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Valuation of Inventory/Stock

The Valuation of Inventory/Stock

Net realizable value
The net realizable value of stock is its saleable value less all the selling expenses. Selling expenses are those expenses that are incurred directly in the selling of goods such as marketing expenses, and sales commissions, travelling and lodging expenses of salespersons.

If the cost of stock is higher than its net realizable value, it’s the net realizable value that should be taken in when preparing the final accounts. The underlying reason for this is that stock should not be over-valued. Over-valued stock will show an inflated profit. To ensure that stock is recorded at its net realizable value, any decrease in the value of stock due to obsolescence, damage, rust, rot, deterioration, etc must be considered as soon as it is detected.

For example, a fire caused considerable damage to manufactured goods worth $150,000 stored within a warehouse, and the sale value of the undamaged goods is now put at $40,000. The $40,000 must be accepted as the realistic value and recorded using the following journalized entry.

Date Accounts Folio Debit Credit
$ $
20XX
Sep 30 Inventory Loss 110,000
Inventory 110,000
(Revised value of inventory)

Any other expense accounts may be used for the inventory loss. Some choose to


Lower of cost or market value
Sometimes the market value of inventory has dropped below its purchase price. Here, the lower of cost or market value rule is applied to revalue the goods in stock.

For example, a large consignment of 200 computer games was purchased at $100 per unit. After 120 of these games were sold, the price for each unit dropped to $80. The unsold 80 units in store have now a lower value of $6,400 and not $8,000 as it would be if the price had not dropped. The loss of $1,600 is journalized in the following entry.

Date Accounts Folio Debit Credit



$ $
20XX
Oct 30 Inventory Loss 16,000
Inventory 16,000
(Revised value of inventory)

Valuation methods
Let’s assume that a company deals with one type of goods as the following table shows. The goods are bought in batches at different times and at different prices. At the end of the financial year, the 30 units left in stock have to be valued. Since the units are bought at different prices, it means the closing stock of goods has to be calculated at the prices they are bought. But not many companies know whether to use the earlier or the later purchase price. The price of the earlier batch is lower that the later batch.

Goods purchases Goods sold
Date Units Unit Cost Amount Date Units Unit Cost Amount
$ $
20XX 20XX
Mar 30 15 450 Apr 23 20 460
Jul 50 20 1,000 Aug 22 25 550
Nov 70 25 1,750 Oct 30 30 900
Dec 45 30 1,350
3,200 3,260

The stock valuation needn’t be based on the price the items were bought. In other words, the valuation does not have to be done based on only one price or cost. Stock can be calculated with different amounts. There is a variety of inventory valuation methods that are being used, a few of which are explained here:

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1 Perpetual method 743
2 Periodic method 767
3 Average cost method 768
4 Last in, first out method (LIFO) 745
5 First in, first out method (FIFO) 764