Question

Q.3
Write short note on the significance of Inventory Valuation.
04
Monit​

Answer 1

Answer:

Significance of Inventory Valuation

When we talk about inventory we usually refer to the stock-in-trade with a company of raw materials, semi-finished goods, finished goods, and spare parts. So at the end of the year inventory has to be counted to get to the closing stock.

However only counting inventory is not enough, it also has to be valued. The process of inventory valuation helps determine the value at which we will record the inventories in the final accounting statements of the company. The correct inventory valuation is essential to have a fair representation of the company’s finances. Let us take a look at the reasons inventory valuation is so important for a company.

1] Helps Determine Income

To calculate the gross profit or loss for the year we match the cost of goods sold to the direct revenue of an accounting period. The formulae for calculating the cost of goods sold is as follows,

COGS = Opening Inventory + Purchases + Direct Expenses – Closing Inventory

Inventory valuation will have a major impact on income determination if valuations are over or understated, this can be explained as:

•When closing inventory is overstated, net income for the accounting period will be overstated.

•When opening inventory is overstated, net income for the accounting period will be understated.

•When closing inventory is understated, net income for the accounting period will be understated.

•When opening inventory is understated, net income for the accounting period will be overstated.

So as you can see inventory valuation (closing inventory) has a direct impact on income determination of a firm. The misstatement or miscalculation of inventory can overstate or understate the profits of the firm.

2] Helps Determine Financial Position

Inventory is not only a part of the Profit and Loss statement but also of the Balance Sheet, Inventories are considered as Current Assets of a firm. So it is very important to have precise and correct inventory valuation. If the calculated value of the inventory is wrong it will represent a wrong financial position on the date of the balance sheet.

3] Liquidity Analysis

Inventory is a current asset because the firm is not expected to hold it for a long period of time. There is a lot of turnovers when it comes to stock. So inventory actually is a significant portion of the working capital of a company. It is important to value it correctly so the current ratio and liquid ratios can be calculated accurately. These ratios are important to check for the liquidity of a company.

4] Statutory Compliance

Inventory valuation is not statutory compliance under the Companies Act 2013. In accordance with the Accounting Standard (AS2), all firms now have to disclose the valuation of each class of inventory. The disclosure must include

Accounting policies adopted for the inventory valuation

The total amount of the inventories along with the classifications (raw materials, WIP, finished goods etc.)

Answer 2

ANSWER :

Inventory is one of the important items of a business enterprise. In most of the cases it is found that it is the largest of the current asset held by a Trading or manufacturing enterprise. According to the American Institute it Certified Public Accountants, "A major objective of accounting for inventories is the proper determination of income through the process of matching appropriate costs against revenues".

✪ The significance of the valuation of inventoy are briefly summarized below :-

• [1] Helpful in to Profit Determination : The valuation of inventory is essential for determining the profit earned by a business firm during a particular period. To determine gross profit cost of goods sold is matched with the direct revenue earned during an accounting period. In accounting, Gross Profit = Direct Revenue - ( Opening Inventory + Purchase + Direct Expenses - Closing Inventory). Hence, inventory valuation (closing inventoryl has a direct impact on income determination of a firm.

• [2] Effect on the Balance Sheet : If inventory is not valued properly, the balance sheet will not give a true and fair view of the affairs of the business during an accounting period. An under or over statement of inventory will result in misrepresentation of a financial position on the date of the balance sheet. Hence, to get a true and fair representation of the financial position of the business on the balance sheet, proper inventory valuation is necessary.

• [3] Significance in Liquidity Analysis : Liquidity of a business firm is analysed with reference to net working capital. Net working capital is the excess of current assets over current liabilities. Inventory is a major component of current assets and hence there is the need for a proper valuation of inventory. it must be ensured that this item of current assets i.e., inventory is not overstated or understated.

• [4] Statutory Compliance : Though Companies Act, 2013 is silent about the valuation of inventory, but the Section 260 (2) stated that a company administrators will prepare with respect to the company a complete Inventory of all asset and liabilities of whatever nature. Again Section 129 (1) stated that financial statements shall comply with the accounting standards notified under Section 133 and hence it is mandatory to comply with the Indian Accounting Standard inventory is which has stated that the financial statement are disclosed the accounting policies adopted in measuring inventory is including the cost formula used. Thus, there is a statutory need of valuation of inventory as per the existing provisions of the Act and Accounting Standard.