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Valuing Inventories

The basic principle of inventory valuation is that the value of a unit of inventory is its cost. For example, if your company purchases products at a wholesale cost and resells them to consumers at a retail price, then the value of your inventory of goods is determined by the amount you pay to acquire them. The inventory itself consists of whatever you have purchased for the purpose of resale, in your normal business operations. So inventory would not include the building that you purchased for office space: although you might resell it, you wouldn't expect to do so as part of normal business operations.

On the other hand, if your company manufactures or otherwise produces goods, the situation is more complicated. In that case, there are typically three categories of inventory: raw materials, work in process, and finished goods. You would value each category differently. The value of the raw materials is simply their acquisition cost. The value of work in process is the cost of the raw materials plus any labor costs incurred to date. And the value of finished goods consists of the material cost plus all the labor costs involved in bringing the product to completion—including factory overhead.


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