Inventory Valuation Methods

This Help File Page was last Modified on 03/04/2018

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Inventory Valuation Methods

This Help File Page was last Modified on 03/04/2018

There are three Inventory Valuation Methods available in the Inventory Tracking module (also see the "An Analysis of the various Inventory Tracking System Processes" section in the Understanding how Inventory Values & Counts are Calculated chapter)

1.Original Price - The Value originally entered (or manually updated) as the Price and COGS Value on the Sale-Purchase Items Form (see the "Original Price (Cost)" discussion immediately below).

2.Average Inventory Cost - The Average Cost of each Inventory Item - based on Quantities Purchased, the Cost of those Purchases, and the Quantities Sold is updated and maintained, as needed, but initially set by using the Calculate Inventory Item Average procedure (see the "Average Cost of Inventory discussion below).

3.LIFO - Last In / First Out - The Price and COGS Value is automatically reset on the Sale-Purchase Items Form based on the most recent Price paid for the Inventory Item as recorded on a Bill (see the "LIFO" discussion below).

 

Also see the Understanding how Inventory Values & Counts are Calculated chapter for more information if you are (or will be) using the updated STARK 35 General Ledger System.

 

I.Original Price (Cost) - By default (except for STARK 35 General Ledger System Users who should use LIFO (preferred) or the Average Cost of Inventory method), the Value of each Inventory Item is the original Price (Cost) assigned to that Inventory Item as it was entered (or subsequently manually updated) in the Sale-Purchase Category Form.

1.Whenever an Inventory Item is Purchased or Sold, this original or manually updated Price (Cost) is the Value that is used in the associated General Ledger System transaction, and as the default Price when entering a Bill

2.If your Company is using this Original Price Valuation Method, future Purchases - regardless of the Cost actually paid for an Inventory Item - do not change the original Price (Cost) on the Sale-Purchase Item Form.

3.Also, the Inventory Tracking & Job Costing System and the General Ledger System will always use the Value of an Inventory Item as it exists on the Sale-Purchase Item Form.

4.If the original original Price (Cost) is manually changed on the Sale-Purchase Items Form, this revised Price (Cost) becomes the default Value that is used in future General Ledger System transactions. 

5.Thus valuation drift occurs over time as Costs are re-set, and/or Purchases are made when the same Inventory Item is being billed at a different Price (Cost), but the previous history and timing of those Cost re-sets are unclear.

See the "How to Adjust for, and properly Post any Inventory Valuation Drift" discussion below for additional information about this valuation drift issue.

 

II.Average Cost of Inventory - Another approach to Inventory Valuation is to use the Average Cost of Inventory for the Value that is used for the Cost when posting Inventory related Financial Transactions into the General Ledger System, and for Inventory Related Reports and General Ledger System's Financial Statements and Reports.

Why use the Average Cost of Inventory?

By using the Average Cost of Inventory, all Price (Cost) changes are taken into consideration whenever the Value of an Inventory Item is reported.

Averaging the Cost of each Inventory Item - by adjusting the Internally maintained COGS Value for each Inventory Item (shown as a separate field on the Sale-Purchase Item Form) whenever it is Purchased - should, except for "shrink" and breakage - mostly eliminates valuation drift.

See the "How to Adjust for, and properly Post any Inventory Valuation Drift" discussion below for additional information about this valuation drift issue.

 

Once implemented, the Inventory Cost Averaging Calculation identifies and records:

Each Purchase of an Inventory Item

The specific Price (Cost) paid for that Inventory Item

The Quantity of each Inventory Item that was Purchased

The Quantity of each Inventory Item that was Sold

 

Operationally, the Inventory Cost Averaging Calculation of each Inventory Item that is currently "in stock" is calculated by adding the Quantity of all new Inventory Purchases and subtracting the Quantity of new Inventory Sales.

An Average Inventory Cost table is internally maintained by the system for each Sale-Purchase Item that has been specifically identified as an Inventory Item (i.e., there is a Check in its Inventory Item box on the Sales-Purchase Items Form).

