Costing for Inventory Valuation Only
Apr 03, 2014
As a costing consultant I am constantly looking for new and better ways to help people identify and measure their costs related to their products or operations. In virtually every case, I’m seeking to offer the best solution, one with multiple functions and that provides maximum usefulness to the management team. Costing systems can be complex and expensive, or they can be simple and inexpensive. The goal, however, is always to provide the most versatility and the highest functionality in the most cost-effective way.
What if all your business really needs is the ability to quickly and reliably value your inventory at the end of every month or year. Many of our past cost forum attendees came from businesses that the primary function of the costing system was to accurately value inventory. In many cases, the inventory valuation method was primarily focused on passing the year-end audit testing with far less consideration to management reporting. Accordingly, all the bells and whistles available in a comprehensive cost system were of little interest to the cost managers that were directed to provide the best inventory valuation method they could.
This is not to say that just any method is acceptable for valuation of inventory. In fact a properly constructed inventory evaluation method provides alternatives for valuing inventory under Generally Accepted Accounting Principles (GAAP), as well as, the alternative for valuing inventory under today’s federal income tax rules. The computation of variances or other management information is not necessary for a system that is designed to do just inventory valuation.
It has been my experience that poorly constructed cost systems can be one of the root causes of radical fluctuations in inventory. I can cite numerous examples in my personal experience where overly simplified inventory valuation methods or perhaps improperly constructed valuations systems have led to multiple problems in determining month-to-month profitability of an operating company with little obvious indication as to what really was causing the problem.
If your goal as part of your cost management responsibilities is to simply value inventory, then I would first look to GAAP to provide guidance relative to what must be capitalized as inventory costs and what must be expensed, as well as how to deal with material differences between what was planned to be recovered in the costing process and was actually recovered. Further, I would look to income tax code section 471 and 263A to determine what must be capitalized for tax purposes. There, of course, are differences, and if you are aware of those differences at the outset of the design of the system, then you can design your costing model with both alternatives. This allows for your year-end inventory to be computed first for GAAP purposes and a second time for tax purposes. However, do not lose sight of making sure that you are meeting the management accounting goals as well.
Categories: Cost Accounting