Understanding the concept, characteristics and fundamentals of inventory valuation systems turns out to be very useful for the company, since it is these that really set the point of production that can be had in a period. The financial administrator must have the pertinent information that allows him to make decisions about the management that should be given to this item of organizational assets.
In order to record and control inventories, companies adopt the relevant systems to value their merchandise stocks and thus determine their possible volume of production and sales.
Periodic inventory system
Through this system, merchants determine the value of merchandise stocks by periodically carrying out a physical count, which is called initial or final inventory, as the case may be.
- Initial inventory: It is the detailed and meticulous list of merchandise stocks that a company has at the beginning of its activities, after making a physical count. Final inventory: It is the list of stocks at the end of an accounting period.
Permanent inventory system
Through this system, the company knows the value of the merchandise in stock at any time, without the need to perform a physical count, because the movements of purchase and sale of merchandise are recorded directly at the time of the transaction at its price cost.
Companies that adopt this type of system must keep a merchandise assistant called "Kárdex", in which each item bought or sold is recorded. The addition and subtraction of all the operations in a period results in the final merchandise balance.
Coupling the criteria. Merchandise inventories constitute all inventories at cost price with which the company produces goods or markets its finished products
Methods for the valuation of inventories
Companies must value their merchandise, in order to value their inventories, calculate the cost, determine the level of profit and set production with its respective level of sales. The following methods are currently used to value inventories:
1. Assessment by specific identification
In companies whose inventory consists of the same merchandise, but each one of them is distinguished from the others by its individual characteristics of number, brand or reference and a certain cost, automobiles are a clear example of this type of valuation, since these Although apparently identical, they differ in color, engine number, series, model, etc.
2. Valuation at standard cost
This method facilitates the handling of the “Kárdex” merchandise auxiliary since it only needs to be carried in quantities by homogeneous units:
3. Valuation at cost price
Valuing inventory at cost price means that the company relates the goods to the acquisition price.
Companies must choose the valuation system that best suits their needs and allows them to exercise permanent control over them
Methods for fixing the cost of inventories
The most used methods to set the cost of the company's goods are the weighted average, LIFO or FIFO and FIFO or LIFO, below are its fundamentals and an example of its application:
1. Weighted average method
This method consists of finding the average cost of each of the items in the ending inventory when the units are identical in appearance, but not in the purchase price, since they have been purchased at different times and at different prices.
To set the value of the cost of the merchandise by this method, the value of the merchandise is taken from the initial inventory and the purchases of the period are added to it, then it is divided by the number of units of the initial inventory plus those purchased in the period.
2. FIFO or FIFO method
Applying it to merchandise means that the stocks that first enter the inventory are the first to leave it, this means that the first that are bought, are the first that are sold.
3. LIFO or LIFO method
This method is based on the fact that the last existence to enter is the first to leave. This is that the last acquired are the first that are sold.
In the following video-lesson (3 videos, 34 minutes), from facilcontabilidad.com, the methods for setting the cost of inventories are clearly explained: weighted average, FIFO and LIFO.
Application of the methods
The following example is intended to explain the application of each of the methods for setting the cost of goods in inventory.
| Quantity | Unit cost | Total value | |
| Initial inventory | 10 pcs. | $ 10,000 | $ 100,000 |
| Purchases | 30 pcs. | $ 15,000 | $ 450,000 |
| Total quantity | 40 pcs. | $ 550,000 | |
| Sales period | 35 pcs. | ||
| Final inventory | 5 pcs. |
1. Weighted average
Total Value / Total Amount = $ 550,000 / 40 = $ 13,750
Average cost per item is $ 13,750
The ending inventory value = 5 pcs. * $ 13,750 = $ 68,750
The final inventory is valued at the average cost of merchandise in stock.
2. FIFO or FIFO
Ending inventory value per = 5 Unit. * $ 15,000 = $ 75,000
The final inventory is valued at the cost of the last merchandise purchased.
3. LIFO or LIFO
Ending inventory value per = 5 Unit. * $ 10,000 = $ 50,000
Ending inventory is valued at the cost of the first merchandise in stock.
4. Final analysis
| Average | $ 68,750 |
| FIFO | $ 75,000 |
| LIFO | $ 50,000 |
When analyzing the three methods, it can be concluded that the lowest valuation is the one obtained with the LIFO, the highest with the FIFO and an intermediate valuation with the average.
The inventory includes: Raw materials; Goods owned by the company that are in the warehouse; Goods in transit; consignment merchandise
Here is a video-course about the inventory systems that we know will be useful for you. Periodic and permanent inventory systems, weighted average methods, FIFO and LIFO, inventory accounting and kardex cards, among others, are reviewed. (8 videos, 3 hours and 10 minutes)
