Inventory Valuation Methods

Inventory Valuation Methods

There are three methods of inventory valuation. These methods are

a)    FIFO (first in First Out) - Inventory purchase First is to be consumed first.

b)   LIFO (Last in First out)- Inventory purchased last would be consumed first.

c)    Average or weighted average

Inventory is an important item for financial statements; it not only has direct impact on the financial performance (profit) calculation, but also an important item of statement of financial position. Therefore inventory valuation is very important calculation.

1.   FIFO Inventory Valuation Method

First purchase first consumed valuation method is very logical and understandable concept. This is also relatively easy to value the inventory under this method. The method gives more current valuation of inventory. Characteristics of FIFO methods are listed below

a)    FIFO is a logical and understandable method.

b)   FIFO is relatively easy to calculate method for valuation.

c)    FIFO Valuation is based on the most recent prices.

2.   LIFO Inventory Valuation Method

LIFO is last purchased first consumed method of valuation. This method is difficult to explain logically and therefore rarely used by management. Valuation under the method is also not current, because valuation is based on the old prices. Characteristics LIFO Valuation methods are listed below

a)    LIFO is difficult to understand.

b)   LIFO is not based on the current prices of inventory.

c)    LIFO is expected to give low value of inventory. (due to inflation)

d)   LIFO is relatively difficult to calculate than FIFO.

3.   Weighted Average Valuation

Weighted average method is another important method of inventory valuation. These methods also value the inventory at current price. This method of inventory calculation is bit difficult, as inventory valuation is to be updated with each movement in inventory. Characteristics of weighted average valuation methods are

a)    Inventory is valued at current prices (reasonably current prices).

b)   Weighted Average method is regularly updated.

c)    Weighted average method is based on easy to understand concept (average).

d)   This method can be difficult in case of high stock turnover.

Example Inventory Valuation Method

Particulars	Units	Rate
Opening Stock Item A	200	50
Purchase	800	60
Purchase	500	80
Sale	800

Solution

1. Calculate Closing Stock units

Opening Stock	200
Purchase (800+500)	1300
Sale (Item A)	(800)
Closing Stock	700

2. Valuation under FIFO

Unit	Rate	Value
500 (Second Purchase)	80	40,000
200 (First Purchase)	60	12,000
700		52,000

3. Valuation under LIFO

Unit	Rate	Value
200 (Opening Purchase)	50	10,000
500 (First Purchase)	60	30,000
800		40,000

Perpetual Inventory Accounting

Perpetual Inventory Accounting

In this article we would discuss the perpetual inventory accounting or perpetual inventory system. In perpetual inventory system stock is updated regularly for each movement in stock.

In this inventory system one account is created or maintained for inventory related movement i.e. receipt and issues. All receipt of inventory is debited to stock account and all issues are credited to stock account.

Purchases & perpetual Inventory:

Date	Particulars	Dr	Cr
	Stock  A/c	30,000
	Cash A/c		30,000

 Sales & Perpetual Inventory:

In perpetual inventory system there is two entries for sales i.e. one relates to inventory account and cost of sales and another relates to sales account and receivable account. These entry have been explained below

When the inventory is sold , then on on hand Cost of sales is recorded at cost , while on other hand sales is recorded at sale price. these both entries are shown below

Cost of sales are recorded at cost.

Date	Particulars	Dr	Cr
	Cost of Sales  A/c	30,000
	Stock A/c		30,000

A sale is recorded at sale price.

Date	Particulars	Dr	Cr
	Cash  A/c	50,000
	Sales A/c		50,000

    Sales Return & Perpetual Inventory

Two entries were made at time of sales; therefore two entries would be required to accommodate sales return. Stock is to be increased (debit) and crediting cost of sales. Sales are to be reduced by debiting sales return and receivable is to be reduced by crediting receivable.

Date	Particulars	Dr	Cr
	Stock  A/c	5,000
	Cost of Sales A/c		5,000

It is to be noted that sales return are not directly debited to sales and first it is debited to sales return account and then at the end of the year , sales return are deducted from the sales.

Date	Particulars	Dr	Cr
	Sales Return  A/c	5,000
	Receivable  A/c		5,000

Normal Loss & Perpetual Inventory:

Stock account is reduced by the normal losses. This normal loss will be transferred to profit & loss account at the end of year.

Date	Particulars	Dr	Cr
	Normal Loss  A/c	15,000
	Stock  A/c		15,000

 Accounting process summarized:

a)    No need of purchase account.

b)   All movement is recorded in stock account.

c)    Inventory account is automatically updated with each transaction.

d)   Trial balance shows the closing balance and cost of sales figure.

Periodic Inventory Accounting

 Periodic Inventory Accounting

In this article we would explain the periodic inventory accounting or system. In Opening stock & purchase both appear in trial balance and these both balances are transferred to the cost of sales. Closing stock counted at the end of year and transferred to the cost of sales. The periodic inventory accounting has been briefly explained below

Opening Inventory

Opening inventory are transferred to cost of sales, this is done at the end of year after trial balance is prepared. The opening stock is transferred by the following entry.

Date	Particulars	Dr	Cr
	Cost of Sales  A/c	10,000
	Opening Stock A/c		10,000

Purchases

In first place inventory purchases are charged to purchases account and at the end of year those purchases are transferred to cost of sales.

Date	Particulars	Dr	Cr
	Purchases  A/c	30,000
	Cash A/c		30,000

Date	Particulars	Dr	Cr
	Cost of Sales  A/c	30,000
	Purchases A/c		30,000

Sales

In case of periodic inventory system, there is no entry in stock account for sales and there is only one entry which is relates to sales directly.

Date	Particulars	Dr	Cr
	Cash  A/c	30,000
	Sales A/c		30,000

Closing Inventory

Closing inventory counted at the end of the period and credited to the cost of sales. It is important to note that closing inventory does not appear in the trial balance, rather it is an adjusted entry.

Date	Particulars	Dr	Cr
	Closing Inventory  A/c	20,000
	Cost of Sales A/c		30,000

                                          Cost of Sales A/c

Date	Particulars	Dr	Date	Particulars	Amount
	Opening Stock	10,000		Closing Stock	20,000
	Purchases	30,000		Profit & Loss	20,000

                                          Profit & Loss A/c

Date	Particulars	Dr	Date	Particular	Amount
	Cost of sales	20,000		Sales	30,000
	G.Profit	10,000
		30,000			30,000

The above entries of periodic inventory system have been summarized below

a)    Opening stock and Purchases both appearing in trial balance.

b)   Opening stock and purchases are transferred to cost of sales (debit side)

c)    Closing inventory is counted and created as an asset.

d)   Cost of sales is debited by opening stock and purchases.

e)    Cost of Sales account is credited by closing stock.

f)     Costs of sales are transferred to comprehensive income.

g)   Sales are also transferred to Comprehensive income account.

h)   Gross profit is calculated in comprehensive income account as balancing figure.