FIFO Inventory Valuation

• Material cost refers to the total expenses incurred by a company to acquire raw materials, components, and other items necessary for production

Inventory Valuation

• Inventory valuation determines the monetary value of goods for sale or use in production.
• Accurate inventory valuation is essential for financial reporting, COGS calculation, and profitability analysis.
• The main inventory valuation methods are FIFO, LIFO, and Weighted-Average Cost.

First-In, First-Out (FIFO)

• FIFO assumes the first units purchased are the first ones sold.
• Ending inventory consists of the most recently purchased items.
• FIFO often reflects the actual physical flow of inventory.
• In periods of rising prices, FIFO results in a higher ending inventory value and lower COGS, leading to higher reported profits.
• During periods of inflation, FIFO can overstate profits because older, cheaper inventory is matched against current, higher revenues.

Last-In, First-Out (LIFO)

• LIFO assumes the last units purchased are the first ones sold.
• Ending inventory consists of the oldest units purchased.
• LIFO is not permitted under IFRS.
• In periods of rising prices, LIFO results in a lower ending inventory value and higher COGS, leading to lower reported profits and potentially lower tax obligations.
• During periods of deflation, LIFO can lead to higher reported profits.

Weighted-Average Cost

• The weighted-average cost method calculates the average cost of all units available for sale during a period to determine the value of COGS and ending inventory.
• Weighted-average cost is calculated by dividing the total cost of goods available for sale by the total number of units available for sale
• This method smooths out price fluctuations, providing a more stable valuation than FIFO or LIFO.
• It is less sensitive to price volatility.

Inventory Control

• Inventory control manages the levels of raw materials, work-in-progress, and finished goods to minimize costs and ensure items are available when needed.
• Effective inventory control helps reduce the risk of stockouts and overstocking.

Minimum and Maximum Stock Levels

• Minimum stock level is the lowest quantity of a particular item that a company should hold in inventory
• Falling below the minimum stock level can result in stockouts and disruptions to production or sales
• Maximum stock level is the highest quantity of a particular item that a company should hold in inventory
• Exceeding the maximum stock level can result in increased storage costs, obsolescence, and tied-up capital

Re-Order Level

• Re-order level is the inventory level at which a new order should be placed to replenish stock
• It is calculated to ensure that new stock arrives before the existing stock falls below the minimum level
• The formula for calculating the re-order level is: Re-Order Level = Lead Time Demand + Safety Stock.
• Lead time demand is the quantity of an item likely to be consumed during the lead time.
• Safety stock is the extra inventory held to buffer against unexpected demand or delays in delivery.

Average Stock Level

• Average stock level is the average quantity of inventory held by a company over a period of time
• It helps in assessing the efficiency of inventory management
• The formula for calculating the average stock level is: Average Stock Level = (Minimum Stock Level + Maximum Stock Level) / 2.
• This formula assumes that inventory levels fluctuate evenly between the minimum and maximum levels.

Safety Stock

• Safety stock is the extra inventory held to protect against the risk of stockouts due to unexpected demand or delays in supply
• The determination of safety stock levels involves balancing the costs of holding extra inventory against the costs of potential stockouts (lost sales, customer dissatisfaction, and production disruptions)
• Factors influencing the level of safety stock include the variability of demand, the variability of lead time, and the desired service level (the probability of meeting demand from available stock).
• A higher service level requires a higher level of safety stock.

Explanation of First-In, First-Out (FIFO) inventory valuation method. FIFO assumes that the first units purchased are the first ones sold. In periods of rising prices, FIFO results in a higher ending inventory value and lower COGS.