Inventory valuation remains an essential aspect of any business because it forms a part of its financial management. Also known as stock, inventory appears on a balance sheet as a positive feature. Under the GAAP, there are four ways of inventory valuation (Epstein, Nach, & Bragg, 2009):
Specific Identification Method
Under this method, every time an item is sold, the specific unit is removed from the company’s inventory. The inventory account is then credited whereas the cost of goods sold is increased by the amount paid for the specific item (Epstein, Nach, & Bragg, 2009). This method works best in small companies where it is possible to establish the cost of each item. Car dealers and jewelry shops can employ this method in valuing their stock.
First In, First Out Method
This method is based on the assumption that goods that were bought first will be the ones sold first. It bases the cost of items sold on the cost of the items bought earliest during the period, while basing the cost of the stock on the cost of the items bought later in the period. The system results in a current replacement: cost system of valuing inventory. It can be best used in flower shops or grocery stores (Epstein, Nach, & Bragg, 2009).
Last In, First Out Method (LIFO)
Under this method, the inventory is valued based on the cost of the material earlier in the trading period. The cost of goods sold is based on the items acquired towards a trading period’s end. This method results in costs, which strictly estimate the current cost of the goods (Epstein, Nach, & Bragg, 2009). It can be used in companies that trade in items that have long shelf life.
Weighted Average Method (WAM)
Under this method both the cost of goods sold and the inventory uses average cost of all items bought during a trading period. Companies that sell very many identical items such as hardware firms can employ this method (Epstein, Nach, & Bragg, 2009).