stock valuation


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Fig. 82 Stock valuation. Two methods. The opening stock is 20 units, costing £10 each; the purchases are 100 units at @@@; 12 each; the sales are 100 units at @@@ 15 each; the closing stock is 20 units.

stock valuation

the placing of an appropriate money value upon a firm's STOCKS of raw materials, WORK IN PROGRESS and finished GOODS. Where INFLATION causes the price of several different batches of finished-goods stock bought during a trading period to differ, the firm has the problems of deciding:
  1. what money value to place upon the period-end physical stock in the BALANCE SHEET;
  2. what cost to attach to the units sold in the PROFIT-AND-LOSS ACCOUNT.

The second decision has a direct bearing upon the COST-OF-GOODS SOLD and so upon GROSS PROFIT.

Different formulas used to value stock can lead to variations in the balance-sheet value of stock and in the cost of goods sold. For example, the first-in, first-out (FIFO) method assumes that goods are withdrawn from stock in the order in which they are received so that the cost of goods sold is based on the cost of the oldest goods in stock, while the value of closing stock is based on the prices of the most recent purchases (see Fig. 82). By contrast, the last-in, first-out (LIFO) method assumes that the most recently purchased goods are (theoretically) withdrawn from stock first so that the cost of goods sold is based on the costs of the most recent purchases, while the value of closing stock is based on the oldest goods available (see Fig. 82). The last-in, first-out method gives a higher figure for cost-of-goods sold, i.e. one which more closely approximates to the replacement cost of goods sold, but it tends to understate the value of period-end stocks.

In the interests of prudence the firm would tend to value stocks at cost or market value, whichever was the lower, to avoid overstating profits. Generally stocks of work in progress and finished goods will include the raw materials, direct labour and OVERHEAD costs involved in manufacturing them. See also STOCK APPRECIATION, INFLATION ACCOUNTING.

stock valuation

the placing of an appropriate money value upon a firm's STOCKS of raw materials, work-in-progress and finished goods. Where INFLATION causes the price of several different batches of finished-goods stock bought during a trading period to differ, the firm has the problem of deciding what money value to place upon the units sold in the PROFIT-AND-LOSS ACCOUNT since this affects the cost of goods sold and so GROSS PROFIT. This decision simultaneously affects the cost attached to stocks in the BALANCE SHEET.

Various formulas can be used for this purpose. For example, the first-in, first-out (FIFO) method assumes that goods are withdrawn from stock in the order in which they are received, so the cost of goods sold is based on the cost of the oldest goods in stock, while the value of stock is based on the prices of the most recent purchases. By contrast, the last-in, first-out (LIFO) method assumes that the most recently purchased goods are (theoretically) withdrawn from stock first, so the cost of goods sold is based on the costs of the most recent purchases, while the value of stock is based on the oldest goods available. See INFLATION ACCOUNTING.

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