One way to calculate the total value of inventory owned by a company in a certain period is to use the inventory valuation method.
The calculation of inventory value is based on the total costs incurred to purchase inventory and prepare it for sale in the market.
The choice of this method is very important in accounting where the valuation of each item plays a role in calculating Cost of Goods Sold .
Using an appropriate inventory valuation method will also have a direct impact on the data in the income statement and balance sheet.
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Therefore, this article will explain what are the various methods of inventory valuation along with their differences and examples.
What is Inventory Valuation?
What is meant by inventory valuation is an accounting practice used by a company to find out the value of unsold inventory.
This inventory value will be recorded when the company prepares its financial statements.
As you know, inventory is an important asset for an organization, and companies are no exception.
And if the company wants to record it on the balance sheet, then the inventory needs to have financial or financial value.
This value can help you in determining the inventory turnover ratio.
Not only that, inventory values will also make it easier for you to plan your purchasing decisions.
For example, if you run a shoe business and you only have 25 pairs of shoes at the end of the period, you need to calculate the financial value.
You must record this value on your balance sheet. So, to calculate the value of inventory, there are several methods that you can use.
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For a further explanation of the types of methods and reasons why calculating inventory values is important, don’t stop here.
Keep watching the discussion below until the end!
Why It’s Important to Know Inventory Valuation
It is very important for companies to identify unsold items, companies usually use goods inventory applications to identify this.
In addition, the company certainly also requires a rate that can be multiplied by the quantity or number of goods to reach the final value of the inventory.
Each item may have a different price and may change throughout the year.
So you have to choose the right inventory valuation method in order to get valid results.
Continuing the illustration from the previous example, here is a detailed table of inventory values that you can see and pay attention to:
| Period | Purchase (per pair) | Price (per pair) |
| January | 150 | Rp. 50,000 |
| March | 100 | Rp. 52,000 |
| June | 100 | Rp. 52,000 |
| September | 200 | Rp. 50,000 |
| December | 125 | Rp. 53,000 |
| Total Items Paid | 675 | |
| Total Items Sold | 650 | |
| Total Unsold Items | 25 | |
| Inventory Value | 25 X (Rp. 50,000 or Rp. 52,000 or Rp. 53,000) |
Based on the table above, you can see that at the end of the year or period, your business has 25 pairs of unsold shoes.
However, because there are increases and decreases in product prices, it will certainly make you confused in determining which rate you should use.
Therefore, you need to choose the right inventory valuation method in calculating the stock items used.
In the following discussion, this article will explain some of the inventory valuation methods that you can use.
Of course, this explanation also contains a discussion of how to calculate the value of inventory along with examples.
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Various Methods of Inventory Valuation
In accounting, there are three methods you can use to calculate inventory value.
Among them are FIFO, LIFO , and WAC (Weighted Average Cost). Here’s an explanation:
1. Metode FIFO (First In, First Out)
This inventory valuation method assumes that the inventory that is produced first will be the first unit sold and fulfilled.
The function of using this method is to make it easier for you to determine inventory values based on existing inventory even if there are changes to the COGS.
Under the First-In-First-Out (FIFO) valuation method, inventory items are sold in the same order in which they were purchased or manufactured.
The FIFO valuation method is the most commonly used inventory valuation method.
That’s because most companies sell their products in the same order in which they buy them.
For example, consider the following illustration:
Business A purchases several units of laptops at different times and at different prices.
In the first transaction or purchase, business A bought ten laptops, each costing Rp. 4,000,000
Then, in the second transaction, business A bought another five laptops for Rp. 5,000,000 per unit.
By the end of the month, the business had sold eight laptops.
With the FIFO valuation method, the cost is calculated from the first transaction, namely when buying ten laptops for Rp. 4,000,000 per unit.
So, how to calculate the inventory value after selling eight laptops is as follows:
Accounting balance for HPP = (8 laptops x Rp. 4,000,000) = Rp. 32,000,000
Two laptops are still left from the first purchase, each costing Rp. 4,000,000, as well as five laptops from the second purchase each costing Rp. 5,000,000. So:
Inventory account accounting balance = (2 laptops x Rp. 4,000,000) + (5 laptops x Rp. 5,000,000)
= Rp. 8,000,000 + Rp. 25,000,000
= Rp. 33,000,000
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2. Metode LIFO (Last In, First Out)
The last-in-first-out (LIFO) inventory valuation method is precisely the opposite of the FIFO valuation method.
According to the LIFO method, how to calculate inventory value is from the most recently purchased or produced items sold first.
With LIFO, the cost of the most recently purchased or produced product is the first to be counted as goods sold.
Using this method, the lower cost of the old product will be reported as inventory value.
Continuing from the previous illustrative example, if using the LIFO method, the calculation method is as follows:
Accounting balance for HPP = (8 laptops x Rp. 5,000,000) = Rp. 40,000,000
Two laptops are still left from the first purchase, each costing Rp. 4,000,000, as well as five laptops from the second purchase each costing Rp. 5,000,000. So:
Inventory account accounting balance = (2 laptops x Rp. 5,000,000) + (5 laptops x Rp. 4,000,000)
= Rp. 10,000,000 + Rp. 20,000,000
= Rp. 30,000,000
3. Metode WAC (Weighted Average Cost)
With the WAC inventory valuation method, inventory and Cost of Goods Sold are calculated based on the average price of all items purchased during a period.
This method is mostly used by businesses that don’t have a lot of variety in their inventory.
Let’s use the previous illustrative example that business A has purchased a total of 15 laptops.
Which in the first transaction, there were ten laptops with a price per unit of Rp. 4,000,000.
Whereas in the second transaction, business A bought another 5 laptops at a price of Rp. 5,000,000 per unit.
Thus, the average cost is as follows:
[(Number of laptops I x Rp. 4,000,000) + (Number of laptops II x Rp. 5,000,000)] ÷ Total Laptops
[(10 x $400) + (5 x $5000)] ÷ 15
(Rp. 40,000,000 + Rp. 25,000,000) ÷ 15 = Rp. 4,300,000
So, after successfully selling eight units of laptops, the inventory value is:
Inventory account accounting balance = Number of unsold items x average price
= 7 x Rp. 4,300,000
= Rp. 30,100,000
Well, that’s the discussion about the three types of inventory valuation methods in accounting.
Hopefully this article can help you find references regarding inventory valuation methods for your financial reports.