Save content
Have you found this content useful? Use the button above to save it to your profile.
warehouse shelves | accountingweb | Stock valuation
iStock_urfinguss_warehouse

Taking stock of valuation

by

In an era of eye-watering inflation, it is challenging to put a value on stock. Makbul Patel takes a look at the various stock valuation methods available.

21st Nov 2023
Save content
Have you found this content useful? Use the button above to save it to your profile.

One of the more appealing areas of management accountancy is the opportunity to get out of the finance office and work with those on the coalface, so to speak. 

I like to think I have a fairly healthy relationship with the operatives whose areas I report on. It falls on my shoulders to evaluate stores stock issues to various departments. For service, maintenance and expenditure on social housing, the industry I work in, some goods are delivered directly by suppliers, such as kitchen units, windows and doors and bathrooms. Those are invoiced by the supplier so the valuation is quite simple. We also have an onsite stores department. The more manageable and less expensive items are kept and issued to departments from this site.

The stock maintenance system keeps a track record of stores issues, based on quantity and unit cost. In this era of eye-watering inflation rates costs have only gone one way. Yearly increases have been replaced with more frequent price changes. It is therefore a challenge to accurately value the cost of stock – which brings me on to the various methods of stock valuation.

The choice of method often depends on factors such as the nature of the business, industry practices and accounting standards. Here are some common methods of stock valuation.

First in, first out (FIFO)

This method assumes that the first inventory items purchased are the first ones sold. The cost of the oldest inventory is matched with current sales, leaving the cost of the most recent purchases as the ending inventory.

FIFO is commonly used in industries where the physical flow of goods closely matches the chronological order of acquisition or production. This method is often applied in industries such as retail, food and beverage, and manufacturing.

In a retail setting, where products have a short shelf life, FIFO ensures that the oldest items are sold first to minimise the risk of obsolescence.

Last in, first out (LIFO)

LIFO assumes that the most recently acquired inventory items are the first to be sold. The cost of the newest inventory is matched with current sales, leaving the cost of the oldest inventory as the ending inventory.

LIFO is less common due to its tax implications, but it is often used in industries where inventory costs tend to rise over time. This includes industries such as oil and gas, where the cost of goods in inventory can increase.

In the context of rising prices, using LIFO allows a company to assign the most recent and higher costs to the cost of goods sold, which can result in lower taxable income.

Average costs (AVCO)

This method calculates the average cost of all units available for sale during a specific period. The weighted average is determined by dividing the total cost of goods available for sale by the total units available for sale.

AVCO is a more generic method and is widely used across various industries. It is a simple way of allocating the average cost of inventory to units sold. It is often used in industries where there is a mix of different batches or lots of similar products, such as in the electronics or automotive industries.

Specific identification

This method involves identifying and tracking the cost of each individual item in inventory. It is often used for high-value items or products with unique characteristics.

This method is often used in industries where there is a high degree of specialisation, or where identifying the stock is quick and easy.

Standard cost method

In this method, predetermined standard costs are assigned to each unit of inventory. The actual cost is then compared to the standard cost to determine the value of the ending inventory.

Normally used in industries where there is a rapid issuance of stock items and it is difficult to keep track of stock value on a day-to-day basis. As suppliers impose increases (or decreases for that matter) the standard cost is updated to stay in line.

Retail inventory method

Commonly used in the retail industry, this method estimates the cost of ending inventory based on the ratio of the cost of goods available for sale to the retail price of goods available for sale.

Lower of cost or market (LCM)

This method requires inventory to be valued at the lower of its cost or market value. Market value is often defined as the replacement cost or the net realisable value, whichever is lower.

LCM is used in industries where the stock loses value very quickly. This is particularly the case of technological industries. The electronics industry may apply LCM to components and finished goods, especially given the rapid depreciation and technological obsolescence of electronic products.

Net realisable value (NRV)

NRV is the estimated selling price of inventory minus the estimated costs necessary to make the sale. This method is often used when the market value of inventory drops below its cost.

The selection of a particular method can have implications for financial statements and tax liabilities. It’s important for businesses to choose a method that aligns with their operations and is consistent with accounting standards. Additionally, the method chosen should be disclosed in financial statements along with any changes in method.

Pick your method

In summary, while FIFO, LIFO and AVCO are applicable to a variety of industries, the choice of method depends on factors such as the nature of the goods, pricing trends and tax considerations. Different industries may prefer one method over the others based on their specific business models and operational characteristics.

Our stores use a standard costing method based on agreed prices and increases. All stock is valued at the resale value based on the standard cost. As long as the old stock is usable all stock is valued at the same price.

Replies (0)

Please login or register to join the discussion.

There are currently no replies, be the first to post a reply.