When you need to change the method of valuing your company’s stocks
The valuation of stocks is a part of the accounting of a very very important company.
Basically, there are two ways to value stocks that we are going to see in this article.
In addition, we will find out through an example when it is necessary and benefits you to change the system.
Stock valuation methods
Two stock valuation systems
PMP stock valuation method
Average Cost Method
In general, stocks are valued according to the method of the average price or weighted cost: each time there is an entry in the warehouse, the cost of the goods is recalculated and the average cost is fixed, which is the amount that is cancelled when there are exits.
FIFO stock assessment
However, if the company considers it more convenient for its management, it can opt for the FIFO method (“First In, First Out”), (in Spanish means first in, first out) by virtue of which the goods retain their original acquisition value and, when an exit occurs, it is considered that the first to enter the warehouse leave (so stocks at the end of the year are valued according to the cost of the most recent acquisitions).
Application of inventory valuation
These rules are applicable to interchangeable products, which cannot be identified individually (shoes of the same brand and model, bricks, steel coils…).
Non-exchangeable products, that is, products that can be individually identified (property, vehicles of a dealer, furniture of an antique shop, etc.), must be valued according to their acquisition price or individual production cost.
Stock valuation examples
Example 1 of stock valuation
Comparison and effects
See a simple example of how the valuation of the final inventory will vary depending on the system you have adopted:
Inventory movements
| Concept | Unit / Price | Total cost | Unit. accumulate. | Average cost |
| Initial purchase | 3.000 x 27 | 81.000 | 3.000 | 27 |
| Buy 2 | 550 x 30 | 16.500 | 3.550 | 27,46 |
| Sale 1 | 880 | – | 2.670 | 27,46 |
| Buy 3 | 600 x 32 | 19.200 | 3.270 | 28,29 |
| Sale 2 | 900 | – | 2.370 | 28,29 |
| Buy 4 | 800 x 35 | 28.000 | 3.170 | 29,98 |
Final assessment according to the system used
| Concept | Euros |
| Final assessment according to average cost | 95.047 |
| Final assessment according to FIFO system | 96.640 |
Average cost x units
Each sale has been reducing the stock of older units. Therefore, of the remaining 3,170 units, it is considered that 1,220 (3,000 less sales made) are initial units, and the rest of the units are those acquired in purchases 1 to 3, all of them with their corresponding acquisition price.
Inventory difference
Since the value of the stocks affects the result of the year (the difference between the initial inventory and the final inventory must be accounted for as expenditure or income depending on whether it has decreased or increased), in this case the FIFO system will represent a greater profit of 1,593 euros.
In a context of rising prices – which has been assumed in the example – the FIFO system allows to improve the result. However, it involves a higher Corporate Tax.
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Change of rating system
- Can I change the rating system? If
If your company is already valuing your inventory according to one of the two systems, you can switch to the other without problems.
Of course: you must calculate what the value of the initial inventory would have been with the new method chosen.
Thus, if after changing criteria the value of stocks at the beginning of the year differs by 30,000 euros:
- You must account for the 30,000 euros as a higher or lesser value of the stocks, calculating the counterpart against reserves.
- When you submit the Corporate Tax, you must calculate an extra-accounting adjustment (positive if they have increased in value; negative if they have decreased) of 30,000 euros.
Accounting the criteria must be homogeneous.
However, even if you have to make a positive adjustment with this rule, it is very likely that the change in valuation criteria will pay off and allow you to pay less.
Make your choice based on the impact you want to have on your business results and the expected change in the price of the goods or raw materials in your inventory.
When to change the Stock valuation system?
In short, make your decision based on the economic impact of the change and your priorities:
When to choose the FIFO stock valuation method?
- When you want to increase your benefits
- When the prices of raw materials are rising.
- If you foresee that the sales prices of your products will go down.
When to choose the method of valuation of stocks of weighted average price?
- If you want to reduce your benefits
- If commodity prices are falling
- If sales prices are increasing
If the goods are increasing in price, the FIFO system will result in a higher accounting result.
And if your company provides services, do not forget that in some cases you will also have to account for stocks at the end of the year.
