5a: Inventory Valuation

Inventory

At the end of the year a bussiness will do a “stock take “ or a inventroy check i(coutn how much inventory is unsold and recorded as the closing inventory for the year.

Valuing Inventory

Applying Historical Cost, Prudence to ensure not over valued.

Inventory must be valued at the lower of:

Cost Value: Cost to bussines to buy + carratiage + cost to get goods ready to sale

Net Realisable Value: Expected sell price - cost to get goods ready to sell

Sale or reutnr bases

ApplWhen the legal tilte of goods apesse to the buyer and they ahve obligation to pay for goods or services.

When on sale and return basis. custimer take goods and pay for the owne sthey se. goods still belong to supplesi unkess sold.

Inventory Valuration Statment

What is an inventory valuation statement?

• An inventory valuation statement shows the total valuation for the inventory of a business

• These are useful when a business sells different types of goods

• There is no fixed format, however, a table is normally used

• The statement should show:

  • The name of each type of good

  • The cost of each item

  • The net realisable value of each item

  • The quantity of each type of goods

  • The total value of each type of goods

  • The overall value of the goods

Closing inventory appears in two places in the financial statements, so an error in its value has a double effect:

• Income Statement — used to calculate Cost of Sales

• SOFP — shown as a current asset

Cost of Sales = Opening Inventory + Purchases − Closing Inventory

Gross Profit = Sales − Cost of Sales

The one rule to know

Closing inventory moves profit the same way as it moves.
Opening inventory moves profit the opposite way.

Error	Profit	Current Assets (SOFP)
Closing inventory too high	too high	too high
Closing inventory too low	too low	too low
Opening inventory too high	too low	no effect this year
Opening inventory too low	too high	no effect this year

Why

Closing inventory is subtracted in the Cost of Sales formula — so a bigger closing inventory means a smaller Cost of Sales, which means a bigger profit.

Opening inventory is added — so it works the opposite way.

SOFP link

Closing inventory is a current asset. Profit flows into capital. So if closing inventory is wrong, both current assets AND capital are wrong by the same amount — but the SOFP still balances, so the mistake is easy to miss.