What Inventory Valuation Means
Inventory valuation is putting a monetary value on the goods you hold at a given date, usually month-end or year-end. It sounds like quantity times price. The hard part is which price. If you bought the same item three times this year at three different costs and sold some of it, which cost belongs to the goods sold and which to the goods still on the shelf?
The answer sets two of the most important numbers in your financial statements: cost of goods sold on the income statement and inventory on the balance sheet. An error in one shows up in the other, in gross profit, in taxable profit, and in the picture your bank, partners and investors see.
This guide covers what belongs in inventory cost, the methods allowed under IFRS as applied in Saudi Arabia, one worked example run through every method, the lower of cost and net realisable value rule, common mistakes, and how an ERP keeps valuation accurate all year rather than once a year.
The Accounting Framework in Saudi Arabia
Saudi entities report under IFRS as endorsed by SOCPA: listed companies since 2017 and other entities since 2018, with the IFRS for SMEs available as an option. Under full IFRS, inventory is governed by IAS 2. The rules that matter most:
- Inventory is measured at the lower of cost and net realisable value.
- Items that are not ordinarily interchangeable, or are produced for specific projects, use specific identification of their actual cost.
- Everything else uses FIFO or weighted average, and the same formula applies to inventories of a similar nature and use.
- LIFO is not permitted.
- Standard cost or the retail method may be used for convenience if the results approximate cost.
On the legal side, the Commercial Books Law required merchants to record year-end inventory in an inventory book and keep books for ten years. On 27 October 2026 the Council of Ministers approved a new Commercial Transactions Law that replaces the Commercial Books Law and other statutes, effective 180 days after publication in Umm Al-Qura, so watch its implementing rules on record keeping.
What Goes Into Inventory Cost
Before choosing a method, the unit cost itself has to be right. Cost includes everything spent to bring goods to their present location and condition:
- Purchase price net of trade and volume discounts.
- Import duties and non-recoverable taxes. Recoverable VAT is excluded.
- Freight, insurance, clearance and inbound haulage to your warehouse.
- Conversion costs for manufacturers: direct materials, direct labour and a systematic share of production overheads.
Excluded: abnormal waste, storage after receipt unless needed for production, general admin overheads and selling costs. An importer that books goods at supplier price and expenses freight and duty straight to the P&L undervalues its stock and misstates the period's profit.
One Worked Example, Every Method
A hypothetical distributor carries a single item, engine oil. Its movements for the year:
| Date | Movement | Units | Unit cost (SAR) | Value (SAR) |
|---|---|---|---|---|
| 1 Jan | Opening stock | 100 | 50 | 5,000 |
| 10 Mar | Purchase | 200 | 55 | 11,000 |
| 15 Apr | Sale | 150 | ||
| 20 Jun | Purchase | 300 | 60 | 18,000 |
| Second half | Sales | 250 |
Goods available for sale: 600 units costing SAR 34,000. Units sold: 400 at SAR 90, so revenue is SAR 36,000. Closing stock: 200 units.
1. FIFO (first in, first out)
The oldest goods are assumed sold first. The 400 units sold are 100 from opening stock at 50, 200 from March at 55, and 100 from June at 60.
COGS = 5,000 + 11,000 + 6,000 = SAR 22,000. Closing stock is 200 units from June at 60 = SAR 12,000.
FIFO keeps the balance sheet close to current prices and matches how most goods physically move, especially anything with an expiry date such as food and medicines.
2. Periodic weighted average
One average for the whole period: 34,000 ÷ 600 = SAR 56.67 per unit.
COGS = 400 × 56.67 = about SAR 22,667. Closing stock = 200 × 56.67 = about SAR 11,333.
3. Moving average
This is what most ERP systems run, because the average is recalculated after every receipt and each sale is costed at the moment it happens:
- After the March purchase: (5,000 + 11,000) ÷ 300 = SAR 53.33.
- April sale of 150: cost 150 × 53.33 = SAR 8,000, leaving 150 units worth SAR 8,000.
