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Valuing inventory: method and write-downs
In this article
Inventory is money sitting on the shelf. How you value it determines both what appears on your balance sheet and how much profit you report in a year — with the same sales and the same purchases.
The three methods you see most
| Method | When it fits |
|---|---|
| Individual purchase price | With few, easily distinguishable items (for example a car dealer or an art dealer). |
| Fifo (first in, first out) | With inventory that changes per batch, for example food products. |
| Average cost | With large numbers of similar items; dampens fluctuations in purchase prices. |
Choose one method and stick to it
The method is a valuation principle. Changing it is only allowed as a change of accounting policy: disclose it in the notes and adjust the comparative figures.Why the choice affects your result
If purchase prices rise, then under fifo the inventory on the balance sheet is higher and this year's cost of purchases is lower — so more profit. Under the average method that difference is smoothed. Over the entire life of your inventory it comes to the same thing, but per year it can differ considerably.
The glossary briefly explains cost of purchases, gross margin and book value so that you can follow the effect on your balance sheet and profit and loss account.
Obsolete and slow-moving inventory
Inventory that you no longer sell at the normal price is written down to the expected realisable value. That may be done per item or per group. Record how you did it: a write-down of ten thousand euros without substantiation is the first thing asked about in an audit.
The inventory count
- Count on the balance sheet date and record the outcome in writing.
- Watch for inventory in transit or held by a third party (for example an e-commerce fulfilment company).
- Do not include inventory that has already been invoiced and delivered: that is already turnover.
- Record the quantities and the price used for each line.
What you put in the notes
State the valuation method, whether any inventory has been written down, and how the inventory is composed if it consists of different types (raw materials, semi-finished goods, finished goods). When preparing the annual accounts these notes belong there just as much as the figures themselves.
Frequently asked questions
Which inventory valuation method is mandatory?
Can I use lifo?
How do I value inventory I no longer sell?
Related articles
Read more about this topic.
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