Valuation of inventory aims at attaching a monetary value in the stores or issued for production. This is useful in producing. State costing the output and pricing production, as well as decision making.
Methods used in valuing inventory:
- First In First Out
- Last In Last Out
- Weighted Average method
- First in First out (FIFO)
This method is based on the assumption that stock purchased first is issued first. Prices of stock purchased first are used to determine the cost or value of inventory issued. Closing stocks are carried at the latest costs.
- It is a realistic system: oldest items are usually issued first out.
- Unrealized profits or losses do not arise
- It is easy to calculate if prices of materials don’t fluctuate
- Closing stocks values reflect the latest costs thus tend to reflect the current market values.
- It is acceptable to many tax authorities and is also consistent with accounting practices e.g. IAS/IFRS.
- It involves tedious calculations if the price of materials fluctuate from time to time
- Product costs, based on the oldest material prices, lag behind current conditions especially in inflationary markets.
- Comparison of one job with another may be difficult if materials are issued at different prices.
- Last in first out (LIFO)
Is based on the assumption that the stock purchased last is issued first. Stock valuation should therefore be based on the prices ruling on the acquisition of the last stocks.
- Product costs tend to be based on current market prices and is therefore realistic.
- A charge to production is as closely related to current price levels as possible
- Stocks are valued at the oldest prices.
- It involves tedious calculations if the price of materials fluctuate from time to time.
- Comparison of one job with another may be unfair and difficult
- Weighted average method
This method is a perpetual weighted average system where the issue price is recalculated after each receipt of stocks taking into account both quantities and money vale of the stocks received.
In this case stock used or unused is based on the average price per unit where the average price per unit is calculated as follows:
= Total value of stocks = Average Price Per Unit
No. of units of stock
= (Money value of old stocks + Money Value of New Stocks)