Inventory Accounting

Introduction

At the beginning and end of every period there will be items of stock remain on your selves and in your warehouse. These stocks have to be valued and accounted for in the financial statements. In this topic we will look at the valuation of stock and the various methods of valuing closing stock.

Objectives

Upon the completion of this topic you should be able to:
1. Identify different methods of stock valuation.
2. Examine different methods of stock valuation (LIFO, FIFO, AVCO).
3. Illustrate the different adjustment required to arrive at the closing stock.
4. Show how the necessary adjustments are recorded in the financial statements.

Stock Valuation

Stock are goods purchased for re-sale. Keeping a record of stock involves adding new stock purchased and deducting any stock sold. Stocktaking (taking inventory) is the process of physically checking stock. This involves physically counting the stock on hand and comparing the findings with figures on the stock record. Stocktaking helps to assess the amount of loss due to theft or breakage and ensure that ht stock records are being kept effectively.

There are two ways that stock may be recorded by a business.
1. Perpetual method or continuous method where stocks are updated after each purchase, sale or return of stock.
2. Periodic method where the closing stock figure is determined by physically counting and valuing stock on hand at the end of a period.

Methods of Stock Valuation

There are three methods of valuing stock. These are:
1. First In First Out (FIFO) assumes that the first set of stocks purchased are the first set of stocks that would be sold.
2. Last In First Out (LIFO) assumes that last set of stocks purchase are the first set of stock that would be sold.
3. Average Cost (AVCO) values closing stock by using the average cost of the stocks available for sale. This is done as follows:



You can now examine the valuation of closing stock using each method in the example below.
Example 3.4 A
For 2011 the receipt and issue of stocks are as follows

Receipts	Sales
Jan 20 items at $30 each	June 6 items for $45 each
May 10 items at $33 each	Aug 22 items for $46 each
July 16 items at $38.50 each	Dec 10 items for $48 each
Oct 12 items at $39 each

There was no opening stock.

• Calculate the closing stock using (i) FIFO (ii) LIFO (iii) AVCO.
• Draw up the trading account for the year ended 31 December 2011 showing the different reported gross profits from the figures given in (a)

FIRST IN FIRST OUT METHOD (FIFO)

FIFO	Received	Issued	Stock after each transaction	$	$
January	20 @ $30		20 @ $30		600
May	10 @ $33		20 @ $30	600	930
			10 @ $33	330
June		6 @ $30	14 @ $30	420	750
			10 @ $33	330
July	16 @ 38.50		14 @ $30	420	1,366
			10 @ $33	330
			16 @ $38.50	616
August		14 @ $30	2 @ $33	66	682
		8 @ $33	16 @ $38.50	616
October	12 @ $39		2@ $33	66	1,150
			16 @ $38.50	616
			12 @ 39	468
December		2 @ $33	8 @ $38.50	308	682
		8 @ $38.50	12 @ $39	468

Take note that the first items of stock purchased are the first to be sold. Also note that stock is valued at cost price not at selling (sales) price. The valuation of stock should not include profit amounts.

LAST IN FIRST OUT METHOD (LIFO)

LIFO	Received	Issued	Stock after each  transaction	$	$
January	20 @ $30		20 @ $30		600
May	10 @ $33		20 @ $30 10 @ $33	600 330	930
June		6 @ $33	20 @ $30 4 @ $33	600 132	732
July	16 @ 38.50		20 @ $30 4 @ $33 16 @ $38.50	600 132 616	1,348
August		16 @ $38.50 4 @ $33 2 @ $30	18 @ $30		540
October	12 @ $39		18 @ $30 12 @ $39	540 468	1,008
December		10 @ $39	18 @ $30 2 @ $39	540 78	618

You can observe that when the LIFO method of valuation is used the last item of stock received becomes the first item of stock to be issued.

AVERAGE COST METHOD (AVCO)

AVCO	Received	Issued	Average Cost per unit	Number of units	Value of stock
			$		$
January	20 @ $30		30	20	600
May	10 @ $33		30 + 33 = 31 10 + 20	30	930
June		6 @ $31	31	24	744
July	16 @ 38.50		31 + 38.50 24 + 16 = 34	40	1,360
August		22 @ $34	34	18	612
October	12 @ $39		34 + 39 40 + 12 = 36	30	1,080
December		10 @ $36	36	20	720

You can move on to look at the trading account taking into account the different valuations of stock just calculated.

The sales figure is calculated by adding all the sales

The purchase figure is calculated by adding all the purchase amounts

The use of different methods of valuation of stock would give a different value of gross profit and net profit for the same business.

Topic Summary

You just observed that different methods can be used to value closing stock. You would have noted that these different methods of valuation have a different effect on the profit calculation.