Inventory Valuation: What Objectives Does It Pursue?
Inventory valuation is a process used by businesses to determine the value of the goods they have in stock. It is an important part of a company’s financial health and is used to measure the profitability of the company.
Inventory valuation identifies the monetary value of the things in inventory at the end of an accounting period. Based on the costs incurred to acquire and prepare the inventory for sale, the value of the inventory is determined.
The biggest current business assets are inventories. Using inventory valuation, you may calculate your cost of goods sold (COGS) and, ultimately, your profitability.
Read on to know more about inventory valuation and where to find CPA firms in Massachusetts.
What Objectives Does Inventory Valuation Pursue?
Unsold merchandise intended for sale is referred to as inventory. It talks about the raw materials, semi-finished products, and finished products utilized in production.
After each fiscal year, inventory valuation is completed to determine the cost of both unsold inventory and the cost of sold goods.
This is essential because too much or too little inventory might impair a company’s ability to produce goods and make money.
Calculate Your Gross Income
Gross profit, or the difference between sales and cost of goods sold, is calculated using inventory. The revenue for the accounting period is contrasted with the cost of goods sold to arrive at the gross profit, also known as trading profit.
Opening stock plus purchases minus closing stock equals the cost of goods sold.
The formula above demonstrates the relationship between inventory value and cost and, in turn, gross profit. For instance, if the closing stock is overpriced, the profit for the current year will increase while the profit for the years after will decrease.
You can also seek an accountant in Framingham, MA, if you need help with calculations.
Make A Financial Assessment
A class of current assets is closing stock. The balance sheet’s closing stock value provides information about the company’s financial situation.
An inaccurate assessment of the working capital condition and overall financial situation could result from overvaluation or undervaluation.
What Are the Methods for Inventory Valuation?
A specific approach for valuing inventory may be utilized, depending on how the company manages its inventory over time. Inventory in a business needs to be priced at cost.
The company needs to create a cost flow assumption that it will frequently use because inventory is routinely sold and refilled, and its price changes.
There are four recognized approaches for valuing inventory.
- Specific Identification
- First-In, First-Out (FIFO)
- Last-In, First-Out (LIFO)
- Weighted Average Cost
Let’s explain each in further detail.
Utilizing this technique, you can monitor each item in your inventory from when it is stocked to when it is sold. It is frequently used for large, instantly recognizable objects with several features and related costs.
The main requirement for this system is the ability to track each item separately using an RFID tag, a receipt with a date stamp, or a serial number.
This method increases inventory valuation accuracy but can only be used to value uncommon, pricey items that require such a difference.
First-In, First-Out (FIFO)
The premise of this method is that the first inventory purchased will also be the first to sell. Newly acquired or made assets are contrasted with those still in stock.
Because it is basic and easy to understand, it is one of the methods of inventory valuation that firms employ the most frequently.
The FIFO approach produces higher ending inventory value, lower cost of goods sold, and higher gross profit during periods of inflation.
Unfortunately, the FIFO model cannot portray costs effectively when prices increase quickly. It also offers no tax benefits, in contrast to the LIFO technique.
Last-In, First-Out (LIFO)
This approach of calculating inventory value is predicated on the notion that fresh goods sell more quickly and older stock is kept on hand.
Businesses seldom apply this tactic because older inventories are rarely sold and lose value over time. The result is a huge loss for the business.
Companies only employ LIFO when they anticipate that the cost of their inventory will rise over time and result in price inflation.
Low-cost inventory could be transferred to the cost of goods sold, lowering the claimed profit margins of companies. Businesses may end up paying less tax as a result.
Weighted Average Cost
The cost of products sold and inventories are calculated using the weighted average under the weighted average cost technique. This is how the weighted average cost per unit is determined:
The weighted average cost per unit is calculated as the Total Cost of Goods in Inventory / Total Units in Inventory.
This strategy is often used to establish prices for similar items when keeping track of specific costs is challenging.
Inventory valuation is an important accounting process that helps businesses track the cost of their inventory and ensure that they accurately report their financial results. This process involves assessing the cost of goods purchased or produced, tracking changes in inventory levels, and adjusting the inventory value accordingly.
By understanding the importance of inventory valuation and the different methods used to value inventory, businesses can ensure that their inventory is accurately valued and that their financial statements are accurately reported. You can also consult with an accountant in Framingham to help businesses make better decisions and maximize their profits.
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