Inventory valuation is the dollar amount associated with the items contained in a companyâ€™s inventory. Initially the amount is the cost of those items. However, under certain situations the cost could be replaced with a lower dollar amount.
The inventory valuation includes all of the costs to get the inventory items in place and ready for sale. The inventory valuation excludes the costs of selling and administration.
Since the inventory items are constantly being sold and restocked and since the costs of the items are constantly changing, a company must select a cost flow assumption. Cost flow assumptions include first-in, first-out; weighted average; and last-in, first out. The company must consistently follow its stated cost flow assumption.
A manufacturerâ€™s inventory valuation will include the costs of production, namely direct materials, direct labor, and manufacturing overhead. Manufacturers are also required to consistently follow their cost flow assumptions.
Inventory valuation is important in that it affects the cost of goods sold reported on the companyâ€™s income statement. Inventory is also an important component of a companyâ€™s current assets, working capital, and current ratio.