Measuring Inventory - the details

Someone on the forum asked me about the valuation of inventory, so I thought I'd write a whole blog about it.  I know, it's a heavy subject for a Saturday!

Let's recap on what inventory is:  inventory is a type of an asset that is held for sale as part of the normal course of business.  It can be a finished product, or partially finished.

Inventories are measured at the lowest of

1. cost, and 
2. net realizable value

What is cost?

Cost includes the following:

• Purchase price of the inventory
• Any direct labour that was used on the inventory
• An allocation of any fixed/variable costs
• Import duties/taxes
• Transportation and handling costs
• Interest costs are included only when it takes a long time for the inventory to be finished and there's a policy to capitalize interest costs

What is net realizable value?

Net realizable value includes the following:

• Selling price
• Less: any costs to complete the product (estimate)
• Less: any selling costs

It's important not to confuse net realizable value with fair market value!

Fair market value (FMV) is the actual selling price on the market.  It doesn't include the costs to complete the product or any selling costs.  FMV is therefore usually larger than net realizable value.