Question

What guidance does this standard provide on the cost methods and formulas to be used to cost inventory?

Answer 1

Note:Although the asker has not mentioned as which standard is he/she is referring to. I am mentioning the methods of inventory valuation as per COST ACCOUNTING STANDARDS (CAS).

As per the cost accounting standards, inventory should include all costs that are ordinary and necessary to put the goods in place and in condition for sale.This means when considering your pricing, you’ll also want to include all the other costs that add up, such as:

• Shipping charges
• Packaging
• Custom and duties fees

Some merchants call these costs non-vendor costs.This is the general idea as to what is included in the cost of inventory and what is not.

Mentioned below are the widely used inventory valuation methods and their significance.

1. FIFO (First in first out): This method of costing essentially means that the oldest inventory items are recorded as a sold first. Your oldest purchasing costs will be used to calculate your profit. This means that if there is an inflation/deflation during the year, the effect will be seen in the inventory prices as this methods undertakes the concept that the inventory that is produced first will be sold first. So at the year end the inventory would include the freshly made stock with newest market prices.
2. LIFO (Last in first out): This inventory valuation method means you use the cost of your most recent inventory purchases to calculate your profit. Many US firms would use LIFO since it typically over-values their inventory and reduces the income tax they have to pay. However, the International Financial Reporting Standards (IFRS) have banned the use of LIFO, so many companies have turned back to FIFO. It’s also interesting to note that LIFO is only ever used in the US. So under this method the year inventory would be assumed to be the oldest and would be valued on old prices neglecting the inflation or deflation effect.
3. Weighted average cost method: This method of inventory valuation is quite interest and it is the most widely accepted method as it gives near to fair idea of the cost of invetories. It considers the weighted average of costs of materials and others during the year with weights being based on different parameters be it time etc. So the weighted average gives a fair estimate of the cost which is then multiplied to the average quantity of inventory in hand. To accomplish this, you would take the total cost of the items purchased divided by the number of items in stock. You would then use this number as your cost of ending inventory and the cost of goods sold for your accounting purposes.
4. Price multiplier method : The most common is simply to double your cost. Many businesses use a multiplier formula that multiplies the cost by 2 or 3.
5. Competitive market rates : It’s also very common to price the products based on what our competitors charge. We should always examine the market prices and our competition, but don’t follow this method exclusively when we do the costing.
6. Manual or standard cost : We can also keep track of your inventory costs by manually assigning the cost to our items; however, this is probably the most tedious way and not necessarily the most accurate, especially if prices change on a regular basis.