Inventory Valuation

For companies which operate outside of the service industry, stock (or inventory) valuation is a critical component of their accounting procedure. For most companies, stock on-hand represents a considerable portion of their current assets, and most companies are taxed based on their stock valuation. The lower the stock valuation, the higher the company's profitability; this can serve as a motive for managers to find the lowest valuation method when their bonuses are based on profitability. Despite the importance of stock valuation, there is no single method which has emerged as the accepted standard. Indeed, there are three methods which are commonly used in different environments: first-in-first-out (FIFO), lastinfirstout (LIFO), and weighted average cost (WAC). Each of these methods are generally accepted in the business world (although the LIFO method is not approved for accounting statement valuation in the United Kingdom), and each has peculiarities which render them more (or less) effective to particular business and economic environments. This research examines the various methods for stock valuation and considers the valuation method in place at a building materials company.

Gulf Sail General Trading Company (GST) is a general trading, limited liability, company. The primary business is the wholesale and retail sale of building materials, and the company is divided into three divisions: air conditioning equipment,

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results. The following chart illustrates the effect on gross profit and cost of goods sold during a noninflationary (or low inflationary period). It should be noted that in the charts included in this analysis, the price increases (selling price) generally lag behind the cost since vendors are likely to react more slowly to price increases. No. Units Unit Cost Tot Cost Sold Price Revenue Profit Beg Stock 100 10 1000 75 20 1500 750 Quarter 1 100 10 1000 80 20 1600 800 Quarter 2 150 10 1500 110 20 2200 1100 Quarter 3 200 10 2000 150 20 3000 1500 Quarter 4 150 11 1650 200 20 4000 1935 COGS 700 7150 615 12300 6085 End Stock 85 Effect of FIFO During High Inflation During periods of increasing or high inflation, the FIFO method results in a lower cost of goods sold than other valuation methods. This approach results in a higher gross profit figure than if a different method of stock valuation were used. For companies such as GST, which are interested in using the

Category: Business - I