When it comes to running a business or a company, inventory is one of the most important parts of it. So, for the students who need to gain some insight into this chapter on inventory valuation, this is definitely the right place to be.
What Is Inventory?
Stock or more commonly known as inventory can be defined as the resourceful and yet idle assets which are left lying with the business or the company even after an accounting period is over. This type of asset is very significant to the company and is supposed to be marked in the balance sheet for sure. When it comes to valuing inventory, there is no doubt that it is a very crucial factor when there is a need for accounting in the company. Hence, students will have to read this chapter really carefully so that they know what it means and what its significance is.
Significance of Inventory Valuation
In case there is a talk about inventory, there is a mention of the stock-in-trade which is done for the raw materials of the company, finished goods, semi-finished goods, and the other spare parts. So, in order to get the closing stock, there is a need to calculate the inventory for sure. However, just the counting of inventory is not enough, it needs to be valued as well. This is known as the method of valuation of closing stock. This particular process helps in determining the particular value at which the inventories will be recorded in the company accounting statements. There are so many other inventory valuation methods that students can get to know about.
We have no doubts about the significance of inventory valuation. However, in order to clear out the concept to the students, we are going to provide the benefits in detail.
1. It Helps In Determining Income
With the help of the average cost method of inventory valuation, there is no doubt that people will be able to calculate the gross profit or the loss that happened that particular year. This in turn helps in further calculating the income. This can be done with a basic formula
COGS = Opening Inventory + Purchases + Direct Expenses – Closing Inventory
Students can further get to know about the average cost method formula from the different notes that are provided to them.
2. It Helps In Ascertaining The Company’s Financial Position
When companies understand the inventory valuation meaning and how to calculate it, they can use the information to determine whether the company is in a strong financial position or a weak one. This can be done with the help of proper inventory valuation in the best way.
More information on the 10 methods of inventory valuation can be found in the chapter.
3. Liquidity Analysis
In other words, inventory can also be considered as a proper current asset since the company or the firm is not really expected to hold that for a very long time period. In such cases, there are a lot of different turnovers when there is a question of the stock. That is why inventory forms a very important part of the company’s working capital. Hence, it is essential that the inventory valuation happens properly so the liquid ratios and the current ratios can be accurately calculated without any hassle. These ratios play a very important role when it comes to checking the liquidity of any particular company.
The Main Principles of Inventory Valuation
If we go according to the AS 2 inventory valuation facts there is just one basic principle that is used in the valuation of inventory. In a general sense, the inventory of the firm is supposed to be valued at a lower net or cost realizable value. This is a principle that is generated from certain conservative systems regarding accounting. According to this principle, we are supposed to value all the stock or inventory either at the net realizable value or the inventory cost. The lower amount is recorded between the two and that too is done according to the conservative accounting approach. This principle is also known as the IFRS Inventory valuation process.