Businesses which make things face more complicated issues in valuing stocks (something they must do for the Inland Revenue whether they need to or not otherwise). Stocks are classified either as finished goods (things which have been made and are ready for sale), or raw materials (things which have been purchased or otherwise obtained but have yet to be processed; they do not literally have to be raw). There is also something in between, called work in progress (WIP). In practical terms, WIP may have a realisable value, or it may not. A suit of clothes deemed half-finished might actually be a pair of trousers or a jacket and so be worth something; a half-finished parachute would be worth nothing, except a possible suit for negligence if it were accidentally sold.
The principle of the going concern ¡ª the assumption that the business will be able to continue its trade ¡ª is of great importance in the valuation of work in progress where costs associated with work done to raw materials or components are added to its value as it moves through a factory. These costs include overheads associated with the manufacture as well as the labour of the people working on it. The assumption is that ‘it’ will eventually be finished and sold.
There is potentially a big difference in the working capital requirements of firms which make things for stock and those which make to order. The latter receives an order from a customer which will normally have a delivery date associated with it. The customer may expect credit (this is where the terms creditor and debtor are confusing – a debtor is given credit, a creditor gives it) but competent management should be able to work out when to make and deliver the order to minimise the need for financing stock, and organise any purchases to make the best use of supplier terms available. A company making for stock is much more likely to be acting speculatively, being less certain when it will sell the items it manufactures, if at all. If the item in question is new – in the sense of an innovation – its ‘total cost’ may involve ‘research & development’ and engineering setup. It is at this stage that questions of ‘the lower of cost and realisable value’ become complex. The initial cost of a new product may be more than it will be sold for, if its price is determined by expectations of how many will eventually be sold at a greater volume and therefore a different cost. In the made-to-order case, the certainty is much greater, and a common method of fixing a price is to estimate the cost and add a percentage for overheads and profit. This is called cost-plus pricing.