Understanding Inventory Valuation: Importance, Methods, and

Inventory valuation is the process of assigning value to the company's inventory (Jenkins, 2021). Usually, inventory is a large portion of the company's assets, so it is important to measure the value in a consistent manner (Jenkins, 2021). When there is a clear understanding, profitability can be maximized (Jenkins, 2021). "It also ensures the company can accurately represent the value of inventory on its financial statements" (Jenkins, 2021). It is important to choose the best inventory valuation method that fits the business because once it has been chosen, it can be difficult to change it (Jenkins, 2021). The IRS requires companies to stick to one method during the first year of filing taxes and they must obtain permission to change it in subsequent years (Jenkins, 2021). The inventory valuation helps create an accurate picture of a company's gross profitability and financial position (Jenkins, 2021). To calculate this, the basic formula for cost of goods sold (COGS) is COGS = Beginning inventory + Purchases - Ending inventory (Jenkins, 2021). COGS include direct cost of materials and labor and does not include indirect expenses (Jenkins, 2021). A First In, First Out (FIFO) method is the most intuitive and widely used (Jenkins, 2021). It assumes that the first product sells are the oldest set of material or goods (Jenkins, 2021). First In goods are usually cheaper due to inflation over time. FIFO results in a lower COGS and high gross income (Jenkins, 2021). The disadvantage with this method is that the higher the gross income, the higher the taxes and this method can result in financial statements misleading investors (Jenkins, 2021).