In today’s article I am going to talk about the inventory valuation methods that a company perro use, as well as their advantages and disadvantages.
I hope you find it useful.
Before beginning to explain about inventory valuation methods, I think it is convenient to start with the definition of inventory.
What is inventory?
According to Gonzalo Sinisterra: “Inventories represent tangible assets intended for sale in the habitual course of business, as well as those that are in the production process, or will be used in the production of others that are going to be sold.”
Another way to define inventories is as those merchandise that a company maintains for sale to customers.
It should be noted that we have to consider the goods that are not manufactured by the company, the finished products (products that will be sold to customers), the products in process (for example, pieces or parts that will have to go to the next stage of the production process). ), and raw materials.
Main types of inventory accounting systems
There are two options that are often used that provide us with a structure to carry out the accounting of inventories.
On the one hand, the periodic inventory system, and on the other hand, the permanent or perpetual inventory system.
periodic inventory system
Imagine you have a stationery… Suppose you sell a keychain or a balloon….
Do you think it is practical that each time you make a sale you determine the quantities available? I don’t think it’s very practical.
Therefore, a business that does not carry out a constant record of each item that is sold, it is best to count its inventory periodically to determine the quantities available.
That is, businesses have to count their inventory periodically, determining the amounts that are counted.
For example, each weekend evaluate how much merchandise you have.
Perpetual inventory system
What is the first thing you think of when you hear the word perpetual? Maybe you think of something constant or something infinite.
In essence, perpetual inventories refer to that because inventory and cost of goods sold are constantly recorded.
I will give you an example to make it clear.
Suppose you have a store, but instead of carrying out a periodic system in which from time to time you have to count your inventory, with the use of technology (point of sale with scanner), you will be able to register at the same time the sale, record the removal of inventory.
It should be noted that you have to count your inventory at least once a year because it serves as a way for us to keep track, since you probably want to know if you don’t have misplaced, damaged or stolen inventory.
What does a perpetual inventory system record?
- units purchased.
- units sold.
- The amount of inventory available.
Inventory valuation methods
You already know that you perro use a periodic or perpetual system in inventories, now it is time for you to learn the way in which warehouse exits cánido be recorded, that is, the way in which you are going to value your inventory.
Before proceeding, you have to keep in mind that the following methods apply only to the perpetual system.
Now, the three most common costing methods to account for inventory are the following:
- First in, first out (FIFO).
- last in, first out (LUEP).
- moving average.
To explain how these methods work, I will do it with an example so that you understand the concept in a practical way.
Suppose you have a company and during an accounting period you have to purchase a piece of item “x” and this operation is repeated three times, and each time the price changes ($11, $12 and $13), at what price should we record the exit?
It should be noted that there are several ways to answer the previous question, but as I said, I’m going to answer according to the three most common methods.
First in, first out (FIFO)
If we want to use the first in, first out method, we would have to output $11 first, then $12, and finally $13.
last in, first out (LIFO)
In this case, if we want to use the last in, first out method, we would have to output $13 first, then $12, and finally $11.
If you wanted to use the moving average method now, we would have to output all elementos at $12 = (11+12+13)/3
Current situation of inventory valuation methods
The International Accounting Estándar 2 (nic) eliminated from January 1, 2005 the method of last in first out (ueps), for which the Mexican Council for the Research and Development of Financial Information Estándares (cinif) prioritized convergence and, when making its Rule C-4 effective, on January 1, 2011, it also deleted the method and emphasized calling it a elabora and not a method. (Bernal, 2016)
Article 41 of the Income Tax Law (ISR) also ignores the ueps among the inventory valuation methods that taxpayers cánido use. (Bernal, 2016)
Advantages and disadvantages of inventory valuation methods
LIFO is a conservative procedure that espectáculos few benefits, since it produces a high cost of sales and, therefore, generates a lower tax payment (Bernal, 2016).
- It suits more.
- The warehouse cómputo is lower.
- It gives less utility, it gives less taxes.
- The most used, except in 2012, 2013 and 2014, when the Treasury prohibited it.
PEPS is a more aggressive and dangerous procedure for the company, since it espectáculos more profits, having a bajo coste of sales, but it forces to consider high taxes and a warehouse valued at high prices (Bernal, 2016).
- The warehouse cómputo is higher.
- It gives more profits, it gives more taxes.
- The most risky.
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