Inventory (or stock as we used to call it) is a controversial subject so let’s see why inventory valuations are wrong.
This is not going to be a technical discussion around accounting standards. For statutory purposes you must stick to the rules even though they can cause you to make wrong decisions about inventory. Here we are looking at why inventory valuations especially in manufacturing are wrong and not effective for decision making.
As we increasingly see the failure of the supply chain strategies which many businesses have been persuaded to adopt over the last few years more and more businesses are addressing their inventory policies.
Raw materials and finished goods not the problem with valuation. The “lower of cost or net realisable value” rules are logical and can help us make sensible decisions. It’s Work In Progress (WIP) where it all falls apart.
As things move through the productive process they acquire cost and hence “value” in the eyes of financial accountants, such that we end up with a finished vehicle being worth more than the sum of the parts. That’s logical but wrong in so many cases at the WIP stage. In reality the sales value of WIP is often less than the parts and overhead employed to get to a part complete stage. In order to make effective decisions we must recognise this.
It’s time we realised that for most manufacturers things lose value until they are complete. A part complete table is firewood. A complete table is worth something.
Revaluing WIP on a true basis has a negative effect of short term profit but correctly identifies the situation within the business and highlights where our main activities should be centred i.e. WIP.
Statutory accounts are for statutory purposes – not decision making.
Will you change and internally value you inventory properly? Or, will the truth hurt too much? Either way, in order to make informed and effective decisions on inventory we must keep the statutory valuations for the financial accounts and adopt commercial ones for decision making.
If you want to look at this further we have both manufacturing and service simulations to enable everyone to be more effective then please contact us for details – https://www.wellsassoc.co.uk/contact/
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