Q. Importance of proper inventory valuation?
A merchandising company is able to prepare accurate statements of retained earnings, income statements and balance sheets only if its inventory is correctly valued. On the income statement a company utilizing periodic inventory procedure takes a physical inventory to determine the cost of goods sold. Since the cost of goods sold figure distress the company's net income it as well affects the balance of retained earnings on the statement of retained earnings. On the balance sheet wrong inventory amounts distress both the reported ending inventory and retained earnings. Inventories shown on the balance sheet under the heading "Current Assets" which reports current assets in a descending order of liquidity for the reason that inventories are consumed or converted into cash within a year or one operating cycle whichever is longer inventories habitually follow cash and receivables on the balance sheet.
Remind that under periodic inventory procedure we determine the cost of goods sold figure by adding the beginning inventory to the net cost of purchases as well as deducting the ending inventory. In each accounting period the appropriate expenses should be matched with the revenues of that period to determine the net income. Applied to inventory matching involves determining (a) how much of the cost of goods available for sale during the period should be deducted from current revenues and (b) how much should be allocated to goods on hand and thus carried forward as an asset merchandise inventory in the balance sheet to be matched against future revenues. For the reason that we determine the cost of goods sold by deducting the ending inventory from the cost of goods available for sale a highly important relationship exists Net income for an accounting period depends directly on the valuation of ending inventory.