This Average Inventory Cost table contains the following information:

a.Quantity of each Inventory Item that was Purchased

b.Unit Price Paid for each of those Inventory Items

c.Total Price Paid for the Purchase of those Inventory Items

d.Current Count (the Quantity On-Hand) of each Inventory Item

e.Total Cost Paid for all of the Inventory Items that are currently On-Hand

f.Average Cost of each Inventory Item that is On-Hand.

 

The current Average Cost Value for each Inventory Item - including Sales Tax, if charged on those Inventory Purchases - is displayed in the COGS Value field on the Sale-Purchase Item Form

 

HelpFilesSale-PurchaseItem-InventoryItem-AverageCodePriceIn

 

This example of the Average Inventory Cost table shows how it is accessed and updated as Inventory is Purchased and Sold:

 

 

Quantity

Unit Price

Total Price

Count

Total Cost

Avg. Cost

1st Purchase

1

$3.00

$3.00

1

$3.00

$3.00

2nd Purchase

2

$3.00

$6.00

3

$9.00

$3.00

3rd Purchase

3

$1.00

$3.00

6

$12.00

$2.00

1st Sale

-1

 

 

5

$10.00

$2.00

4th Purchase

1

$4.00

$4.00

6

$14.00

$2.33

2nd Sale

-1

 

 

5

$11.67

$2.33

 

Sample Average Cost Valuation Calculations

 

When a Detail Line Item is added to a Bill for the Purchase of an Inventory Item, a corresponding entry is made in this Average Inventory Cost table with:

a)The Quantity that was Purchased

b)The Unit Price Paid

c)The Total Price Paid

d)A new Count is calculated by adding the Quantity that was just Purchased to the previous Count.

e)The new Total Cost Paid is calculated by adding the Total Price Paid to the previous Total Cost

f)The Average Cost is re-calculated by dividing the new Total Cost be the new Count

 

When a Detail Line Item is added to an Invoice for the Sale of an Inventory Item, an entry is made in this Average Inventory Cost table with:

a)The Quantity that was Sold

b)The Count is re-calculated by subtracting the Quantity Sold from the previous Count.

c)The Total Cost Paid is re-calculated by subtracting the result of the Quantity Sold multiplied by the previously calculated Average Cost.

d)The Average Cost is re-calculated by dividing the new Total Cost be the new Count

 

Implementing the Average Cost of Inventory methodology: By default, the AverageCostInventory option in the Company Settings dialog - accessible from within the Company tab of the User Options Form - is set to False ("F").

To start using this Average Inventory Cost calculation methodology for tracking the Value of Inventory Items within the General Ledger System:

 

HelpFilesUserOptionsCompany-CompanySettings-AverageCost Inventory

User Options - Company tab - Company Settings dialog - Average Cost Inventory option

 

1.If the AverageCostInventory option is re-set to True ("T"), Inventory Valuation will be based on the Average Cost paid for an Inventory Item versus (whatever was) the previously selected Inventory Valuation method.

When AverageCostInventory is set to True ("T"), thereby setting the Inventory Valuation to the Average Cost paid for an Inventory Item, if LIFO (Last In/First Out) was the previously selected Inventory Valuation Method, it will be turned off (LIFO will be Un-Checked) automatically on the on the Inventory Options tab of the User Options Form.

 

2.Once the AverageCostInventory option is set to True ("T"):

i.Open the Calculate Average Item Cost Form,

a)From the Backstage Menu System Select Maintenance and Choose Inventory Tracking, or

b)From the Quick Access Menu, Select Maintenance and Choose Inventory Tracking.

 

3.On the Calculate Average Item Cost Form

i.Choose the Select All option to place a Check in each Update box.

ii.Choose the Calculate Cost option to recalculate both the Average Price paid and the current COGS Value of each Inventory Item previously defined in the Sales-Purchase Items Form.

iii.Choose the Select All option to again place a Check in each Update box.

iv.Choose the Update Accounts option to update the Price, the COGS Value and the Inv. Value fields of each Inventory Item defined in the Sales-Purchase Items Form

 

III.LIFO (Recommended) From time to time, Inventory Items may be Purchased for more, or less, than the Cost that was entered as the original Price and COGS Value (Cost) on the Sale-Purchase Item Form.  

