Inventory Valuation

It must be noted that in some countries, certain statuary compliance regarding method of valuation are enforced. Such methods are prescribed by the accounting standards board or the ones that are formulated by International Accounting Standards Board are followed. An inventory is often defined as the assets that are to be sold in the market or the ones that are being modified to be sold in the market and the products that are to be used in the process of manufacturing goods for final sale. Thus, assets that are intended to be sold as the finished goods are the constituents of an inventory. The valuation is usually done at the end of one accounting period such as a week, a month or a year. Apart from that, unit-based updates are provided on a daily basis.

What is Valuation of Inventory

The process used to identify and define the monetary value of all the items in the inventory is termed as valuation. At the time of final accounting and preparing a statement showing inventory ingredients, 3 principle ways are used to evaluate the inventory of a company.

• First In First Out (FIFO) Method
• Last In First Out (LIFO) Method
• Weighted Average Cost Method

In the first in first in first out method, the supply items that come in first, are given priority of supply and sale. Such methods are used in cases where there are perishable items in the inventory. The second method, i.e., the LIFO method is used in cases where the financial accounting requires tax planning, preparation of cash flow statements and ending inventories. The LIFO method is primarily used in cases of economic melt downs and commodity scarcities in order to keep up the stock of all the goods and prevent a shortage. The LIFO method is many a time used as a retail inventory method in sales businesses. The weighted average cost method of accounting, on the other hand, is a method wherein cost of all goods that are available for sale are divided by the total number of goods that were present at the beginning of the period of accounting. This concept is often referred to as the beginning inventory and ending inventory.

Importance of Inventory Valuation

As emphasized above, valuation of inventories is vital. Financial accounting aims at disciplined recording and presenting all transactions. The transactions are further classified into balance sheets. The balance sheet is prominently used by the investors and management to gauge the financial status of the business. The inventory being an important principal asset, depicts the financial position of the production and sales process. Sales per annum and production per annum depend upon the value of the inventory.

Apart from this merit, a periodically prepared statement showing the valuation of inventory leads to beneficial management decisions. The economic factors affecting business are taken into consideration and consequently, the management reaches a well planned decision such as updating the inventory, changing a particular supply mode, method of valuation of inventory, etc.

The preparation of such a statement is successful in detection of wastage of resources, alternative sourcing of resources, cutting costs and planning new production schedule. Overall, the total cost of production is lowered and the quality of production is optimized. The valuation also forms an excellent ground for cost control methods that can be implemented in the production process. The final result of such a valuation thus, results into increase in the incoming cash flow, resection of expenditures, etc. One great merit of valuation is that the revenue income and expenditure of a particular firm become well-managed.