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How is inventory valued?

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The inventory valuation method chosen determines the cost of a firm’s inventory reflected in the cost of goods sold in the income statement and the value of inventory on the balance sheet for the accounting period.  The most commonly used inventory valuation methods are:

  • First in, first out (FIFO) – Assumes that the first items purchased or produced are the first items sold or used in the production of goods sold;
  • Last in, first out (LIFO)Based on the assumption that the last items purchased or produced are the first items sold or used in the production of goods sold;
  • Specific identification – Inventory items are identified separately at the end of the accounting period in some manner, such as by serial number; and
  • Weighted-average costing – Divides the total cost of all the units purchased or produced for inventory during a period by the number of units in inventory at the end of the period.

Whereas GAAP allows a company to use the LIFO method of inventory valuation, it is prohibited under IFRS.  LIFO tends to result in unusually low levels of reported income and typically does not reflect the actual flow of inventory, making the application of FIFO valuation to inventories as required under IFRS more correct.

Inventory Valuation – US GAAP vs. IFRS
US GAAP IFRS
LIFO, FIFO or the weighted-average cost methods may be used to determine the cost of inventory. FIFO or the weighted-average cost methods are generally used to determine the cost of inventory.
LIFO must also be used for tax purposes if it is used for book purposes. The use of LIFO is prohibited.

 

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