If using the Original Price (Cost) Valuation Method (explained above), these Purchases would not change the Price and COGS Value (Cost) which the Inventory Tracking System and the General Ledger System uses to Value that Inventory Item.  

The Inventory Item continues to be Valued in Inventory Related Reports and Financial Statements and Reports of the General Ledger System based on the Price (Cost) that was initially entered for each Inventory Item

 

However, from an accounting standpoint, your Company will usually want to alter this default Original Price (Costbehavior by having that original Price and COGS Value (Cost) Value automatically re-set, based on the most recent Cost paid for an Inventory Item - as charged on a Bill from a Vendor for the Re-Purchase of each Inventory Item.  

This automatic Price and COGS Value (Cost) re-set - based on the most recent Price (Costpaid for an Inventory Item - not including Sales Tax - is referred to as Last In - First Out, or LIFO for short.

However, valuation drift may still occur over time as Costs are re-set, and/or Purchases are made when the same Inventory Item is being billed at a different Price (Cost), Inventory is being broken, lost or stolen; so the previous history and timing of those Cost re-sets are unclear.

See the "How to Adjust for, and properly Post any Inventory Valuation Drift" discussion below for additional information about this valuation drift issue.

 

This is the preferred and recommended method when your Company will also be using the STARK 35 General Ledger System and is turned on by Checking the LIFO box on the Inventory tab of the User Options Form.

Check the LIFO box on the Inventory Options tab of the User Options Form to initiate this type of Last In - First Out Inventory Valuation Method.

 

HelpFilesUserOptionsInventoryOptions-LIFO

User Options  - Inventory tab - Check in LIFO (Last In First Out) box

 

Thereafter, whenever an Inventory Item is Purchased or Sold, this continuously updated (LIFO) COGS Value is the Value that is used for the Cost when posting an Inventory Purchase and Inventory Usage related General Ledger System transactions.

When Purchasing an Inventory Item, the default Cost will be the "Price" recorded as the Cost of the most recently purchased Inventory Item of the same type.

oInitially, this will be the Price that was originally entered when the Inventory Item was first defined.

oWhen creating a Purchase Order and/or a Bill: be sure to enter the actual Price (Cost) being charged by a Vendor for each Inventory Item.

oOnce the actual Price being charged by the Vendor is entered, this will become the new  "Price" on the Sale-Purchase Category Form.

oThe updated "COGS Value" on the Sale-Purchase Category Form will also be set as the Price paid for most recently purchased Inventory Item.

 

How to Adjust for, and properly Post any Inventory Valuation Drift

Normally, within most Companies, a Re-Count of all Inventory Items is periodically undertaken (typically annually, but more often when a Company's business model dictates it).

No Inventory Valuation Method will completely eliminate value anomalies when comparing General Ledger System Inventory Asset Account Values with the Inventory Valuations reported in certain Inventory Related Reports.

This valuation drift occurs over time as Costs are re-set, and/or Purchases are made for same Inventory Item at a different Price (Cost), and the history and timing of those Cost re-sets will be unclear.

There is also the possibility of loss, theft, and/or damage changing the Value and Quantity of your Company's Inventory

 

Whenever a full Inventory Re-Count is completed, the process outlined below will allow you to properly adjust the General Ledger System Inventory Asset Account Values (whether your Company is using the MKMS General Ledger or a separate stand-alone system).

1.The existing Available On Hand Quantities must be adjusted (based on the results of the Re-Count) to make the sum of the Committed On Hand plus the Available On Hand equal the Total On Hand Quantity found during the physical Inventory Re-Count.

Note: Read the "Special Purpose Adjust, Transfer, and Transfer Buttons on the Warehouse Inventory Form" discussion in the Warehouse Inventory chapter for instructions on how to make these Quantity adjustments).

 

2.The result: The internally tracked Value in the Inventory Tracking System will now align with what is actually In Stock and ready to be used (i.e., Available On Hand plus Committed On Hand) currently in your Company's Warehouse(s).

Note: If your Company is using the MKMS General Ledger System, the appropriate General Journal entries will be made automatically when these Inventory Adjustments are posted, so the only other Financial Transaction entries (i.e., General Journal Adjustments as described in 4., a. and/or b. below) that will be required as a result of "shrink" and "breakage" which occurred after the full Inventory Re-Count.

