Chapter 3.8® - Glossary of Important Inventory Valuation Terms
Cost of Inventory - Cost refers to the acquisition price of inventory calculated using one of the historical cost principle methods such as specific identification, LIFO/FIFO or Average cost.
Direct Inventory Costing Method - Direct method involves simply recording the ending inventory at the market figure at year-end if lower than cost. Then, the market value number is substituted for cost when valuing the inventory. As a result of this, no loss is reported separately on the income statement because the loss is hidden in cost of goods sold.
Gross Profit Method - It is most often used when an interim financial report needs to be prepared and on hand inventory number is to be derived. Other cases when it is used include when inventory is destroyed by fire or some natural disaster, and the amount of inventory destroyed in the catastrophe is to be estimated for insurance purposes.
The gross profit method of estimating inventory is based on three assumptions:
i) The beginning inventory + purchases = the cost of goods available for sale that must be accounted for:
ii) Goods not sold must be on hand in ending inventory (logically)
iii) When net sales (reduced to cost) are deducted from cost of goods available for sale, the result is net ending inventory.
Net realizable value (NRV) - NRV
is the inventory’s estimated selling price in the ordinary operations
of the business minus reasonable predictable costs to complete and dispose
of the item.