Valuation of work in progress and finished stock

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VALUATION OF WORK-IN-PROCESS AND FINISHED STOCK

The valuation of work-in-process and finished goods inventory depends to a certain extent on the method of pricing the raw material and to a large extent on the method of costing used to apportion the fixed manufacturing overheads. Direct Costing and Absorption Costing are the two techniques used for allocation of costs to the inventory.
Direct costing is based on the traceability of cost to the cost objective. All indirect costs (which may include fixed manufacturing overheads) are charged to the income statement and are known as period costs. If the fixed costs are directly identifiable, then it is considered for inventory valuation.

Absorption costing is a technique, which treats the fixed manufacturing overheads as product costs. Thus, all costs i.e. both fixed and variable will be assigned to the inventory value.

This difference in approach to costing will affect the inventory value and also the profits. The direct costing method lowers the inventory value (by not considering the indirect costs) and increases profits with a decrease in inventory level (when the inventory level decreases the direct costs come down while the fixed costs remain the same). Contrary to this the inventory valuation will be higher for stocks valued under absorption costing method as it considers all the fixed manufacturing overheads.

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Valuation of Work in Progress and Finished Stock