Inventory Valuation and Cost of Sales
Inventory valuation affects cost of sales, gross profit and the statement of financial position. The cost of sales formula is: opening inventory + purchases + carriage inwards - returns outwards - closing inventory. IAS 2 requires inventory to be valued at the lower of cost and net realisable value (NRV).
Core rules
- Cost includes purchase price and costs of bringing inventory to its present location, such as carriage inwards and import duty.
- NRV = estimated selling price - costs to complete and sell.
- FIFO and weighted average are acceptable cost formulas; LIFO is not permitted under IAS 2.
- Carriage outwards is a selling expense, not part of cost of sales.
Worked example
Opening inventory €5,000; purchases €40,000; returns outwards €1,000; carriage inwards €2,000; closing inventory €6,000. Cost of sales = 5,000 + 40,000 - 1,000 + 2,000 - 6,000 = €40,000.
A line of inventory costs €8,000. It can be sold for €9,000, but selling costs are €1,500. NRV = €7,500, so it is valued at €7,500 and written down by €500.
Traps
Including carriage outwards in cost of sales; forgetting returns outwards; valuing inventory at selling price; and using the same closing inventory figure incorrectly in both cost of sales and the statement of financial position. Also check whether a write-down is needed before calculating gross profit.