Valuing stock - or inventory - may not sound exciting at first, but it’s a vital part of running any business that buys and sells goods. Getting it right helps ensure accurate profits, fair tax reporting, and good decision-making.
But how exactly should stock be valued? The most appropriate method depends on the nature of your business and the types of goods you sell. Below, we explore the main methods and when each one is most suitable.
First In, First Out (FIFO)
One of the most common methods is First In, First Out (FIFO). This assumes that the first items bought will be the first ones sold. This approach makes sense for businesses handling perishable goods or products with a limited shelf life, such as supermarkets or food retailers.
It reflects a logical flow of stock and often results in higher profits when prices are rising, since older (and usually cheaper) stock is counted as sold first.
Example:
A company like McDonald’s uses FIFO to ensure older ingredients - such as buns, lettuce, and cheese - are used before newer deliveries. This reduces waste, maintains freshness, and ensures accurate cost tracking.
Last In, First Out (LIFO)
Then there’s Last In, First Out (LIFO), which does the opposite – it assumes the most recently purchased items are sold first. While LIFO is not permitted under FRS 102 in the UK, it’s still worth understanding, as it can impact how businesses view inventory in other jurisdictions.
In periods of inflation, LIFO tends to reduce reported profits because newer, more expensive stock is counted as sold first.
Example:
A large hardware retailer may stock thousands of identical screws, bolts, and other materials. If prices are rising, using LIFO means the more expensive, newer stock is counted as sold first, which reduces the reported profit and in some cases, the tax bill.
Weighted Average Cost (WAC)
The Weighted Average Cost method spreads the cost of all stock items evenly, regardless of when they were purchased. It’s especially useful when stock items are identical or bought in large quantities at varying prices.
This method smooths out price fluctuations and avoids the extremes of FIFO or LIFO.
Example:
A company like Coca-Cola buys large amounts of sugar and other ingredients at different times and prices. Using the weighted average cost helps smooth out the cost fluctuations, making it easier to value the stock without worrying about which specific batch was used first.
Net Realisable Value (NRV)
Sometimes, stock can’t be sold at its original cost because it’s damaged, obsolete, or outdated. In these cases, it should be valued at its net realisable value - what it could realistically be sold for, minus any costs required to sell it.
Example:
Fashion retailers such as Topshop or Zara may unsold items from previous seasons. As a result, they might have to sell it at a discount or clear it out completely. In this case, the stock’s value in the accounts would be based on the lower price expected from from selling the item, rather than the original purchase cost.
This ensures the business doesn’t overstate the value of its stock.
What FRS 102 Says
Under FRS 102 in the UK, inventory must be measured at the lower of cost and NRV. In other words, stock should never be valued higher than what it’s worth in the market. This ensures your accounts give a fair and realistic view of your business’s assets.
In summary, there’s no one-size-fits-all method for valuing stock. The best method depends on your business model, your type of stock, and current economic conditions.
Whichever method you choose, consistency and accuracy are key - they ensure your financial results are reliable and that you meet accounting standards with confidence.
How We Can Help
Accurate stock valuation is essential for producing reliable accounts and managing tax effectively. If you’re unsure which method best suits your business or how to apply the FRS 102 requirements, our accounting team can help.
We can review your inventory processes, advise on valuation methods, and ensure your financial reporting remains compliant and consistent.
Get in touch with our team today to discuss how we can support your business.
Author, Morayo Sanusi - Audit
Morayo.Sanusi@ArnoldHill.co.uk
