Chapter 29 The valuation of inventory. Learning objectives. After you have studied this chapter, you should be able to: Calculate the value of inventory using three different methods Explain why using the most appropriate method to value inventory is important
Chapter 29The valuation of inventory
After you have studied this chapter, you should be able to:
Calculate the value of inventory using three different methods
Explain why using the most appropriate method to value inventory is important
Explain what effect changing prices has on inventory valuation under each of three different methods
Explain why net realisable value is sometimes used instead of cost for inventory valuation
Adjust inventory valuations, where necessary, by a reduction to net realisable value
Explain how subjective factors influence the choice of inventory valuation method
Explain why goods purchased on ‘sale or return’ are not included in the buyer’s inventory
Inventory is the name given to goods held for resale, work-in-progress and raw materials.
There are several different ways to value inventory
FIFO (first in, first out)
LIFO (last in, first out)
AVCO (average cost)
Using the following transactions, we will look at the FIFO, LIFO and AVCO methods of valuation.
* 10x30=300 + inventory received (10 x 34) =340 = total 640. then 640/20 = 32
* *12x32=384 + inventory received (20 x 40) =800 = total 1184. there are 32 units in inventory, 1184/32 = 37
The choice of valuation method used has an effect on profit.
Once a valuation method has been chosen and used, you need to consider whether that value is realistic.
If the inventory is not worth its value at the end of the period, an adjustment must be made.
This adjustment is in accordance with the prudence concept.
Net realisable value is calculated as:
If the net realisable value of inventory is less than the cost of the inventory, then the net realisable value is used in the financial statements.
Ignorance of other methods.
Convenience, because it’s the easiest method.
Custom, because it’s the usual method in the industry.
Taxation – lower profits delay taxation payments.
Making the business look attractive with a high stock valuation.
Remuneration purposes, if someone is paid according to profits earned.
Lack of information, because proper records haven’t been kept.
Advice of the auditors, who prefer a particular method.
Sometimes goods are supplied on a sale or return basis.
This means that payment is not due until the buyer has sold the goods on.
In this situation, the buyer cannot recognise the existence of the goods in either the stock valuation or the purchases figure.
You should have now learnt:
That methods of valuing inventory, such as FIFO, LIFO and AVCO, are only that – methods of valuing inventory. It does not mean that goods are actually sold on a FIFO or LIFO basis
That because different methods of valuing inventory result in different closing inventory valuations, the amount of profit reported for a particular accounting period is affected by the method of inventory valuation adopted
That using net realisable when this is lower than cost, so that profits are not overstated, is an example of the application of the prudence concept in accounting
That many subjective factors may affect the choice of inventory valuation method adopted
That without inventory records of quantities of items, it would be very difficult to track down theft or losses or to detect wastage of goods
That without proper inventory records, it is unlikely that AVCO or LIFO can be applied in the way described
That goods sold on sale or return should be included in the inventory of the seller until the buyer has sold them
That stocktaking is usually done over a period of time around the end of the accounting period
That the inventory levels identified at a stocktake need to be adjusted to the level they would have been at, had the stocktake taken place on the date of the statement of financial position