Chapter 11 Inventory Valuation AS 2 (V. Rajasekaran and R.

Lalitha)
First In first Out (FIFO) : This method is based on the assumption that flow of cost is in the order in which the expenditures were made. To explain, the units that are received first will be sold first, i.e. the units are sold in the order in which they were acquired (purchased) The flow of costs is presumed to be the same as flow of goods. The closing (ending) inventory consists of the latest lots and is valued at the price paid for such lots. The results achieved under this method may be more or less similar to those obtained under specific identification method. Last In first Out (LIFO) : The LIFO method allocates the cost of goods available for sale between closing inventory and cost of goods sold based on the assumption that the most recent purchases are the first to be sold. Under this method, the most recent purchase is allocated to the cost of

goods sold and the earliest purchase allotted to closing inventory. Goods purchased last are issued first. The LIFO cost of goods sold is calculated by adding the cost of beginning inventory to purchase and subtracting the cost of closing inventory. Distinguish Between FIFO and LIFO Methods:

First In First Out (FIFO) 1) In this method, Goods purchased first are issued first. 2) The value of closing stock will be nearer to the current market price, so Balance sheet shows the true position. 3) This method is very popular

Last In First Out (LIFO) 1) In this method, Goods purchased last are issued first. 2) The value of closing stock will be on the basis of old purchases, so Balance sheet does not show the true position. This method is less popular.

4) This method is easy to 4) This method is understand and is practical. comparatively complicated. 5) This is approved by the 5) This method is not approved International Accounting by the International Accounting Standards Committee (IASC) Standards Committee (IASC) 6) In this method, principle of 6) In this method, principle of original cost is seen. market price is seen. 7) This method is not reliable 7) This method is more reliable for fixing the selling price. for fixing the selling price. 8) Even though prices 8) As the prices increase, the increase the cost of production cost of production will be will be less. higher. C) WEIGHTED AVERAGE METHOD: [WAM] Under this method, the rate is calculated at the time of every purchase (Receipts) for pricing the issues of goods. The Weighted Average Method Rate can be ascertained with the help of the following formula:

Weighted Average Rate = P1Q1 + P2Q2 Q1 + Q2 Where, P1 = Price (Rate) of the first purchase P2 = Price (Rate) of (next) new (current) purchase. Q1= Quantity of new first purchase (stock on hand) Q2 = Quantity of new (next) (current) purchase. In this method stock will be shown at Weighted Average Rate and issues are valued at one rate only. ADVANTAGES OF WAM: 1. It is easy to calculate and operate. 2. When prices vary widely, it evens out the variations. 3. Closing stock value is acceptable and can be used in the financial accounts. 4. It reduces the number of calculations if receipts are not numerous, as each issue is charged at the same price until a fresh lot of material is received. DISADVANTAGES OF WAM: 1. Profit or loss in issue may arise as issues are not valued at actual cost. 2. Closing stock is not at current cost. 3. Excessive high (or low). Prices paid earlier are reflected in the average for a long time even after consuming the expensive (or inexpensive) material. 4. To avoid errors, the average price is to be calculated to four or five decimal places.

Periodic Inventory System

Periodic inventory system is a method of ascertaining inventory by taking the actual physical count(measure or weight) of all the inventory items on hand at a particular date, usually at the end of an accounting period. It is also known as the physical inventory system because of the actual physical count. The cost of goods sold is determined using the following equation: Cost of Goods = Opening Inventory + Purchases Sold Closing Stock Perpetual Inventory System The perpetual inventory system is a system of records that reveals the physical movement of stocks and their current balance. It is a method of recording inventory balances after each purchase and sale takes place. The closing inventory is calculated by using the following equation: Closing = Opening + Purchases - Cost of Goods Inventory Stock Sold OR Cost of Goods = Opening + Purchases - Closing Sold Stock Inventory

Q.1 From the following information, you are required to calculate the value of Ending Inventory and cost of

goods sold assuming (a) Perpetual Inventory (b) Periodic Inventory System under: 1) FIFO 2) LIFO 3) Weighted Average Cost Date Transactions Units Price per unit 02/01/09 Opening Balance brought 100 10 forward 09/01/09 Purchases 400 15 14/01/09 Sold 300 25/01/09 Purchases 500 20 29/01/09 Sold 400 Q.2 Purchases and sales of a certain product during Jan.2009 are given below. Purchases On Jan 2, 2009 100 units @ Rs.5 On Jan 12, 2009 200 units @ Rs.4.80 On Jan 17, 2009 100 units @ Rs.4.60 On Jan 22, 2009 100 units @ Rs.4.50 Sales On Jan 7, 2009 50 units On Jan 14, 2009 150 units On Jan 28, 2009 100 units

There was no Opening Inventory. You are required to compute the Value of Ending Inventory and Cost of Goods Sold under the methods: 1) FIFO 2) LIFO 3) Weighted Average Cost Q.3 From the following particulars selecting to raw materials, prepare the stock Register of K & T Stores as per Weightage Average Method. Date Particulars Quantity Rate (Rs.) (Pieces) (Per dozen) 1-1-94 Opening Stock of Raw 72 480 materials 3-1-94 Goods Received 100 600 10-1-94 Goods sent on Job 84 15-1-94 Goods Received 144 720 20-1-94 Goods sent on Job 72 24-1-94 Goods Received 120 840 25-1-94 Return from 20-1-94 12 31-1-94 Shortage 24 Q.4 Following are the details of X Ltd. during June 2008.

