When inventory is valued at the lower of cost or market, and the market is less than cost, a loss is recorded. (Market is the replacement cost constrained by the net realizable value and the net realizable value minus the normal profit.) For example, let's assume that on December 31 the market is greater than the cost of inventory; therefore, the cost is reported on the balance sheet. Then on January 31 the market is $1,000 less than cost. On January 31, the company records a loss by debiting the income statement account Loss from Reducing Inventory to LCM for $1,000 and crediting the balance sheet account Allowance to Reduce Inventory to LCM for $1,000. On February 28 the inventory has a market amount that is only $200 less than cost. The question is "What causes this $800 recovery?"

I see two reasons why the January loss might be reduced/recovered in February. The first possibility is that the market (constrained replacement cost) has increased for the items that were on hand on January 31 and remain on hand at February 28. The second possibility is that some of the items on hand on January 31 that had a market value less than their cost were sold during February–thereby eliminating the need for most of the balance that had been in the Allowance account.

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