Definition of Valuing Inventory
Generally, the financial statements of a U.S. company must report its inventory at its historical cost (not at its selling prices).
Inventories are to be reported at less than the historical cost if the net realizable value of the inventories is lower than the cost.
Companies should physically count their inventories at least once a year and the calculations reviewed carefully since the cost of the inventory is critical in the calculation of a company’s profits and working capital.
Examples of Ways to Value Inventory
Since the costs of products are likely to change during an accounting year (seems there is always some inflation), a company must select a cost flow assumption that will be used consistently. Examples of cost flow assumptions that U.S. companies use include:
- FIFO in which the oldest costs are removed from inventory when an item is sold (leaving the most recent costs in inventory)
- LIFO in which the most recent costs are removed from inventory when an item is sold (leaving the oldest costs in inventory)
- An average method such as weighted-average or moving-average
The inventory values using LIFO or the average methods will vary slightly depending on whether the inventory system is periodic or perpetual and whether a dollar-value method based on price indexes was used.
