An inventory valuation is a statement which provides information about the value of goods held in inventory. Goods in inventory can make up a substantial portion of a company’s equity and there is therefore a great deal of interest in the total value of a company’s inventory. This information is reported in financial statements which can be used internally and externally for a variety of tasks related to accounting, valuing the company as a whole, and making business decisions.
There are a number of ways to perform an inventory valuation and different approaches to maintaining records about inventory. One method is to record sales and movement of inventory as they occur. For example, when a book sells a copy of a dictionary, it would record the fact that the inventory was short one dictionary while also noting the amount of the sale. This is called perpetual recording, because the inventory numbers are constantly being updated. One advantage to this system is that it provides real time data which can be reviewed at any time and used for everything from inventory valuation to ordering new products to replace things that are selling out.
Another method is periodic. In this case, sales are recorded at the time they take place but the change to inventory is not. At the end of a set period, the inventory is manually counted and recorded. For example, at an ice cream store, people do not record each scoop as it leaves inventory. Instead, they note how many tubs of ice cream the store has at the end of the day.
In addition to having different ways of tracking inventory, there are also different methods which can be used for inventory valuation, based on how people record the value of items in inventory. One is the first in, last out method, which assumes that when an item sells, it was the oldest such item in inventory. For example, if a store receives shipments of shampoo on Monday and Wednesday and it sells four shampoo bottles on Friday, for accounting purposes these units are treated as having come from Monday’s shipment. Last in, first out is another method which can be used for inventory valuation; in the shampoo example, the four units sold on Friday would be accounted as coming from Wednesday’s shipment. Averaging is also possible.
One reason why it is important to know which method of inventory valuation is used is because prices shift over time. To borrow the shampoo example, the store might have gotten Wednesday’s bottles at a better price from the distributor than Monday’s. The difference in accounting methods can change the inventory valuation; if the store has 22 bottles in stock, the inventory valuation will vary depending on which method was used.