Valuation of Inventory
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The method you use to value your inventory and the way you look at costing can have a significant impact on your small business.
Inventory valuation methods and costing for pricing and accounting purposes
Although this might seem obvious, in the frenzy of running your business it is possible to miscalculate on total costs and lose money on a sale. Price is generally referred to as the dollar amount charged to your customer, while cost is the amount your business pays for your inventory.
However, costing your inventory is not necessarily just what you pay for the goods. In most inventory-control software packages, you can add these non-vendor costs to any purchase order as a dollar amount or as a percentage. Once you put together all the different items you account for in your product cost, the next step is to choose how to price your product accordingly.
There are a few methods that businesses use to do this:. Many businesses use a multiplier formula that multiplies the cost by 2 or 3.
Inventory Valuation
Moving average cost is a common way to track the value of your inventory. Your inventory cost is essentially re-calculated every time you make an inventory purchase. To accomplish this, you would take the total cost of the items purchased divided by the number of items in stock. You would then use this number as your cost of ending inventory and the cost of goods sold for your accounting purposes.
One thing to keep in mind, however, is that you can only use moving average cost with a perpetual inventory tracking system that keeps up-to-date records of inventory balances. This is easily accomplished by using inventory software like inFlow Cloud, which you can try right here:. You can also keep track of your inventory costs by manually assigning the cost to your items; however, this is probably the most tedious way and not necessarily the most accurate, especially if your vendor prices change on a regular basis.
This method of costing essentially means that the oldest inventory items are recorded as a sold first. The most commonly used inventory valuation methods under a perpetual system are:. These methods produce different results because their flow of costs are based upon different assumptions. The FIFO method bases its cost flow on the chronological order purchases are made, while the LIFO method bases it cost flow in a reverse chronological order.
The average cost method produces a cost flow based on a weighted average of goods.
Inventory Valuation - Learn About Valuing Business Inventories
There are fundamental differences for accounting and reporting merchandise inventory transactions under the periodic and perpetual inventory systems. To record purchases, the periodic system debits the Purchases account while the perpetual system debits the Merchandise Inventory account. To record sales, the perpetual system requires an extra entry to debit the Cost of goods sold and credit Merchandise Inventory.
FREE software to e-file tax return of your clients. If you have any other questions, our support team would be happy to help! The two most widely used inventory accounting systems are the periodic and the perpetual. You then average these costs, weighting by the quantity of the stock for each point. Log In Sign Up. There are fundamental differences for accounting and reporting merchandise inventory transactions under the periodic and perpetual inventory systems.
By recording the cost of goods sold for each sale, the perpetual inventory system alleviated the need for adjusting entries and calculation of the goods sold at the end of a financial period, both of which the periodic inventory system requires. Under certain circumstances, valuation of inventory based on cost is impractical. If the market price of a good drops below the purchase price, the lower of cost or market method of valuation is recommended. This method allows declines in inventory value to be offset against income of the period.
When goods are damaged or obsolete, and can only be sold for below purchase prices, they should be recorded at net realizable value.
How to price your products appropriately
The net realizable value is the estimated selling price less any expense incurred to dispose of the good. A normal loss which occurs during the production process is apportioned over the remaining no of units and abnormal loss is treated as an expense. Refer Case studies given at the end of the article. The formula used should reflect the fairest possible approximation to the cost incurred in bringing the items of inventory to their present location and condition. However, when it is difficult to calculate the cost using above methods, Standard cost and Retail cost can be used if the results approximate the actual cost.
The following should be disclosed in the financial statements: Standard Cost and Retail cost methods are allowed if its close to actual cost.
Standard Cost method is not allowed to be used. Shall be the cost of inventory available on the day of commencement of business. Treatment of Normal loss and abnormal loss: Company A purchased items at the cost of Rs. Calculate the Inventory value: Case Law Quick References Some of the popular case laws and its important decision for references: To the same effect is the judgment in the case of C. British Paints India Ltd I. Paid E-filing by Expert CAs.
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