Inventory valuation: the number that decides your profit

Inventory valuation is how you decide what the stock on your shelves is worth, and it is one of the few accounting choices that visibly moves reported profit. Buy the same item at three prices over a year and the figure you carry depends entirely on which of those purchases you treat as still being on the shelf. Nothing physical changes; the profit does.

What inventory valuation includes

• The purchase price, less trade discounts and rebates actually received.
• Import duties and non-recoverable taxes, which are part of cost rather than an expense.
• Inbound freight and handling to get the goods to where they are sold from.
• For manufactured items, direct materials, direct labour and a share of production overhead.
• Not storage of finished goods, not selling costs, not administrative overhead — those are period expenses, and including them overstates both stock and profit.

FIFO against weighted average

First in, first out assumes the oldest stock sold first, so the balance sheet carries recent prices and, when prices are rising, reports a higher profit. Weighted average smooths the cost across all units and reports something between the extremes. Both are acceptable in most jurisdictions; what is not acceptable is switching between them because one produces a nicer figure this year. Pick on the basis of how the goods actually flow, write it down, and apply it consistently — the consistency is what makes the comparison between years mean anything.

Last in, first out is prohibited under international standards and permitted in a few jurisdictions including the United States. If you have read about it in American material, check before assuming it is available to you — this is the commonest cross-border confusion in the subject.

The write-down nobody wants to make

Stock is carried at the lower of cost and what you could realistically sell it for, less the cost of selling it. That rule bites on anything obsolete, damaged or simply unsellable at the price you paid — and writing it down reduces profit in the period you admit it, which is why it gets deferred. Deferring does not help: the loss has already happened, carrying it forward only moves the admission, and an auditor who finds three-year-old stock at full cost will ask about everything else as well. The honest discipline is to review slow-moving lines on a schedule rather than when somebody notices.

Doing it without a system

1. Count what is there first, because a valuation applied to the wrong quantity is precise and wrong.
2. Record the purchase cost per line at the time of purchase rather than reconstructing it from invoices later.
3. Choose one method, document it, and keep the documentation where the accountant will find it.
4. Add inbound freight to cost rather than expensing it, which is the most common small-company error.
5. Flag lines with no movement in twelve months for a write-down decision at each year end.
6. Keep the working, since the valuation is one of the figures most likely to be queried.

Ettex Sheets holds the working — quantity, unit cost, method and the resulting value per line — which is all most small companies need before an accountant touches it. The quantity has to come from a count rather than from the system, and keeping that count close to the valuation makes the annual question a check instead of an investigation.