 

3.An Inventory Listing is then printed which will contain the Gross Value - derived from your Company's selected Inventory Valuation Method (e.g., LIFO) - of the Total On Hand Quantities , the Value of which is based on what is actually Available On Hand plus Committed On Hand in your Company's Warehouse(s).

 

4.Using this report (the Inventory Listing), simple General Journal entries are created to re-balance the Actual Inventory Value with the Inventory Asset Value reported in your Company's General Ledger Balance Sheet  which is accomplished as follows:

a.If the Gross Value reported on the Inventory Listing is less than the current Value of the General Ledger's Inventory Asset Account's Balance, create a General Journal entry to:

i.Credit (reduce)  the General Ledger's Inventory Asset Account's Balance by the difference between that current Inventory Asset Account's Value and the Value reported on the Inventory Listing,

ii.Debit (increase) the Inventory Expense Account by that same Value

b.Conversely, if the Gross Value reported on the Inventory Listing is greater than the current Value of the General Ledger's Inventory Asset Account's Balance, create a General Journal entry to:

i.Debit (increase) the General Ledger's Inventory Asset Account's Balance by the difference between that current Inventory Asset Account's Value and the Value reported on the Inventory Listing,

ii.Credit (reduce) the Inventory Expense Account by that same Value

 

5.At this point, Inventory Counts, the associated Values, and the General Ledger's Inventory Asset Account should all be in "sync".

 

Summary of the effects on the Sale-Purchase Item Form as they relate to these Inventory Valuation Methods:

The Price for an Inventory Item will be the default Price (Cost) inserted for that Inventory Item in the Detail Line Item when recording that Purchase on a Bill.  

 

HelpFilesBillFormInventoryDetailLineItemPrice

Bill Form - Detail Line Item entry - Inventory Item's Price

 

How and whether the PriceInv. Value, and/or COGS Value fields will be displayed within the Inventory Info box on the Sale-Purchase Item Form is based on which Inventory Valuation Method has been chosen.  

Those differences in how these Price and/or COGS Value fields are shown in the illustrations that follow:

Original Price - If the Original Price (Cost) Inventory Valuation Method is in effect, the Price field will be displayed as a normal mandatory field on the Sale-Purchase Item Form if this is an Inventory Item.

 

HelpFilesPurchaseItemsInventoryInfoFields

Inventory Info box - Original Price Inventory Valuation Method selected

 

Price - Enter the Price that should be used for calculating the Cost of Goods Sold Value of this Inventory Item.

COGS Value - This field is filled in by the system once the Price is entered (see illustration above).

oWhen the Original Price Inventory Valuation Method is in effect, the contents of the Price and COGS Value fields are the same unless manually changed.

oTherefore, changing the Price will change the COGS Value automatically.

 

LIFO - If the LIFO Inventory Valuation Method is in effect (which is the preferred and recommended method for STARK Version 35), the contents of this COGS Value field will be updated each time another Inventory Item of this type is Purchased with the Cost re-set to the most current Price including Sales Tax that charged on a Bill.

 

HelpFilesPurchaseItemsInventoryInfoFieldsLIFO

Inventory Info box - LIFO Inventory Valuation Method selected

 

Price - Enter the Price that should be used initially for calculating the Cost of Goods Sold Value of this Inventory Item.

oThereafter, this Value will change to the current Price Paid excluding any Sales Tax.

oThe COGS Value field will change to the current Price Paid excluding any Sales Tax.

 

COGS Value - This field is filled in by the system once the Price is entered (see illustration above).

oWhen the LIFO Inventory Valuation Method is in effect, the contents of the COGS Value field will change to the current Price Paid each time there is a new Purchase of this Inventory Item.

 

In the General Ledger System the Financial Transaction entries for new Inventory Purchases will be to:

I.When a Locale or National Sales Tax (but not a Canada Sales Tax) is charged on a Bill from a Vendor::

a)The Bills Form does not separate and post the Sales Taxes that are charged to special Local and National Sales Tax Expense Accounts in the General Ledger.

b)Instead - with the exception of Canada Sales Tax as explained below - these Sales Tax charges will be added (posted as a Credit) to the Accounts Payable Liability Account, and added (posted as a Debit) to the Expense Account associated with the Sale-Purchase Item (as well as posting that expense to the Current Earnings Equity Account and the special Earnings Posting Account).

