10- Bases of Inventory Valuation:

The basis for valuing inventory- the rule for

assigning a cost to a physical unit- affects both periodic net

income and the amount at which inventories appear on the

balance sheet. Accounting uses at least five valuation bases

for various purposes: acquisition cost, current cost

measured by replacement cost, current cost measured by

net realizable value. Lower of (acquisition) cost or market,

and standard cost. Generally, accepted accounting

principles require the use of the lower-of-cost-or-market

basis for most purposes. The basis of inventory valuation is

explained as follows:

Acquisition Cost Basis:

The acquisition cost basis values units in inventory at

their historical cost until sold. In accounting, the terms

acquisition cost and historical cost mean the same thing

using acquisition costs implies using the realization

convention: gains (or losses) caused by increases (or

Chapter Four: Inventories and the cost of goods sold

178

decreases) in the market value of assets do not appear in

income until a firm sells the particular assets. When a firm

uses the acquisition cost basis, any changes in the value of

inventory items occurring between the time of acquisition

and the time of sale do not appear in the financial

statements. The figure shown on the balance sheet for

inventory becomes out of date to the extent those prices

have changed since the firm acquired the items. The longer

the period of time since the firm acquired inventory, the

more likely the current value of the inventory will differ

from its acquisition cost.

Current Cost Basis:

A current cost basis values units in inventory at a

current market price. Two current cost bases are (1) current

entry value, often called replacement cost, and (2) current

exit value, often called net realizable value. When a firm

states inventories at current cost, it must recognize gains

and losses from change in prices during the holding period

that elapses between acquisition (or production) and the