inventories is above replacement cost and below the net realizable value. The net realizable value less the normal profit margin is below the replacement cost.

A. In general what criteria should be used to determine which costs should be included in inventory?

B. In general, why is the lower of cost or market rule used to report inventory?

C. At what amount should Steel’s inventories be reported on the balance sheet? Explain the application of the lower of cost or market rule in this situation.

D. What would have been the effect on ending inventories and net income for the second year had Steel used the lower of average cost or market inventory method instead of the lower FIFO cost or market inventory? Why?