 

II.When Canada Sales Tax is being charged on a Bill from a Vendor:

a)Credit (add) the Accounts Payable Liability Account for the Total Cost of the Purchase including Local Sales Tax and any National Sales Tax, if charged (see the Canada Sales Tax chapter for more information)

b)Debit (add) the Amount of the National Sales Tax to the HST/GST Asset Account (see the Canada Sales Tax chapter for more information)

c)Debit (add) the Amount of the Local Provincial Sales Tax to the PST Expense Account (see the Canada Sales Tax chapter for more information) 

d)Debit (subtract) the Amount of the PST Sales Tax, if charged, to the Earnings Posting Account

e)Debit (add) the net value (excluding Canada Sales Tax) of the Inventory Items that were Purchased to the Inventory Asset Account

 

For more detailed General Ledger posting information: see the Tracking Inventory Values & Quantities as Assets, Liabilities, Sales & Expenses chapter.

 

Average Inventory Cost - If the Average Inventory Cost Inventory Valuation Method is in effect, the contents of the COGS Value and Inv. Value fields will be updated each time another Inventory Item of this type is Purchased 

a)the Value of the COGS Value field is re-set to the Average Inventory Cost based on what is charged on the current Bill averaged with what was previously charged for these Inventory Items that are still "in stock" (i.e. Quantity On Hand plus WIP - Work In Progress - Quantity), and

b)the Value of the Inv. Value field is recalculated based on the current COGS Value multiplied by the Quantity of the Inventory Items which are currently still "in stock" (i.e. Quantity On Hand plus WIP - Work In Progress - Quantity). 

 

HelpFilesPurchaseItemsInventoryInfoAverageFields

Inventory Info box - Average Cost Inventory Valuation Method selected

 

Price - The Price that was entered initially for this Inventory Item, reset if the Calculate Average Inventory process is (re-)executed, or manually changed on the Sale-Purchase Item Form.

COGS Value - This system maintained field is updated based on what is charged on the most current Bill, averaged with what was previously charged (including Sales Tax) for these Inventory Items which are still "in stock" (see illustration above).

Inv. Value - This system maintained field is the total COGS Value of what is currently "in stock" (i.e. the sum of the Quantity On Hand plus WIP - Work In Progress - Quantity multiplied by the current COGS Value) for this Inventory Item which is also updated automatically after each Purchase and/or Sale, or if (re-)executed using the Calculate Average Inventory process.

 

Recap of how the Value will be used for Inventory Items within the General Ledger System as those Values relate to Bills for, and Invoices (Sales) of Inventory Items when each one of these Inventory Valuation Methods is active.

The Value used for the the wholesale Cost of an Inventory Item when posting a General Ledger System Inventory related Transaction is based on the currently selected Inventory Valuation Method.  

How each Valuation Method's Transaction is posted is described below:

 

1.Original Price - The Value of each Inventory Item is the original Price Value assigned to that Inventory Item when it was entered in the Sale-Purchase Category Form (or manually changed later), and will inserted as the Value in the COGS Value field

a)Purchases - The Price as originally entered on the Sale-Purchase Item Form's Price field (which is then written to the COGS Value field) for that Inventory Item will be the Value used and will be posted as follows:

i.The Inventory Asset Account will be Debited (increased) by the Value of the Inventory that was Purchased based on the Value currently in the Sale-Purchase Item Form COGS Value field for that Inventory Item  

ii.The Accounts Payable Liability Account with be Credited (increased) by the Value of the Inventory that was Purchased based on the Value currently in the Sale-Purchase Item Form COGS Value field for that Inventory Item (plus any Sales Tax or Shipping Expense charged on that Purchase).

b)Sales - The Price as currently entered (which is the COGS Value field) on the Sale-Purchase Item Form for that Inventory Item will be the Value used and will be posted as follows:

i.The Inventory Asset Account will be Credited (reduced) by the Value of the Inventory that was Sold based on the Value currently in the Sale-Purchase Item Form COGS Value field for that Inventory Item 

ii.The Inventory Cost of Goods Sold Expense Account will be Debited (increased) by the Value of the Inventory that was Sold based on the Value currently in the Sale-Purchase Item Form COGS Value field for that Inventory Item

