2. INVENTORIES ARE ASSETS.
1.HELD FOR SALE IN THE ORDINARY
COURSE OF BUSINESS(FINISHED GOODS).
2.IN THE PROCESS OF PRODUCTION OR
MANUFACTURE(RAW MATERIALS AND
WORKING PROCESS).
3.IN THE FORM OF MATERIALS AND
SUPPLIES TO BE CONSUMED IN SUCH
PROCESS OF PRODUCTION OR
MANUFACTURE(STORES, SPARES).
3. AN INVENTORY VALUATION ALLOWS A
COMPANY TO PROVIDE A MONETARY
VALUE FOR ITEMS THAT MAKE UP
THEIR INVENTORY.INVENTORIES ARE
USUALLY THE LARGEST CURRENT ASSET
OF A BUSINESS AND PROPER
MEASUREMENT OF THEM IS NECESSARY
TO ASSURE ACCURATE FINANCIAL
STATEMENTS.
4. ACCORDING TO MATCHING PRINCIPLE,THE
EXPENSES DURING AN ACCOUNTING
PERIOD SHOULD MATCH THE INCOME
EARNED DURING THE ACCOUNTING
PERIOD.
COST OF GOODS SOLD=OPENING
STOCK+PURCHASES-CLOSING
STOCK.
5. IF THERE IS AN ERROR IN
VALUATION OF INVENTORY IT
WILL AFFECT NOT ONLY THE
CURRENT YEAR’S PROFIT BUT
ALSO THE NEXT YEAR’S PROFIT
BECAUSE THE CLOSING STOCK
OF CURRENT YEAR IS THE
OPENING STOCK OF NEXT YEAR.
6. AS PER GENERALLY ACCEPTED
ACCOUNTING PRINCIPLES,INVENTORIES
SHOULD BE VALUED AT COST.
COST REFERS TO COST OF ACQUISITION
PLUS
COST OF CONVERSION.
7. 1.RAW MATERIALS,STORES,SPARE
PARTS,CONSUMABLES,E.T.C=
COST OF ACQUISITION THAT IS PURCHASE
COSTS INCLUDING DUTIES AND
TAXES,FREIGHT AND OTHER EXPENSES
DIRECTLY RELATED TO SUCH PURCHASES.
SIMILARLY ANY DISCOUNTS , REBATES ON
SUCH PURCHASES SHOULD BE REDUCED.
8. 2.FINISHED GOODS IN CASE OF MANUFACTURING
CONCERN=
COST OF RAW MATERIALS PLUS COST OF
CONVERSION OF RAW MATERIALS INTO
FINISHED GOODS . IT CONSISTS OF DIRECT
EXPENSES LIkE LABOUR COSTS AS WELL AS
INDIRECT MANUFACTURING COSTS LIkE
POWER. WATER , FUEL,ETC DIRECTLY
ATTRIBUTABLE TO PRODUCTION /
MANUFACTURING. INDIRECT EXPENSES LIkE
SALARIES, OFFICE EXPENSES ETC. ARE NOT
INCLUDED SINCE THEY ARE PERIOD COSTS.
9. 3.WORk IN PROCESS =
WIP IS VALUED AT COST AS
ABOVE DEPENDING UPON
THE STAGE OF COMPLETION
OF LABOUR AND
OVERHEADS WHICH IS
DETERMINED BY THE
PRODUCTION DEPARTMENT.
10. EVEN THOUGH INVENTORIES ARE TO BE
VALUED AT COST,THE COST ALSO kEEPS
ON CHANGING DURING THE YEAR.IT MAY
NOT ALWAYS BE POSSIBLE TO LINk THE
COST OF PURCHASE WITH THE CLOSING
STOCk OF GOODS IN HAND.THE
COMMONLY USED METHODS FOR
VALUATION OF INVENTORY AT COST
ARE:
11. 1.FIFO ( FIrst In FIrst Out ) : Here It Is
assumed tHat tHe stOck receIved
FIrst Is cOnsumed/sOld FIrst. Hence
tHe stOck at Hand at tHe end OF tHe
year Is FrOm tHe latest purcHase.
In case OF rIsIng prIces, tHIs may
lead tO OvervaluatIOn OF stOcks
and Overstatement OF prOFIts and
In case OF FallIng prIces tHIs
metHOd leads tO understatement
OF stOck and prOFIts.
12. 2.lIFO ( last In FIrst Out ) : Here It Is
assumed tHat last unIts purcHased
are cOnsumed /sOld FIrst .Hence tHe
stOck at Hand at tHe end OF tHe
year Is FrOm tHe earlIest
purcHases.
In case OF FallIng prIces, tHIs may
lead tO Overstatement OF stOck
and prOFIt and In case OF rIsIng
prIces tHIs metHOd leads tO
understatement OF stOck and
prOFIts
13. 3.WeIgHted average cOst (Wac) :
Here tHe average cOst Is
applIed tHat Is aFter every
purcHase an average cOst Is
cOmputed FrOm tHe cOst OF
purcHases and tHe cOst OF
stOck. tHIs metHOd trIes tO
even Out tHe eFFects OF prIce
FluctuatIOns.
14. InventOry valuatIOn aFFects tHe prOFIt
and lOss accOunt as Well as tHe balance
sHeet.
1.FIFO – mOre realIstIc InventOry value
but unrealIstIc prOFIt .
2.lIFO - mOre realIstIc prOFIt but
Outdated InventOry value .
3.Wac - tHe average OF tHe tWO.
accOuntIng standard dOes nOt allOW tHe
use OF lIFO. under IncOme tax laW any
metHOd may be adOpted but It sHOuld be
FOllOWed cOnsIstently.
15. tHOugH generally tHe InventOrIes are
valued at cOst, sOmetImes It may be
prudent tO value It belOW cOst. WHen
tHe InventOry Has suFFered a reductIOn
In value due tO:
1.damage
2.deterIOratIOn
3.reductIOn In sellIng prIces
4.ObsOlescence
tHen sucH lOss Is recOgnIsed by valuIng
InventOry at tHe lOWer OF cOst Or net
realIsable value. sucH metHOd may be
applIed tO all Items OF InventOry Or
sImIlar grOup OF Items.
16. If the method of Inventory valuatIon Is
changed from year to year , the results
for two perIods becomes Incomparable.
It wIll affect the true and faIr vIew of
the fInancIal statements. however If a
change In method Is necessary for
better presentatIon of fInancIal
results, It can do so.
hence It Is very Important to understand
a company’s polIcy of Inventory
valuatIon whIle InterpretIng the
fInancIal results.
