Approaches to Inventory valuation

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Managerial Accounting

Lesson 3: Inventory Valuation and JIT Approach to Inventory Management

Approaches to Inventory valuation

As we discussed in our previous lesson, selling and general administrative expenses are treated as period costs and are therefore not included as part of the product cost. Hence, such period costs are not included in the valuation of inventory. There are two schools of thoughts on the treatment of fixed manufacturing overheads. One school advocates that fixed manufacturing overheads should be expensed as period costs. Product costs and inventory costs should therefore exclude fixed manufacturing overheads. This method of product costing and valuation of inventory is referred as variable costing method.

The other school advocates that fixed manufacturing overheads are part of the product costs and these costs are therefore treated as product costs. In this approach, both product costs and the value of inventory include manufacturing fixed overheads. This approach is referred to as full absorption costing method. Fixed manufacturing overheads are period costs in the sense that the components of fixed manufacturing overheads such as factory rental, salaries of indirect labour, are determined based on the period in which they are incurred. However, in the full absorption