 

2.Average Inventory Cost  - The continuously recalculated Average Inventory Cost (including any Sales Tax charges) is stored in the COGS Value field on the Sale-Purchase Item Form  

a)Purchases - The current COGS Value (which includes any Sales Taxes charged) is calculated (initially by using the Calculate Inventory Average Cost procedure; and thereafter by continuously recalculating the Average Inventory Cost) and resets the COGS Value and Inv. Value field Values on the Sale-Purchase Item Form for that Inventory Item . The current COGS Value Value is used as follows:

i.For the Inventory Item(s) being Purchased the Inventory Asset Account will be Debited (increased) by the Value of the Unit Price that was charged on the Bill times the Quantity Purchased + any Sales Tax [(Billed Price * Quantity Purchased) + Sales Tax charged = the Value]. 

ii.The  Accounts Payable Liability Account with be Credited (increased) by that same Value (which includes any Sales Tax charged on that Purchase).

iii.The COGS Value and Inv. Value fields are then recalculated (see the "Average Cost of Inventory" discussion above) and updated on the Sale-Purchase Item Form.

 

b)Sales - The COGS Value continuously recalculated Average Inventory Cost field (see the "Average Cost of Inventory" discussion immediately above) on the Sale-Purchase Item Form for that Inventory Item will be the Value used and will be posted as follows:

i.When Inventory Item(s) are sold, the Inventory Asset Account will be Credited (reduced) by the current COGS Value times the Quantity of the Inventory Item that was Sold 

ii.The Inventory Cost of Goods Sold Expense Account will be Debited (increased) by the same COGS Value times the Quantity of the Inventory Item that was Sold

iii.Additional Financial Transactions (e.g., Accounts Receivable, Current Earnings, Sales Tax Liability, etc.) are posted as explained in the Tracking Inventory Values & Quantities as Assets, Liabilities, Sales & Expenses chapter.

 

Once the Average Inventory Cost Inventory Valuation Method has been implemented, changing this method will also change how future Inventory related Financial Transactions are posted in the General Ledger.  

oIf you attempt to change from the Average Inventory Cost Method, a Warning Message will be presented.

 

HelpFilesTurningOffAverageCostInventory

 

3.LIFO - The Value in the COGS Value (including any Sales Tax that was charged) and the Price (excluding any Sales Tax) field is re-set, based on the most recent Cost (and Tax) recorded on an Bill for the Purchase of that Inventory Item.  This is the preferred and recommended method when your Company will also be using the STARK 35 General Ledger System and is turned on by Checking the LIFO box on the Inventory tab of the User Options Form.

a)Purchases - The Price of the Inventory Item as currently recorded on the Sale-Purchase Item Form for that Inventory Item will be the default Cost Value inserted when entering a Bill for that Inventory Item, unless the Cost is manually over-written while entering the Detail Line Item, and will be posted as follows: 

i.The Inventory Asset Account will be Debited (increased) by the resulting Cost (including any Sales Tax charged on that Purchase) of the Inventory Item(s) being Purchased 

ii.The Accounts Payable Liability Account with be Credited (increased) by that same Cost (including any Sales Tax charged on that Purchase).

iii.The Price field on the Sale-Purchase Item Form will be updated with the Price currently charged for that Inventory Item excluding any Sales Tax, if charged.

iv.That revised Price will become the new default Cost Value inserted as the default Price when entering the next Bill for that Inventory Item

 

b)Sales - The COGS Value (Cost plus Sales Tax) maintained by the LIFO re-set process on the Sale-Purchase Item Form for that Inventory Item will be the Value used and will be posted as follows:

i.The Inventory Asset Account will be Credited (reduced) by the COGS Value of the Inventory Item that was Sold 

ii.The Inventory Cost of Goods Sold Expense Account will be Debited (increased) by the COGS Value of the Inventory Item that was Sold

 

See the Understanding how Inventory Values & Counts are Calculated chapter for more information about Inventory Transactions in the General Ledger.