Concept of stock and stock valuation

Stock in accounting

is defined as the items/products left unsold at the end of a particular period. However, stocks can also be used to refer to items held to be used for production purpose, like raw materials, but also items/products that are in a process of production (work in progress).

The International Accounting Standard (IAS) number 2 provides a standard definition of stocks which are also referred to as inventories that, they are "assets either, held for sale in the ordinary course of business; or in the process of production for such sale; or in the form of materials or supplies to be consumed in the production process or in the rendering of services".

Classification of stock

The standard definition of stock/inventory as per IAS 2 leads to inventory being classified into three categories, namely: raw materials, work in progress, and finished goods. These are further explained in detail as:

1. Raw materials:

   are factors of production which are inputs that a business needs in the production process. They are of different forms depending on the nature of the business in question. Raw material could be direct as well as indirect materials. Direct materials are those materials which are used in the manufacturing process, and they form part of the final products example timber in the carpentry business; cotton in textile industry and flour in baking business. On the other hand, indirect materials do not form part of the finished goods, but they are consumed as goods are being produced example use of oil to lubricate machines and use of glue to seal boxes of packing clothes in textile firm.

2. Work in progress:

   are the items which are midway through the production process. They include items which are unfinished (partly complete) by the end of the accounting period. Example of work in progress is a partly complete building for a real estate business and undecorated cake in the baking business.

3. Finished goods:

   are the output of the production process. They are the essence of the production process. Though they are finished but they could form part of an input resources in the production of another products. Examples include a complete table for a carpentry business and decorated cake in the baking business.

Stock valuation

is the determination of the value of inventory on hand at a particular date. The purpose is to determine the value of inventory to be included in the financial statements. It also helps in identifying the value of inventory damaged or lost for insurance compensation purposes. Inventory valuation involves establishment of the physical existence and ownership of the inventory items, determination of unit cost of the items and calculation of provisions in reducing the inventory cost to net realizable value where necessary.

IAS 2 requires that all items of inventory be measured at the lower of cost and net realizable value. These terms are to be explained later in this chapter.