Out of inventory evaluation

Entrances to inventory are valued with goods acquisition price or with the production cost.

Exits from inventory intervene at various moments, either for sale, or for incorporation in the production process.   

In case of fixed acquisition price of all goods which enter the inventory, the acquisition price A is applied to the total quantity in inventory X.

Stock value is then X x A  

But, the economic reality makes that acquisition prices vary. Furthermore it is not always easy to identify which exact product is taken out inventory. So, the inventory can, at some point, be composed of:

• X quantities of an article acquired at a price A,
• and Y quantities of the same article acquired at a price B …

In most of the companies, every product in stock is not identified alone. We do not know if the outgoing product is the first one that had been bought, the last one or the intermediary.  

It is thus necessary to use a method which allows estimating inventory exits at any moment by taking in a consideration the changes of products acquisition prices or production costs.

The rule recommends applying the MAP (Moving Average Price) method. But it is allowed to choose FIFO or LIFO methods if the company considers that it can improve the global management. 

Once chosen the valuation method, the company will have to conform to the uniformity in the management method principle. Changes in this method will be accepted only in exceptional and justified cases. 

• MAP ( Moving Average price). The prices moving average is calculated taking into account the received quantities at a given price.

• FIFO (First In, First out). Last exit valuation is made using the first reception acquisition price. So shipments are valued in the same order as the inventory was constituted. Inventory is recorded with its receiving value respecting the chronological order.  

• LIFO (Last In, First Out). Last exit valuation is made using the last reception acquisition price. So shipments are valued in the inverse order as the inventory was constituted. Inventory is recorded with its receiving value respecting the chronological order.  

• Example

• MAP (Moving Average Price) 

There are two ways to calculate it:end of periodbefore every exit. The example below corresponds to this more common way of calculating the MAP.

Detailed MAP calculation:

[(1.000 x 4) + (500 x 6)] / (1.000 + 500) = 4,67

[(100 x 4,67)+(900 x 7)] / (100 + 900­)    = 6,77 

Inventory value at 1-31-2008 is 6.767

•  FIFO

In that case, we build a board with two dimensions (Prices and Quantities by movement type). For each product reception with different price we open a new column. To cover the exit needed quantities, we consume firstly the most former units.

Inventory value at 1-31-2008 is 6.900 

• LIFO

We apply the same principle as FIFO. But to cover the exits needed quantities, we consume firstly the last entered units.

 Inventory value at 1-31-2008 is 6.700 

• Inventory value according to each method is:

LIFO   6.700

FIFO   6.900

MAP    6.767

FIFO and LIFO methods lead to extreme values while the MAP method produces an intermediate value. 

FIFO method leads to a stronger valuation of assets in case of inflation, because it values inventories at the last acquisition prices. Observation is inverse with the LIFO method. 

Using FIFO method while the market is rising, while profit is serving for dividends distribution, risks to uncapitalize the company because sales income would not allow supplying the inventory.