Why Is Stock Valuation Necessary?

Valuation of stocks is necessary for the final accounts of the business and for pricing issues of materials brought from the stores. The principle of prudence dictates that the value attached to stock must be the lower of the purchase price or net realizable value.

In an inflationary period it is likely that the current realizable value will be greater than the purchase price but the problem is which purchase price should be given for valuation purposes.

It is likely that materials in store were received at probably at different prices. It would be impractically to value each from store at the price paid for that particular delivery of materials. Instead one of five methods will be chosen:

FIFO method assumes that the oldest stock is issued first thus the price paid for the first batch of materials to the business is used for all issues until that particular batch is used up. Thereafter, the issue price is based on the price paid for the next batch until in turn is depleted.

The LIFO method prices issues from stock at that of the most recently purchased batch.
In the Replacement Price method, materials are valued at the replacement price on the day of issue from stores.In the Weighted Average Cost method, all stock is valued at a single representative cost, calculated by dividing total cost by the number of items.

The Standard Price method gives a predetermined price for all issues that eliminates price fluctuations and establishes a measure of control over purchasing operations.