Answer
Method one can be recording the inventory at cost and the n reducing it to market value. This method will therefore reflect a loss in the current period and is often referred to as the indirect method. On the other hand, method two can be substituting market for cost when pricing the new inventory. This method will therefore increase cost of goods sold by the figure of loss and fails to reflect on the loss separately.
Work Step by Step
In method one, the loss would then be shown as a separate item in the income statement and the cost of goods sold for the year would not be distorted by its inclusion. An objection to this method of valuation is that an inconsistency is created between the income statement and balance sheet. In attempting to meet this inconsistency some have advocated the use of a special account to receive the credit for such an inventory write-down, such as Allowance to Reduce Inventory to Market which is a contra account against inventory on the balance sheet.
