Stock Evalaution – SS2 Book Keeping Lesson Note (Second Term)

Stock valuation, also called inventory valuation, is the process of determining the value of goods a business holds for resale. It fixes the cost of goods sold and the value of inventory shown on the balance sheet. The main methods are FIFO, LIFO, weighted average cost and specific identification.

Behavioural objectives

By the end of the lesson, students should be able to:

1. Explain the meaning of valuation and of stock valuation.
2. State five reasons for valuing stock.
3. Name the four methods of valuing stock.
4. Describe how FIFO, LIFO, weighted average cost and specific identification work.

What is valuation?

Valuation is the process of determining the monetary worth or value of an asset, investment, business or financial instrument. It involves assessing the intrinsic or market value of the asset based on factors such as its physical attributes, financial performance, future earning potential and market conditions.

Valuation is essential for making informed decisions on investment, financing, mergers and acquisitions, financial reporting, taxation and other business activities.

What is valuation of stock?

The valuation of stock, also known as inventory valuation, is the process of determining the value of the goods or products held by a business for resale. It is needed to report the cost of goods sold (COGS) and the value of inventory on the balance sheet accurately.

Stock valuation methods include FIFO (First-In-First-Out), LIFO (Last-In-First-Out), weighted average cost and specific identification.

Why do businesses value stock?

1. Financial reporting: Accurate stock valuation is necessary for preparing financial statements, including the income statement and balance sheet.
2. Taxation: Stock valuation affects the calculation of taxable income and tax liabilities, particularly for determining the cost of goods sold.
3. Decision making: Business decisions on pricing, purchasing, production and inventory management rely on accurate stock valuation.
4. Performance evaluation: Stock valuation provides insights into the profitability and efficiency of inventory management practices.
5. Investor relations: Investors and stakeholders use stock valuation information to assess the financial health and performance of a business.

What are the methods of valuing stock?

FIFO (First-In-First-Out)

This method assumes that the oldest inventory items are sold first, and the cost of goods sold is based on the cost of the oldest purchases.

To calculate FIFO, determine the cost of your oldest inventory and multiply that cost by the amount of inventory sold.

LIFO (Last-In-First-Out)

LIFO assumes that the newest inventory items are sold first, and the cost of goods sold is based on the cost of the most recent purchases.

To calculate LIFO, determine the cost of your most recent inventory and multiply it by the amount of inventory sold.

Weighted average cost

This method calculates the average cost of inventory by dividing the total cost of goods available for sale by the total number of units available for sale.

Specific identification

Under this method, each inventory item is individually identified and tracked. The cost of goods sold and the ending inventory are determined from the specific costs assigned to each item.

Evaluation

1. What is valuation?
2. Define stock valuation.
3. State five reasons for valuing stock.
4. Name the four methods of valuing stock.
5. How is the weighted average cost of inventory calculated?

Assignment

1. Explain the difference between FIFO and LIFO.
2. Describe how the specific identification method works.