| There are several ways to determine the value of | | | | recent purchases are the first to be sold leaving the |
| your inventory and each type of valuation has benefits. | | | | older items remaining in inventory. One argument for |
| The most common type used by small businesses is | | | | using this method is that it matches the most current |
| average cost or weighted average costing. This is | | | | cost of items purchased against the current sales |
| based on the average cost of identical units. Using the | | | | revenue. Also when prices are rising net income |
| total actual cost of all similar items available for sale | | | | calculated by this method is smaller than the amount |
| divided by the number of units available for sale would | | | | determined from using other methods resulting in a |
| result in a weighted average cost per unit. Multiplying | | | | smaller income tax. This would be reversed if pricing |
| the weighted average cost per unit times the number | | | | were falling. |
| of units unsold gives you the value of your inventory. | | | | One other, however uncommon, method is specific |
| First-In, First-Out Costing (FIFO) assumes that the first | | | | identification costing which requires that each item that |
| goods purchased are the first goods sold and | | | | is sold and each item remaining in inventory is |
| therefore that the last goods purchased are the ones | | | | separately identified in respect to it's purchase cost. |
| remaining in inventory. This system is used frequently | | | | This method is not practical for most businesses. Only |
| because whenever the flow of inventory can be | | | | those businesses that sell items where the cost is |
| controlled it makes sense that the oldest items are | | | | relatively high, and sales volume is low and it is easy to |
| sold first satisfying the accounting convention that | | | | identify the cost and sale price of each item |
| inventory should be shown on the balance sheet at | | | | separately would find this method useful. |
| the most current cost possible. Also because this | | | | When choosing a method consider the practical issues |
| method has been used for such a long time, continued | | | | of how the valuation can be accomplished accurately |
| use assures consistency for income calculations | | | | and with the least amount of effort, and be sure to |
| comparability. | | | | consult your tax preparer for tax return considerations. |
| Last-In, First-Out Costing (LIFO) assumes that the most | | | | |