The document discusses the concept and significance of inventory valuation, which is critical for assessing a company's financial position and determining income. It outlines various methods for valuing inventory, including FIFO, LIFO, and the weighted average cost method, each with its advantages and disadvantages. Proper inventory valuation is essential for accurate financial reporting and compliance with accounting standards.

1. Inventory Valuation
Concept, Importance & Methods
Dr. Anu Gupta

2. Inventory Valuation
 Inventory or stock is the resourceful but idle
assets lying with the company at the end of
the accounting period. It is one of the most
significant assets of a company on its balance
sheet. So inventory valuation is a very
important factor in the accounting of a
company. Let us learn more about it.

3. Significance of Inventory
Valuation
 Inventory usually refer to the stock-in-trade with a
company of raw materials, semi-finished goods,
finished goods, and spare parts. So at the end of
the year inventory has to be counted to get to the
closing stock.
 However only counting inventory is not enough, it
also has to be valued. The process of inventory
valuation helps determine the value at which we
will record the inventories in the final accounting
statements of the company. The correct inventory
valuation is essential to have a fair representation
of the company’s finances.

4. 1] Helps Determine Income
 To calculate the gross profit or loss for the year we
match the cost of goods sold to the direct revenue of
an accounting period. The formulae for calculating
the cost of goods sold is as follows,
COGS = Opening Inventory + Purchases + Direct
Expenses – Closing Inventory
 Inventory valuation will have a major impact on
income determination if valuations are over or
understated

5. 2] Helps Determine Financial
Position
 Inventory is not only a part of the Profit and Loss
statement but also of the Balance Sheet, Inventories
are considered as Current Assets of a firm. So it is very
important to have precise and correct inventory
valuation.
 If the calculated value of the inventory is wrong it will
represent a wrong financial position on the date of
the balance sheet.

6. 3] Liquidity Analysis
 Inventory is a current asset because the firm is not
expected to hold it for a long period of time. There is
a lot of turnovers when it comes to stock. So
inventory actually is a significant portion of the
working capital of a company. It is important to
value it correctly so the current ratio and liquid ratios
can be calculated accurately. These ratios are
important to check for the liquidity of a company.

7. 4] Statutory Compliance
 Inventory valuation is not statutory compliance
under the Companies Act 2013. In accordance
with the Accounting Standard (AS2), all firms now
have to disclose the valuation of each class of
inventory.
 As per the AS 2, there is one basic principle for
inventory valuation. Generally, the inventory of a
firm should be valued at the lower of cost or net
realizable value. This principle comes from the
conservative system of accounting

8. • Pricing of inventory may change from time to time.
• Inventories are usually acquired by several deliveries at
different prices.
Therefore, the inventory valuation system adopted should be
the simplest and the most effective one.
1. First In First Out (FIFO) Method.
2. Last In First Out (LIFO) Method.
3. Average Costing Method.
Methods of Inventory Valuation

9. • It is an inventory costing method which assumes that the
first items placed in inventory are the first consumed.
• Inventory at the end of a year consists of the goods
most recently placed in inventory.
First In First Out Method

10. It is simple to understand and easy to operate.
Material cost charged to production represents actual cost.
In the case of falling prices, the use of this method gives better
results.
Closing stock of material will be represented very closely
at
current market price.
It is a logical method because materials are issued in order
of purchases, so materials received first are utilized first.
This method is useful when transactions are not too many and
prices of materials are fairly steady.
Advantages of FIFO method

11. If the prices fluctuate frequently, this method may
lead to clerical error.
In case of fluctuations in prices of materials,
comparison between one job and the other job
becomes difficult.
For pricing rise, the issue price does not reflect
the market price as materials are issued from the
earliest consignments.
Disadvantages of FIFO method

12. Practice Question
ABC Co. has following data available
01-06-2011 Inventory 800 units@Rs.6/unit.
05-06-2011 Purchased 200 units@Rs.7/unit.
08-06-2011 Purchased 200 units@Rs.8/unit
10-06-2011 Issued 700 units to work in Process
11-06-2011 Issued 300 units to work in Process

13. ABC Corporation.
Material Costing ledger
Date Description Quantity Amount
Balance
Units Amount
01 June Opening balance 800@6/unit 4800 800 4800
05 June Purchases 200@7/unit 1400 1000 6200
08 June Purchases 200@8/unit 1600 1200 7800
10 June Issued 700@6/unit 4200 500 3600
11 June Issued 100@6/unit
200@7/unit
2000 200 1600
First In First Out Method

14. • LIFO is an inventory costing method which assumes
that the last items placed in inventory are first
consumed during an accounting year.
• Inventory at the end of a year consists of the goods
placed in inventory at the beginning of the year.
Last In First Out Method

15.  The cost of materials issued will be nearer to the current
market price.
 It enables us to match cost of production with current sales
revenues.
 The use of the method during the period of rising prices
does not reflect undue high profit in the income statement.
 In the case of falling prices profit tends to rise due to
lower material cost.
 In the period of inflation LIFO will tend to show the
correct profit and thus avoid paying undue taxes to some
extent.
Advantages of LIFO method

16.  Calculation under LIFO system becomes complicated
when frequent purchases are made at highly fluctuating
rates.
 Costs of different similar batches of production carried on
at the same time may differ.
 This method of valuation of material is not acceptable to
the income tax authorities.
 The stock in hand is valued at price which does not reflect
current market price.
 Closing stock will be understated or overstated in the
Balance Sheet.
Disadvantages of LIFO method

17. ABC Co. has following data available
01-06-2011 Purchased 100 units@Rs.5/unit
05-06-2011 Purchased 500 units@Rs.8/unit.
06-06-2011 Issued 200 units to work in Process
07-06-2011 Purchased 100 units@Rs.10/unit
08-06-2011 Issued 300 units to work in Process
Practice Question

18. ABC Corporation.
Material Costing ledger
Date Description Quantity Amount(Rs.)
Balance
Units
Amount(Rs.)
01-June Purchases 100@Rs5/unit 500 100 500
05-June Purchases 500@Rs8/unit 4000 600 4500
06-June Issued 200@Rs8/unit 1600 400 2900
07-June Purchases 100@Rs10/unit 1000 500 3900
08-June Issued 100@Rs10/unit
200@Rs8/unit
2600 200
1300
Last in First Out

19. Weighted Average Cost
Method
 The weighted average cost method is the happy
medium between LIFO and FIFO. It uses a weighted
average to work out how much money goes into COGS
and inventory. To calculate the weighted average cost,
divide the total cost of goods purchased by the number
of units available for sale.
 Best for: Businesses with a variety of non-perishable
items at different prices.

20.  Provides a good overall estimate of inventory value.
 Best for when it’s difficult to assign specific costs to
individual items.
 Standardizes expenses across inventory batches.
 Harder to manipulate inventory accounting figures.
 Can provide an accurate picture of financial health.
Advantages of WAC method

21.  Doesn’t match inventory flow.
 Actual expenses are not assigned to items sold.
 Reported net income falls between FIFO and LIFO.
 Future tax benefits and cash flow advantages can be
minimized.
Disadvantages of WAC method