Inventory Valuation

Inventory valuation refers to assigning product costs to the inventory. Inventory valuation is done at the book value and not at the market value. It is a statement that provides information about the value of goods held in inventory. Inventory valuation provides a monetary value for items that make up their inventory. Inventories are the largest asset in the company and hence proper measurement of them is essential to assure accurate financial statements. Inventory valuation is recorded in the financial statements which are used for accounting, valuing the company and making business decisions.

There are various ways in which inventory valuation is performed in a business. The four methods are the throughput method, direct or variable costing method, full absorption method and the activity based costing method. The throughput method is a method that involves tracing the least amount of cost to the inventory. In this method only the direct material costs are charged to the inventory. Throughput method evaluates inventory with the formula, sales less the direct materials cost. In the direct or the variable costs method, only the variable manufacturing costs are capitalized or charged to the inventory. This method does not provide proper matching as the current fixed costs, charged to expense regardless of whether or not the output is sold during the period.

Full absorption costing method is a method where all manufacturing costs are capitalized in the inventory, i.e., charged to the inventory and become assets. The costs charged under this method do not become expenses until the inventory is sold. This costing method is required for external reporting. The activity based costing (ABC) method was developed to provide accurate product costs. It is accomplished by tracing costs to activities. Under this method the activities consume resources and products consume activities. The ABC method assigns costs to products including engineering, marketing, distribution and administrative costs, although some facility related costs may not be assigned.

Questions

• What is inventory valuation?
• What are the various inventory valuation methods?