IGC-L19 — Inventory Valuation
Understanding how inventory is valued and why correct valuation is essential for accurate profit measurement and reliable financial statements.
Learning Objectives
- Define inventory in the context of financial accounting
- Explain the importance of inventory valuation
- Apply the rule “lower of cost and net realisable value (NRV)”
- Calculate inventory value using FIFO and weighted average methods
- Understand the effect of inventory valuation on profit
Concept Framework
What is Inventory?
Inventory refers to goods purchased or produced by a business for the purpose of resale.
Inventory represents a current asset and appears in the Statement of Financial Position.
It also plays a critical role in determining cost of sales and profit.
Inventory and Cost of Sales
The basic cost of sales formula is:
Opening Inventory
+ Purchases
− Closing Inventory
= Cost of Sales
Because closing inventory is deducted, its value directly affects profit.
If closing inventory is overstated, profit will increase.
If closing inventory is understated, profit will decrease.
Inventory Valuation Principle
Accounting standards require inventory to be valued at:
Lower of Cost and Net Realisable Value (NRV)
This rule applies the prudence principle, ensuring that assets and profits are not overstated.
Net Realisable Value
Net realisable value represents the estimated selling price of inventory less any costs required to complete or sell the goods.
NRV = Estimated Selling Price − Selling Costs
Inventory Cost Methods
Two commonly used cost methods are:
FIFO — First In First Out
The earliest goods purchased are assumed to be sold first.
The most recent purchases remain in closing inventory.
Weighted Average Method
The average cost of all units available is used to value both cost of sales and closing inventory.
Diagram 1 — Cost of Sales Flow
Opening Inventory
+
Purchases
↓
Goods Available for Sale
↓
┌─────────────────────┐
│ │
│ Goods Sold │
│ → Cost of Sales │
│ │
└─────────────────────┘
+
Closing Inventory (Unsold Goods)
Cost of Sales Formula
Opening Inventory
+ Purchases
− Closing Inventory
= Cost of Sales
Closing inventory is deducted because these goods have not yet been sold.
Diagram 2 — FIFO Inventory Flow
Example purchases:
Batch 2 → 10 units @ £10
Batch 3 → 10 units @ £12
Goods sold first:
10 units @ £10
Remaining inventory:
Closing inventory value:
FIFO Rule:
Oldest goods sold first
Newest goods remain in stock
Diagram 3 — Inventory Valuation Decision
Start
│
Determine Cost of Inventory
│
Determine Net Realisable Value
│
Compare Cost and NRV
│
┌─────────────────────────┐
│ Is NRV lower than Cost? │
└─────────────────────────┘
│ │
YES NO
│ │
Inventory = NRV Inventory = Cost
│
Record the Lower Value
Example:
Cost = £1,500
NRV = £1,320
Inventory value = £1,320
Worked Examples
Example 1 — Lower of Cost and NRV
Cost of inventory = £1,200
NRV = £1,050
Inventory value recorded:
£1,050
Because NRV is lower.
Example 2 — FIFO Calculation
Purchases:
20 units @ £6
30 units @ £8
Units remaining in inventory = 25
Under FIFO, remaining inventory comes from the most recent purchases.
Inventory value:
📌 Additional structured inventory valuation questions are available in the
🎯 Premium resources , Guess Question Papers + YouTube Explanation section.
Students should practise inventory valuation calculations regularly and review video explanations for clarity.
Structured Practice
Level 1 – Concept Check
Define inventory.
State the rule used for inventory valuation.
Define net realisable value.
Level 2 – Application Practice
A business has inventory costing £900.
Net realisable value is estimated at £840.
Determine the value at which inventory should be recorded.
Level 3 – Examination Style Question
Explain why inventory must be valued at the lower of cost and net realisable value.
(4 marks)
📌 Additional structured Statement of Financial Position questions are available in the 🎯 Premium resources , Guess Question Papers + YouTube Explanation section.
∗ Additional structured Errors and Suspense Account questions are available in the Premium Resources , Guess Papers and YouTube Explanation section. Students should practise journal corrections and Suspense Account preparation regularly and review video explanations for procedural clarity.
Enrolled students may submit questions from recognised textbooks, past examination papers or other genuine academic material for expert clarification through the Student Doubt Support facility.
Proficiency Check
Learn → Unlearn → Relearn
Students who believe they have already mastered this topic should attempt the following without referring to notes.
Inventory cost = £2,500
NRV = £2,300
Determine the correct inventory value.Explain how overstating closing inventory affects profit.
Purchases:
20 units @ £6
30 units @ £825 units remain in inventory.
Calculate closing inventory using FIFO.
If any question cannot be answered confidently, revisit the lesson carefully before proceeding.
Detailed Activity Solutions
Solution to Level 3 question
Solution — Level 2
Cost = £900
NRV = £840
Inventory value = £840
Solutions to Proficiency Check
Proficiency Check Solutions
Inventory value = £2,300
(lower value is used)
If closing inventory is overstated:
• cost of sales decreases
• profit increases
Therefore profit becomes overstated.
FIFO calculation:
Remaining units come from most recent purchases.
Closing inventory value = £200
How This Topic Appears in the Examination
Inventory valuation is commonly assessed through:
• cost and NRV calculations
• FIFO or average cost calculations
• explanation questions on inventory principles
Examiners frequently assess:
• correct application of the lower of cost and NRV rule
• accurate inventory calculations
• understanding of profit impact
Students should practise inventory valuation questions regularly and review video explanations for clarity.
Enrolled students may submit questions from recognised textbooks, past examination papers or other genuine academic material for expert clarification through the Student Doubt Support facility.
Self-Assessment Checklist
- I understand the meaning of inventory
- I can apply the lower of cost and NRV rule
- I can calculate inventory using FIFO
- I understand how inventory valuation affects profit
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