- After the June purchase: (8,000 + 18,000) ÷ 450 = SAR 57.78.
- Second-half sales of 250: cost 250 × 57.78 = about SAR 14,444.
COGS = 8,000 + 14,444 = SAR 22,444. Closing stock = 200 × 57.78 = SAR 11,556.
4. Specific identification
Each unit carries its own actual cost. It is required for unique or high-value items: vehicles by chassis number, serialised equipment, jewellery, goods built for a specific project. It is not appropriate for interchangeable items stored together, because it would let you pick which units were "sold" to produce the profit you want.
5. LIFO, for comparison only
Had it been allowed, COGS would be 300 × 60 + 100 × 55 = SAR 23,500 and closing stock SAR 10,500. We show it only because some foreign software and articles still present it. It is not permitted under IFRS as applied in the Kingdom.
Comparing the Results
| Method | COGS | Gross profit | Closing stock | Under IFRS |
|---|---|---|---|---|
| FIFO | 22,000 | 14,000 | 12,000 | Allowed |
| Moving average | 22,444 | 13,556 | 11,556 | Allowed |
| Periodic weighted average | 22,667 | 13,333 | 11,333 | Allowed |
| LIFO | 23,500 | 12,500 | 10,500 | Not allowed |
COGS plus closing stock equals SAR 34,000 every time. The method does not change total cost; it changes how cost is split between what was sold and what remains. When prices are rising, as here, FIFO shows the highest profit and the highest stock value, with averages in between. SAR 667 on one item looks trivial. Across thousands of items and millions of riyals it can reshape the year.
Lower of Cost and Net Realisable Value
Net realisable value is the expected selling price in the ordinary course of business less the costs needed to make the sale. When NRV falls below cost, inventory must be written down, because stock cannot sit on the balance sheet above what you expect to recover.
Back to the example under FIFO: 200 units at a cost of SAR 60. A competitor launches a substitute and the expected selling price drops to SAR 58, with SAR 4 per unit of selling and delivery cost. NRV is SAR 54, six riyals below cost. The write-down is 200 × 6 = SAR 1,200, expensed in the period, bringing inventory to SAR 10,800.
If prices recover later, the write-down is reversed, but never by more than the original amount. Typical triggers for an NRV review: items close to expiry, damaged or technologically obsolete stock, and slow movers that will only sell at a deep discount. Our article on dead stock covers how to find and deal with them.
The Journal Entries
Under a perpetual system every inventory event has an entry. The main ones for the example, using FIFO:
| Event | Debit | Credit | SAR |
|---|---|---|---|
| June purchase (300 units) | Inventory | Accounts payable | 18,000 |
| Input VAT on purchase | Recoverable VAT | Accounts payable | 2,700 |
| Cost of units sold in the year | Cost of goods sold | Inventory | 22,000 |
| Write-down to NRV | Inventory write-down expense | Inventory or write-down allowance | 1,200 |
| Count shortage of 5 units (before write-down) | Inventory shrinkage | Inventory | 300 |
The shortage is posted to its own account rather than buried in COGS, so management can see it and ask why. Under a periodic system it simply disappears into cost.
Perpetual vs Periodic Inventory
Under a periodic system, COGS is known only after a physical count: opening stock plus purchases minus closing stock. Management sees its real margin once a quarter or once a year, and theft, damage and errors vanish into COGS. Under a perpetual system every receipt and issue is recorded at cost when it happens, so the book balance is always known. Physical counts still happen, but they become a control: the difference between counted and book quantity is a variance to investigate. ERP systems run perpetual inventory and support cycle counting through the year instead of shutting the warehouse for days. See our guide to stocktaking.
Metrics That Depend on Valuation
- Inventory turnover = COGS ÷ average inventory. In the example, average inventory is (5,000 + 12,000) ÷ 2 = SAR 8,500 and turnover is 22,000 ÷ 8,500 = about 2.6 times a year.
