In the most businesses the value put on stock is an important factor in the determination of profit. Stock valuation is however, a highly subjective exercise and consequently there is a wide variety of different methods used in practice.
The statutory regulations and accounting standards requirements have been developed to achieve greater uniformity in the valuation methods used and in the disclosure in financial statements prepared under the historical cost convention.
Accounting standards defines stocks and work in progress as,
- Goods or other assets purchased for resale.
- Consumable stores.
- Raw materials and components purchased for incorporation into products for sale.
- Products and services in intermediate stages of completion.
- Long term contract balances.
- Finished goods.
In published accounts the companies act requires that these stock categories should be grouped and disclosed under the following heading,
- Raw materials and consumables stocks.
- Work in progress stocks.
- Finished goods and goods for resale.
- Payments on account. This is presumably intended to cover the case of a company which has paid for stock items but not yet received them into stock.
Determination of the cost of stock
To determine profit costs should be matched with related revenues. Since the cost of unsold stock and work in progress at the end of an accounting period has been incurred in the expectation of future sales revenue, it is appropriate to carry these costs forward in the balance sheet and charge them against the profits of the period in which the future sales revenue is eventually earned.
As the explanatory note to accounting standards expresses;
“If there is no reasonable expectation of sufficient future revenue to cover cost incurred the irrecoverable cost should be charged to revenue in the year under review. Thus stocks normally need to be stated at cost or if lower at net realized value”