Inventory or stock is defined as assets that are held for sale in the ordinary course of business such as properties held for sale by a property developer, cars and vehicles held by a car dealer, or bread and milk that is held for sale by a supermarket.
Inventory or stock can also be in the process of production with view of being sold to customers such as radios and televisions in the manufacturing workshop of Sony or Samsung factories or training shoes and T-shirts in the Nike or Reebok sewing shops. Goods that are in the middle of production or ones that are yet to be completed also qualify as business inventory or stock. The accounting term for goods that are still being manufactured is work in progress (WIP).
Inventory can also be in the form of materials or supplies to be consumed in the production process or in the rendering of services. Raw materials such as cloth used in the tailoring dresses and suits or timber used in manufacture of furniture or steel and bricks used in construction of buildings also constitute stock or inventory.
Valuation of Inventory or Stock
Inventory or stock is disclosed on the balance sheet as part of current assets. The valuation of inventory or stock involves the following process:
- As part of valuing inventory or stock the business must first establish the physical existence and ownership of the stock or inventory. The existence of stock is verified through month end or year stock or inventory counts. If the stock or inventory cannot be located physically for example if it is missing or if it has been stolen then it must be written off because keeping it on the balance sheet would amount to keeping a fictitious asset. Ownership can be ascertained through the organization’s ability to restrict usage by another party. If the business passes ownership control to a third party it should cease to recognize that inventory or stock as its assets.
- Once ownership and existence have been confirmed the business must determine the unit costs of the stock or inventory. There are a plethora of methods that a business can use to ascertain the cost of its stock and they include: First In First Out (FIFO), Last In First Out (LIFO), and Average Cost (AVCO). The cost determined from either the FIFO, LIFO, or AVCO will form the cost that will be used as the carrying amount on the balance sheet if the stock or inventory has not been damaged or if it has not suffered any impairment.
- In an ideal world stock or inventory would be valued at cost; however, there instances when the carrying value of the stock or inventory is higher than the expected net selling price stock or inventory which is known as the net realizable value. This happens when the stock or inventory is close to expiry date or when the stock is damaged. This necessitates the calculation of provisions to reduce cost to net realizable value. Under IAS 2 inventory has to be valued at the lower of the cost and the net realisable value.
Munya Mtetwa - Munya is an ACCA and IFA qualified accountant with over ten years financial management and accounting experience acquired in a plethora of ...
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