IAS 2 is the International Accounting Standard that relates to inventories (stock). This determines how we value the inventory and deal with it in the figures. There are several separate ways to value and determine the cost of inventory. There is no specific right and wrong way of determining the cost, which is what a lot of people expect in accountancy, however, you must be consistent in your method.
The stages of inventory
Inventory can come in many different forms. The majority of businesses will hold inventory. If you imagine a company like Tesco, think of both the volume of inventory they hold but also imagine how quickly that gets turned over.
Alternatively, there are different businesses, such as motor vehicle manufacturers, where the cars will remain in inventory for a lot longer since it takes a considerable amount of time to build them. In this instance, stock can be valued at three different stages. These are:
- Raw Material: when the individual pieces have been bought but not assembled to make the product.
- Work In Progress (WIP): this is when you have started to put them together but not quite finished.
- Complete: the inventory of the finished product.
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How is inventory valued?
Stock must be valued at the ‘lower of cost’ or Net Realisable Value (NRV). What this means is that when you give the piece of inventory a value in the accounts, you can only value it at what it has cost you to produce to the level it is currently at. It does not mean the price you are hoping to sell it for. The reason being is that inventory can quickly become obsolete, due to recent developments in that field and/or better products being brought out (mobile phones are a good example of this).
However, if you are aware of the developments, you will know if your product can no longer be sold at the previously planned selling price. Your current market value may therefore be lower than what it cost you to make, so you must value it at this. By being aware of developments and competing products in the market, you are already planning for the potential loss, so it won’t be a surprise when it is sold.