1. Understanding Inventory Valuation
Inventory valuation determines the monetary value of stock a business holds at a given time. It affects:
- Financial statements (Balance Sheet & Profit & Loss Account)
- Cost of Goods Sold (COGS), which influences profitability
- Tax calculations, as undervaluing or overvaluing inventory can lead to compliance issues
- Investment decisions, since working capital depends on accurate inventory valuation
For Indian businesses, choosing the right valuation method is crucial for profitability and tax efficiency.
2. Key Inventory Valuation Methods in India
A. First-In, First-Out (FIFO)
✔ Oldest stock is sold first, newest stock remains
✔ Useful in inflationary markets as older stock has a lower cost, reducing COGS and increasing profits
✔ Accepted under Indian Accounting Standards (IND AS 2) and GST compliance
B. Weighted Average Cost (WAC)
✔ Inventory is valued based on the average cost of all units
✔ Suitable for industries with frequent price fluctuations, like pharmaceuticals & FMCG
✔ Reduces extreme price variations in COGS calculations
C. Specific Identification Method
✔ Used for high-value, unique items like jewelry, real estate, and luxury goods
✔ Each unit is valued individually, ensuring precise financial reporting
D. Last-In, First-Out (LIFO) [Not Allowed in India]
🚫 LIFO is not permitted under Indian accounting standards
🚫 Can artificially reduce profits and taxes, leading to compliance risks
3. Impact of Inventory Valuation on Financial Planning
A. Profitability & Tax Optimization
✔ Choosing FIFO during inflation increases profits but may result in higher tax liabilities
✔ WAC helps stabilize profits over time, reducing tax fluctuations
B. Cash Flow Management
✔ Overvaluation can inflate taxable income, leading to higher GST & corporate tax payments
✔ Undervaluation may cause working capital mismanagement and financial risks
C. Loan & Investment Decisions
✔ Banks and investors assess inventory value when evaluating loan applications
✔ Accurate valuation builds trust with investors & lenders
D. GST & Compliance Risks
✔ GST Input Tax Credit (ITC) is linked to inventory valuation, requiring proper documentation
✔ Incorrect valuation can lead to penalties during tax audits
4. Common Mistakes to Avoid in Inventory Valuation
❌ Using outdated or non-compliant valuation methods
❌ Ignoring inflation impact on COGS and pricing
❌ Not reconciling physical stock with book value
❌ Misreporting inventory for tax savings, leading to penalties
