Methods of Valuing Inventory

You can use several methods to value inventory. QuickBooks uses the average cost method, in which the cost of all pieces of a single inventory item is totaled and then the total is divided by the number of items in stock, providing an average cost for each item. Although this method is effective and easy to maintain, it is not the most popular method of valuing inventory.

The three most popular methods of inventory valuation are not supported by QuickBooks. They are

• First in, first out (FIFO) Users of this method of inventory valuation make the assumption that the first items you purchase are the first items you sell. You'll notice a grocery store prefers to sell items on this basis, always moving the items with the earliest date to the front of the shelf so they never have any old stock on hand. The value of inventory at the end of the year (or reporting period) is determined by taking a physical inventory count and then matching the costs of the most recently purchased items to the quantity of items on hand. The cost of the earliest items purchased is then added to the cost of sales. By using this method, your inventory is always valued at its most current cost.

• Last in, first out (LIFO) Users of this method of inventory valuation make the assumption that the last items (the most recent items) you purchase are the first items you sell. Imagine a clothing store, where the latest fashions are the ones that sell, whereas the older articles of clothing stay on the racks. Items remaining in your inventory are assumed to be the oldest items and are therefore valued at the cost of the oldest items purchased.

• Specific identification method Users of this method of inventory valuation have an inventory that lends itself to the tracking of individual items. As each item is sold, the value of the inventory on hand is reduced by the actual cost of the specific item. For example, all automobiles have a vehicle identification number (VIN), so tracking specific automobiles that go in and out of inventory is commonplace.