Basis and Techniques of Inventory Valuation

Inventory valuation is the process of determining the value of an inventory. It involves estimating the cost of goods sold and related expenses to determine how much profit can be made from stock. Inventory is the number of goods and materials a company has in its possession. It is also known as stock. 

Importance of Inventory Valuation

It is an essential process in cost accountancy. It is used to determine the value of inventory. Inventory valuation involves a series of steps to calculate inventory value. 

The process begins with identifying the cost of goods sold on hand and then calculating the cost based on the quantity, unit price and sale price. Once that is done, it is calculated by multiplying this figure by the average days’ supply at hand. The result will be divided by the number of days in a year to get an annualised rate. 

Methods of Inventory Valuation 

There are many different methods for inventory valuation, but the most common ones are cost-based and Replacement Cost based methods. 

Cost-based: The cost of goods sold is calculated by multiplying the number sold by the average unit price. So, a Continuous Inventory System is used when inventory levels are checked continuously, such as every day or every hour. It involves recording all transactions affecting the cost of goods sold and inventory in a single day’s work in an accounting journal and then summarising them in a “general journal” ledger sheet. 

Many companies have different costs included in their inventory valuation, such as raw materials, direct labour and overhead expenses. 

Inventory valuation is a process of estimating the value of inventory items based on cost and other relevant information. 

The formula for inventory valuation is as follows: 

Value = Cost x Quantity 

Different types of inventory costs can be classified as follows:

• Raw materials inventory: Includes all materials that have been purchased for use in production but have not yet been into production. 

• Work in progress inventory: Includes work that has been started in a production process but has not yet been completed. 

• Finished goods inventory; Includes all products ready for sale and stored in a warehouse, storeroom, or another storage area. 

Replacement Cost: The replacement cost is calculated by multiplying the total cost incurred during a specific period by the average number of units consumed. The difference between these two figures represents net income or loss for that period. So, a periodic inventory system is used when inventory levels are checked at regular intervals, such as monthly or quarterly. It involves recording the cost of goods sold and the inventory value at the end of each period. 

Objectives of Inventory Valuation

• Inventory valuation aims to determine the value of inventories on hand and the cost per unit. The information obtained from this process helps make decisions about purchasing or selling stock. 

• Inventory valuation can be done by either physical count or using a formula based on historical data and market conditions. 

• Inventory valuation is the process of estimating the cost of inventory. It is done to determine the amount charged to the customer. 

• Inventory valuation is an essential part of cost accountancy. The process involves identifying and evaluating an inventory, assigning it a value and charging it to a customer to determine the cost of goods sold. 

• One of the benefits of inventory valuation is that it helps businesses identify their total cost at any given point to better forecast future prices. It also allows companies to identify their profit margins and maximise them by minimising expenses or increasing sales. 

• Three different methods can determine inventory valuation: Cost per Unit, Total Cost of Goods Available for Sale and Net Realisable Value. 

Techniques for Inventory Valuation 

The best inventory valuation techniques depend on the business’s size and industry. LIFO is better for companies with high inventories and low turnover rates because it allows more accurate cost accountancy calculations. However, for companies with common stocks and high turnover rates, FIFO is better because it reduces accounting errors caused by stockouts and overstocking. 

• (First in, first out) FIFO- this technique uses the oldest units first and then down to the newest units. The inventory is valued at cost plus a percentage markup. 

• (Last in, first out) LIFO – this technique uses the newest units first and then down to the oldest branches. The inventory is valued at a cost less a percentage markup.

Conclusion

Inventory valuation is an essential step in Cost Accountancy because it helps companies decide how much they need to charge for their products. Inventory valuation aims to determine the cost of the goods or services in the inventory. It can calculate the price per unit, the total cost of goods available for sale, or net realisable value.  Inventory valuation is a process that can use to calculate an accurate figure for how much money a company has made from their products that are on hand. The method includes inputting data about how many units have been sold.