Date June 2 June 8 June 12 June 15 June 18 June 24 June 28

Purchase / Sale Purchase Purchase Sale Purchase Sale Purchase Sale

Units 1,000 500 500 800 1,000 500 800

Rate per unit (Rs.) 50 60 70 70 85 85 100

You are required to compute (I) The value of stock held on June 30, 2008 using each of the following alternative basis of valuation: a) FIFO b) LIFO c) Weighted Average cost (II) The gross profit earned during June.

Q. 5 The following records have been extracted from the stock ledger of XXL Ltd. Purchase Rate per Date Qty. unit 02/04/11 10,000 100 15/04/11 Date Issue Qty. 8,500

21/05/11 31/07/11 10/02/11 15/03/12

7,000 2,200 800 6,200

95 96 100 101

28/05/11 21/08/11 02/03/12 29/03/08

3,500 7,000 800 4,400

The opening inventory was 3,000 units costing Rs.92 per unit. Till last year, the company used to follow LIFO method under periodic inventory valuation system, during the current year it was changed to FIFO. Find out the effect of change in the policy on profit and on the value of inventory. Solution: Closing inventory quantity = Opening Inventory qty. Issued qty. Here, Closing Inventory qty. = 3,000 + 26,200 24,200, i.e. = 5,000 units. Cost of these 5,000 units under periodic system can be worked as follows: (a) LIFO Method: 5,000 units comprise 3,000 units of opening stock @ Rs.92 and 2,000 units from the first purchase @ Rs.100 each; therefore, the value of 5,000 units will be Rs.4,76,000 (3,000 92 + 2,000 100) (b) FIFO Method: 5,000 units are from the latest purchase as opening inventory and initial purchase is consumed first.

Therefore, cost of inventory 5,000 units is @ Rs.101 amounting to Rs.5,05,000. Now had the company followed LIFO method then value of closing inventory would be Rs.4,76,000 but the company has changed to FIFO method and closing inventory has been reported at Rs.5,05,000, Rs.29,000 more as compared to LIFO method. The impact of such change is the profit of the current financial year has been reported higher by Rs.29,000 as well as the closing inventory also. Similarly, had there been FIFO method till last year and during the current year, the company changes it to LIFO then the effect on profit and closing stock would have been just the opposite. Q.6 Opening stock of an item in the godown is 2,000 units costing Rs.22 per unit, during the year, the following purchase was made: 10,000 units @ Rs.25 ; 6,000units @ Rs.24 ; 9,000 units @ Rs.23 During the year, 24,500 units were sold. Find out value of closing inventory under periodic system using LIFO, FIFO, simple average and weighted method. Solution:

Example no. 6 The quantity of closing inventory is equal to opening stock + purchase quantity less sales quantity. Therefore, closing inventory of 2,500 units (2,000 + 10,000 + 6,000 + 9,000 24,500) Valuation under different methods will be: (a) FIFO method: Closing inventory of 2,500 units is out of the last purchase, i.e. 9,000 hence value of inventory is Rs.57,500 (2,500 23). Cost of goods consumed will be Rs.5,87,500 (6,45,000 57,500). (b) LIFO method: Closing inventory of 2,500 units is comprises 2,000units of opening stock valued @ Rs.22 per unit and 500 units out of the first purchase valued at Rs.25 per unit. Therefore, value of closing inventory is Rs.56,500. Cost of goods consumed will be Rs.5,88,500 ( 6,45,000 56,500). (c) Simple Average Method: Closing inventory of 2,500 units is to be valued at average price that is (22+ 25+ 24+ 23)/4 = Rs.23.50 per unit. Therefore, value of closing inventory is Rs.58,750. Cost of goods consumed will be Rs.5,86,250 (6,45,000 58,750). (d) Weighted average method: Weighted average of price is simply total cost of goods available divided

by the total available quantity. Here The total available inventory quantity = Opening quantity + Purchase quantity) Rs.23.89 (6,45,000/27,000) and closing inventory of Rs.2,500 units is to be valued at this price. Therefore, value of closing inventory is Rs.59,725. Cost of goods consumed will be Rs.5,87,275 (Rs.6,45,000 Rs.59,725).