Understanding the concept, characteristics, and fundamentals of inventory valuation systems turns out to be very useful for the company since these are what really set the production point 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 must be given to this item of organizational assets.

In order to register and control inventories, companies adopt the relevant systems to value their stocks of merchandise and thus set their possible volume of production and sales.

Periodic inventory system

Through this system, merchants determine the value of merchandise stocks by periodically performing 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 when starting its activities, after making a physical count.
  • Ending inventory: It is the list of stocks at the end of an accounting period.

Perpetual inventory system

Through this system, the company knows the value of the merchandise in existence at any time, without the need to perform a physical count, because the purchase and sale of merchandise are recorded directly at the time of carrying out the transaction at its price of cost.

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Companies that adopt this type of system must keep a merchandise auxiliary called ” Kárdex “, in which each item that is bought or sold is recorded. The addition and subtraction of all operations in a period result in the final balance of merchandise.

Companies that are required by law to file a tax return must use the perpetual inventory system

Matching the criteria. Merchandise inventories are all inventories at the cost price with which the company produces goods or sells its finished products.

Methods for inventory valuation

Companies must value their merchandise, in order to value their inventories, calculate the cost, determine the level of utility, and set the production with their respective level of sales. The following methods are currently used to value inventories:

1. Assessment by specific identification

In companies whose inventory consists of identical 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 are differentiated by their color, engine number, series, model, etc.

2. Valuation at standard cost

This method facilitates the handling of the merchandise auxiliary “Kárdex” as it only requires carrying in quantities by homogeneous units:

3. Valuation at cost price

Valuing inventory at cost means that the company relates the merchandise to the purchase price.

Companies must choose the valuation system that best suits their needs and allows them to exercise permanent control over them.

Methods for Determining the Cost of Inventories

The most widely used methods to set the cost of the company’s merchandise are the weighted average, LIFO or LIFO Method, and FIFO or FIFO method

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or LIFO, their fundamentals and an example of their application are presented below:

1. Weighted average method

This method consists of finding the average cost of each of the items in ending inventory when the units are identical in appearance, but not in 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 of the initial inventory is taken 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 to be bought are the first to be 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 purchased are the first to be sold.

Application of the methods

The following example is intended to explain the application of each of the methods for fixing the cost of merchandise in inventory.

Amount Unit cost full value
Initial inventory 10 pcs. $10,000 $100,000
Shopping 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

The average cost value per item is $13,750

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Ending inventory value = 5 Units. * $13,750 = $68,750

Ending inventory is valued at the average cost of goods in stock.

2. FIFO or FIFO method

Ending inventory value per= 5 Units. * $15,000 = $75,000

Ending inventory is valued at the cost of the last merchandise purchased.

3. LIFO or LIFO method

Ending inventory value per= 5 Units. * $10,000 = $50,000

Ending inventory is valued at the cost of the first merchandise in existence.

4. Final analysis

Average $68,750
PEPS $75,000
LIFO $50,000

When analyzing the three methods, it can be concluded that the lowest assessment is the one obtained with the LIFO, the highest with the PEPS, and an intermediate assessment with the average.

Inventory includes: Raw materials; The goods owned by the company that is in the warehouse; Goods in transit; consignment merchandise