Physical Flow of Goods VS Inventory Valuation Methods

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The valuation methods are bookkeeping methods and must not be confused with the physical flow of inventory. As most goods deteriorate with age, the physical movement of goods will probably be organized in such a manner as goods received first are issued or sold first. It should be noted that this physical order of movement is likely to be followed by the majority of firms irrespective of the valuation method.

Example:

Some traders, however, do not deal in inventory which has a short sell by date, but do have inventory which is difficult to handle. An example would be a steel inventory holder, dealing in girders, RSJs and so on, when a new delivery arrives from the steel mills, the inventory holder is unlikely to move the existing inventory to store the new delivery underneath the old one. When he then sells to a customer he will usually take the steel from the top of the pile, and will thus be selling the newer inventory. In other words, LIFO is in practical use, as the last inventory that came in, is the first to go out.

Take another example of a garage that takes a new delivery of petrol into a tank already part full from a previous delivery. When a customer draws off a few gallons, what he takes will be a mixture of the old and new inventory. So in this case physical flow of goods is according to AVCO.

Bases of Inventory Valuation:

One may confuse in selecting an appropriate base for valuing inventory among the following:

(i) Base cost

(ii) Replacement cost

(iii) Original cost

(iv) Net realizable value

International accounting standards (IAS 2) does not allow the use of ‘base cost’ and replacement cost for inventory valuation, so we are left with the choice of valuing inventory at cost or net realizable value.