Inventory Valuation
Inventory Valuation
Retailers define inventory as intended sellable assets consisting of goods that are available for resale to customers. Manufacturers also maintain three components of inventory. These include “finished goods” which are goods that have been completed and are awaiting sales. Manufacturers may also have “work in process inventory” made up of goods being manufactured but not yet completed. The third category of inventory is “raw materials,” consisting of goods that are to be used in producing products. Overall, inventory should include all costs that are both ordinary and necessary to put the goods in place and in condition for their resale. For many companies, what they have in inventory represents a major portion of assets and therefore makes up an important part of the balance sheet. It is therefore crucial for investors to understand how inventory is valued. Inventories are kept track of by periodic and perpetual inventory systems. Both terms, periodic and perpetual, imply a time frame for determining the amount of ending inventory. Under the periodic system the amount of inventory on hand is determined through physical count once at the end of an accounting period or periodically. A more robust system is the perpetual system. With a perpetual system, a running count of goods on hand is maintained at all times. The perpetual inventory method is not a physical check of inventory but rather a recording of changes in inventory when sales transactions occur. The FIFO method, which is explained later, will produce the same financial statement results no matter whether it is applied on a periodic or perpetual basis. This occurs because the beginning inventory and early purchases are taken away and charged to the cost of goods sold whether the associated calculations are done as you go (perpetual) or at the end of the period (periodic). There are advantages to both inventory systems. Through perpetual systems, inventory
Retailers define inventory as intended sellable assets consisting of goods that are available for resale to customers. Manufacturers also maintain three components of inventory. These include “finished goods” which are goods that have been completed and are awaiting sales. Manufacturers may also have “work in process inventory” made up of goods being manufactured but not yet completed. The third category of inventory is “raw materials,” consisting of goods that are to be used in producing products. Overall, inventory should include all costs that are both ordinary and necessary to put the goods in place and in condition for their resale. For many companies, what they have in inventory represents a major portion of assets and therefore makes up an important part of the balance sheet. It is therefore crucial for investors to understand how inventory is valued. Inventories are kept track of by periodic and perpetual inventory systems. Both terms, periodic and perpetual, imply a time frame for determining the amount of ending inventory. Under the periodic system the amount of inventory on hand is determined through physical count once at the end of an accounting period or periodically. A more robust system is the perpetual system. With a perpetual system, a running count of goods on hand is maintained at all times. The perpetual inventory method is not a physical check of inventory but rather a recording of changes in inventory when sales transactions occur. The FIFO method, which is explained later, will produce the same financial statement results no matter whether it is applied on a periodic or perpetual basis. This occurs because the beginning inventory and early purchases are taken away and charged to the cost of goods sold whether the associated calculations are done as you go (perpetual) or at the end of the period (periodic). There are advantages to both inventory systems. Through perpetual systems, inventory