Inventory Valuation Methods

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Records of inventories are not normally included in the double entry system. Most organizations keep a separate record of inventories, outside the ledger, by maintaining an individual record of the transactions of each type of inventory held. These records might be kept on ‘bin cards’, which normally record only quantities, or on inventory sheets, which record values as well. The quantity held is normally checked by means of a physical inventory check at the end of the accounting period.

There are many different methods of arriving at the value of inventories consumed or closing inventories. The most accurate but time consuming method is for each item to be labelled with its cost and when it is sold, the cost notified to the accounts department. However, this is not practical in most organizations, especially where inventories are bought in bulk, and where no distinction is made between old inventories and new inventories. Therefore inventories must be valued using certain assumptions.

When valuing inventory items, there is always the problem as to whether the original purchase price or the immediate current price should be used. The dilemma has led to a number of methods of inventory valuation, all aimed at some form of compromise. There are following methods are used for inventory valuation:

(a) Last in first out (LIFO)

(b) First in first out (FIFO)

(c) Weighted average cost (AVCO) method

(d) Retail valuation method

Note:

(i)  International Accounting Standards (IAS) does not allow LIFO method for inventory valuation.

(ii) Weighted average cost and retail valuation methods may only be used if these are able to value inventory as a good approximation of actual cost. However, they are rarely used.