- Days of inventory = 365 ÷ turnover = about 141 days, so stock sits roughly four and a half months before it sells.
A hypothetical cash effect: a company with SAR 10 million annual COGS and 120 days of inventory carries about SAR 3.29 million on average. Bringing that to 90 days drops the average to about SAR 2.47 million, releasing around SAR 820,000 of cash. If valuation is wrong because import costs were not capitalised or damaged stock is still at full cost, both metrics are wrong too, and so are the buying and financing decisions built on them. Inventory is also a large current asset in the liquidity ratios banks read, explained in our article on the balance sheet.
Choosing a Method
| Business type | Usual best fit | Why |
|---|---|---|
| Food and pharmaceuticals | FIFO | Matches expiry-driven picking |
| High-volume identical items | Moving average | Smooths purchase price swings |
| Vehicles, serialised equipment | Specific identification | Each unit is unique and valuable |
| Repetitive manufacturing | Standard cost with variance analysis | Permitted if close to actual cost |
| Retail with thousands of SKUs | Average or retail method | Unit-level cost tracking is impractical |
On standard cost: a plant sets a standard of SAR 12 per pack. It produces 10,000 packs at an actual cost of SAR 126,000, an adverse variance of SAR 6,000. That variance is analysed into price and usage, allocated between inventory and COGS if material, and the standards are reviewed so they stay close to reality. Whatever you choose, consistency matters more. Changing method is a change in accounting policy that needs justification, retrospective application and disclosure, not a yearly lever for nicer numbers.
Common Valuation Mistakes
- Expensing freight and duty instead of adding them to item cost.
- Negative stock balances: issuing goods before the receipt is posted distorts the average and produces odd costs.
- Skipping the NRV test: carrying expired or obsolete stock at full cost.
- Inconsistent units: buying in cartons and issuing in pieces without a correct conversion multiplies or divides cost.
- No reconciliation to the ledger: the inventory account balance must equal the stock valuation report at every month-end.
A Month-End Valuation Checklist
- Close receiving: make sure every goods receipt for the month is posted, and accrue for goods received but not yet invoiced.
- Finalize landed costs: allocate freight, duty and clearance invoices that arrived after the goods, so item cost is complete.
- Clear negative balances: investigate any item showing negative stock and post the missing receipts or corrections.
- Review ageing: pull items with no movement for 180 days or more and items within three months of expiry, and run the NRV test on them.
- Post count variances: book cycle count differences to the shrinkage account with a short explanation for anything material.
- Reconcile to the ledger: confirm that the stock valuation report equals the inventory control account, and explain any gap before closing.
Done every month, this takes hours rather than days, and year-end stops being a surprise.
Where an ERP Fits
Manual valuation is workable for a few dozen items. With hundreds of SKUs, several warehouses and daily movement it becomes a constant source of error. An ERP costs every issue at the moment it happens, loads import costs onto items, posts the entries so the stock report agrees with the general ledger, and shows stock ageing so you know which items need an NRV review. Classifying items by value with ABC analysis helps focus counts and controls where the money is. In Tranquil, inventory management with central stock and multiple units of measure is connected directly to financial accounting.
Frequently Asked Questions
Which inventory valuation method is best?
None in absolute terms. FIFO suits goods with expiry dates, weighted average suits identical items with volatile purchase prices, and specific identification suits unique items. Pick the one that reflects your business and apply it consistently.
Can I use LIFO in Saudi Arabia?
No. IFRS as endorsed in the Kingdom does not permit LIFO. Use FIFO or weighted average, and specific identification for non-interchangeable items.
When do I need to write inventory down?
When net realisable value, meaning expected selling price less selling costs, falls below cost because of damage, obsolescence, approaching expiry or falling prices.
Is VAT part of inventory cost?
Not if you are VAT-registered and can recover it. Only non-recoverable taxes are included in cost.
Does Tranquil track inventory cost?
Yes. Stock movements are recorded with their cost and linked directly to financial accounting. Contact the Tranquil team to review the right valuation setup for your business.