Actual Cost Valuation Method

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​  Inventory valuation can make or break a company.  It is absolutely essential that the valuation method you choose aligns with the needs of your specific business and the industry it serves.  In this post we will introduce one valuation type known as actual cost valuation.

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  Actual Cost Valuation is one of the most basic and frequently used types of valuation because it values inventory based on the actual costs of items in your inventory.  You may hear actual costing referred to as item or batch costing as well.  Put very simply, actual costing is the actual cost of an item for all its movements through an organization.  This includes but is not limited to, when the item is sold and received, issued to the production floor and moved. 
How Does it Work?
  Actual costing borrows from FIFO by using the dates an item is received in.  It then assigns a lot, batch, order or serial number to each and every item that is received.  This unique number travels with the item or information everywhere.  This is where actual cost is different from FIFO.  Actual cost uses the lot and serial numbers to track and differentiate the actual cost of items that are received on the same day.  Ultimately this enables you to track the actual cost of items or batches that have a lot or serial number assigned to them.
What are the Benefits?
  There are many benefits to this approach.  One is that it improves the accuracy of both job and item costing and estimating.  While you should speak with a professional accountant or a CPA, actual costing is preferred by many manufacturers who’s inventory costs fluctuate between inventory purchases.  Some examples might be job shops, make to order shops or engineer to order manufacturers that often experience drastic changes in their raw material pricing.
Example:

• K&K is a large pharmaceutical distribution warehouse.  K&K tracks inventory as it is received into and out of the warehouse.  Each week K&K receives about 10 orders of a popular virus fighting capsules.  In the first week the cost per bottle is $100 each.  These bottles are given a lot number of 1.  In week 2 the vendor's pricing changes and the order cost inflates to $125 per bottle.  This lot is received in and given a lot number of 2.  In the third week inflation goes down and the bottles again cost $100 per bottle.  This order is received and given a lot number of 3.  K&K receives these in and places each of the orders into bins.  They use a FIFO method so that the oldest order is used first.  Now let’s say that the orders are sold for $500 a bottle without any regard for the cost of each lot.  As you can see the profit in week one and week 3 will be higher than week 2.  Since they use the oldest Materials first the first order is used, then the second and finally the third.  This would be difficult to track the actual costs without a lot number.  However, K&K wisely assigned lot numbers to the bottles and so they are better able to control the inventory and track costs as well as profits per bottle.

Challenge:

• If you buy two lots of materials, the first at $500 and the second at $600 and each of the lots have different lot numbers.  What is the actual cost of each of the lots of materials?  Share your thoughts in the comments section below and receive a coupon to one of Lean Strategies International LLC's courses.

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