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Valuing Stock

All businesses are required to perform a physical stocktake at the end of their financial year. This stocktake process requires every item in stock to be counted and then valued according to cost.

The valuing of stock is not straightforward, however.

Let's suppose that the stocktake reveals that quantity of balls in stock at the end of the year is 10.

These balls may have been purchased at different times and at different prices. So which price do we use to work out the total value of the balls?

Here are a few strategies:

1 Use an average cost, however this would necessitate going through old invoices and computing an average. This is not really practical unless it is a very few invoices.
2 Use the most recent cost, if you feel that the most recent price is a fair price for what balls would cost at the moment. However the most recent price could be a special one-off price. In this case, valuing the stock at the most recent purchase price would create an unrealistic Gross Profit (too much or too little)
3 Use what you believe would be a fair price that you would pay if you went out and bought some balls at the time of the stocktake.

The main principle in valuing stock counted in the end of year stocktake is be conservative i.e. be reasonable when valuing stock. If the value of stock is over-valued, so will the Gross Profit be overvalued.

The would be a tendency for organisations to want to boost the value of stock so as to report a better profit, but this is not a good idea. For starters, the organisation's auditor won't be happy if you over-value stock because they know that, by law, all assets must be correctly valued when reported in the end of year Financial Statements.

Furthermore, over-valuing the stock does not help you to understand how the business is really performing.

So if an organisation does earn income from a significant amount of trading, it will be important to correctly value the stock.

This means:

Organisations that run a licenced bar Check all stocks of bottles and kegs in the cold room and in the bar. Value the stock at cost.
Organisations that run a canteen Check all stocks of food and softdrinks in fridges and freezers. If you are doubtful whether food can be eaten, don't give it a value and throw it away. Value the stock at cost.
Organisations that trade in clothing Check all stocks of clothing. Do not give a value to any stock that is unlikely to sell. Value the stock at cost.
Organisation that trade in equipment Check all stocks of equipment but only value equipment that is kept for resale. If the equipment is being used by the organisation then do not treat as stock. Stock that is being kept purely for resale should be value at cost.

A physical stocktake is required only once per year, at the end of the financial year. It is required because you cannot be sure of your gross profit, unless you are sure of your stock value.

When business do a physical stocktake it may discover some unpleasant facts. For starters, it is quite possible that stock is missing. It may have been pilfered (stolen) during the year and this only comes to light when a physical stocktake occurs.

It is also possible that a stocktake will reveal that stock is damaged and therefore unsaleable.