Cambrige AS and A Level Accounting Notes (9706)/ ZIMSEC  Advanced Accounting Level Notes: Inventory valuation: Inventory valuation methods

  • The figure for inventory is obtained from actual physical stock takes
  • We have already looked at the exact definition of inventories during the introduction to inventories and when we looked at IAS 2
  • It has also been pointed out that there are two ways of maintaining inventory records:
    1. Period-end records and
    2. Continuous records
  • You can click on the links above to learn more about these
  • According to IAS 2 inventories are supposed to be valued at the lower of cost and net realisable value (NRV)
  • Cost-all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their current location and condition
  • NRV-fair value less further costs to sell e.g. costs required to bring the item into a saleable condition
  • Both the above terms are fully explained in our examination of IAS 2
  • Under normal circumstances and in the majority of cases inventory is valued at cost otherwise a business would be making losses
  • There are however circumstances where such as when goods are damaged in storage or  become obsolete where it is necessary to value them at net realisable value
  • During the inventory valuation process the following decisions has to be made:
  • Whether to value goods at cost or net realisable value
  • If goods are to be valued at cost what method should be used to determine the actual cost

Determining the cost of inventory

  • As already repeatedly mentioned traditionally inventory is valued at cost
  • That is the actual cost expended in obtaining the inventory plus any other costs incurred into bringing the stock into a saleable condition
  • In the real world however determining the cost we paid for an item might not be so simple as one would initially assume
  • Consider John who runs a business where he buys roofing nails and sells them for a profit
  • If he purchased 10 000 kgs of nails and sold 9 000 he obviously has 1 000 kgs left as closing inventory
  • If the purchasing price has remained constant at $3 through out the year then the value of closing inventory would be
  • $3 000
  • Now imagine the purchase price had increased from $2.50 to $3.00 during the year
  • It would be hard to determine which of these he bought for $2.50 and which for $3.00 unless maybe each one is marked
  • It is often the case that it is not feasible or practicable (sic) to track the movement of each inventory item although computers are changing that
  • In practice entities come up with a valuation policy when it comes to determining the value of inventory
  • There are generally four accepted methods of individual valuation when it comes to determining cost:
    1. Actual unit cost where this can be tracked especially using bar-codes and computerised computing systems to scan items in out of inventory storerooms
    2. FIFO: First In First Out
    3. Average cost or Weighted Average
    4. LIFO: Last in First Out
  • This is where discussion of the actual unit cost ends you can click on each of the other methods to learn more about it

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