Inventory Valuation
Meaning and Importance
Inventory valuation is the process of assigning a monetary value to unsold stock at the end of an accounting period. It directly affects the Cost of Goods Sold (COGS) and the reported profits.
Need for Inventory Valuation
- To calculate true profit or loss
- To determine accurate COGS
- For proper balance sheet representation
- For tax assessment
- To identify wastage or loss
Methods of Inventory Valuation
1. FIFO (First-In, First-Out)
Assumes oldest inventory is sold first. Closing stock reflects recent costs.
Example:
| Date | Units | Cost per Unit |
|---|---|---|
| Jan 1 | 100 | ₹10 |
| Jan 5 | 100 | ₹12 |
If 150 units sold: 100×₹10 + 50×₹12 = ₹1600 COGS
2. LIFO (Last-In, First-Out)
Assumes latest inventory is sold first. Closing stock reflects older costs.
Example: 100×₹12 + 50×₹10 = ₹1700 COGS
3. Weighted Average Cost (WAC)
Uses average cost of units for COGS.
Average Cost = (100×10 + 100×12) / 200 = ₹11
COGS for 150 units = 150 × ₹11 = ₹1650
4. Specific Identification
Used for unique/high-value items. Each unit is tracked with its actual cost.
Summary Table
| Method | COGS Impact (Rising Prices) | Closing Stock Value | Common Usage |
|---|---|---|---|
| FIFO | Lower | Higher | Retail, General Merchandising |
| LIFO | Higher | Lower | Accepted only in some countries (like USA) |
| Weighted Average | Moderate | Moderate | Manufacturing Firms |
| Specific Identification | Actual Cost | Actual Cost | Cars, Jewelry, Art |
Conclusion
Each method of inventory valuation affects profit, taxes, and balance sheet differently. The choice of method depends on the nature of the business and compliance requirements.
