Introduction to Accounting

STOCK VALUATION
After studying this chapter you
should be able to:
understand stock verification methods;
use both perpetual and periodic inventory
systems;
calculate the value of inventory using
three different methods;
 understand the factors affecting the
choice of method undertaken;
calculate profit and loss using different
methods;
Methods of Stock Verification –
Stock Taking
Periodic Perpetual
Stock Stock
Taking Taking

There
There are
are two
two approaches
approaches to
to the
the
task
task of
of stocktaking
stocktaking
 Periodic Stock Taking.
Does
Does not
not keep
keep aa continues
continues record
record ofof the
the goods
goods
bought
bought &sold;
&sold;
Makes
Makes aa physical
physical count
count of
of the
the inventory
inventory onon
hand
hand atat least
least once
once aa year;
year;
 Uses
Uses this
this system
system for
for inexpensive
inexpensive goods
goods
Beginning
Beginning inventory
inventory ++ Purchases
Purchases

Goods
Goods available
available for
for sale
sale
 Perpetual Stock Taking.
Keeps
Keeps aa continuous
continuous record
record for
for each
each inventory
inventory
bought
bought & & sold;
sold;
Counts
Counts the
the inventories
inventories once
once aa year
year
Uses
Uses this
this system
system for
for all
all types
types of
of goods
goods
Uses
Uses computers
computers toto keep
keep inventory
inventory
It
It isis used
used to to provide
provide managers
managers with
with
information
information to
to aid
aid in
in pricing
pricing or
or ordering;
ordering;
 Entries Under the Perpetual & Periodic Systems are as
follows:-
Perpetual System Periodic System

I. Recording in the Journal

I)Credit purchases of $500,000
Inventory $500,000 Purchases $500,000
Accounts Payable $500,000 Accounts Payable $500,000

II)Credit sales of $450,000 (cost $270,000)

Accounts Receivable $450,000 Accounts Receivable $450,000
Sales Revenue $450,000 Sales Revenue $450,000
Cost of Goods Sold $270,000
Inventory $270,000
 Entries Under the Perpetual &
System are as follows:
Reporting in the Financial Statements
Income Statement (Summary)
Sales Revenue $450,000
-Cost of Goods sold $270,000
Gross Profit $180,000
 Entries Under the Periodic System
are as follows:
Reporting in the Financial Statements

Sales Revenue $450,000

Opening Inventory 200,000
+Purchases 500,000
-Closing Inventory (430,000) 270,000
Gross Profit 180,000
•A quantity discount is a type of trade discount. The larger the
quantity purchased, the lower the price per item. The entries
are:
Debit Inventory $450
Credit A/C Payable (Jane) $450
Credit purchase with discount

•A purchase discount of 3% is a reward for prompt payment

& is recorded as:
Debit A/C Payable (Jane) $450
Credit Cash $436.50
Credit Inventory $13.50
Cash paid within the discount period
•Purchase returns for defective goods are recorded as:-
Debit A/C Payable $50
Credit Inventory $50
Inventory purchased return to seller
•Purchase allowance of $100 for keeping the damaged goods is
recorded as:-
Dr A/C Payable $100
Credit Inventory $100
Purchase allowance received
•Carriage Inwards or Transportation costs of $50 for Inventory
purchased are recorded as:-

Debit Inventory $50

Credit Cash (or A/C Payable) $50
Freight charges paid
•Closing Inventory reported in financial statements is in this format:-

Inventory $40,000
Less: Purchase discounts $400
Purchase returns & allowances $600 1,000
Net Purchase of Inventory 39,000
Add: Carriage Inwards 2,000
Total Cost of Inventory $41,000
Cost of Goods Sold or Cost of Sales

The computation of the Cost of Goods sold is follows:-

Opening Inventory Purchase of Inventory

+Net Purchases -Purchase discounts
+Carriage Inwards
-Purchase returns &
=Cost of goods available for sale allowance
- Closing Inventory
=Cost of goods sold = Net Purchases
What is Inventory?
Inventory is the name given to the goods
for resale, work-in-progress, and raw
materials.
Inventories affect both the Balance sheet
and the Income statement.
Merchandise inventory : a) owned by the
company and b) it is ready for sale.
Inventory in a manufacturing
enterprise.
In a manufacturing enterprise inventory is
usually classified into three categories:
a) Finished goods – they are completed
and ready for sale;
b) Work in process – that is in various
stages of production but not yet
completed.
c) raw materials – that are on hand
waiting to be used in production.
 How to determine the value of the
Inventory?
Bought Sold
2008 2008
January 10 at $30 each $300 May 8 for at $50 each $400

April 10 at $34 each $ 340 November 24 for $60 each 1,440

October 20 at $40 each $ 800

40 1,440 32 1,840
There are three costing methods to
value the inventory.
First-in, first-out Last-in, first-out
(FIFO method) (LIFO method)

Weighted average cost

(AVCO)

The costs of the The goods The latest units

earliest goods available for purchased are the
acquired are the sale are first to be sold
first to be sold homogenous
6-16
 First in, first out method
Date Received Issued Inventory after each
transaction
2008 10 at $30 each 10 at $30 each $300
January
April 10 at $34 each 10 at $30 each $300
10 at $34 each $340 $640

May 8 at $30 each 2 at $30 each $60

10 at $34 each $340 $400

October 20 at $40 each 2 at $30 each $60

10 at $34 each $340
20 at $40 each $800 $1,200

November 2 at $30 each

10 at $34 each
12 at $40 each 8 at $40 each $320
24
Trading account under FIFO
Sales $1,840

Purchases $1,440
Less Closing In-ry. $(320)
COGS $1,120
Gross Profit $ 720
 Inventory Valuation Methods

 Under the LIFO method

◦ The last costs into inventory are the first costs out to Cost of Goods sold
◦ The ending inventory is based on the cost of the beginning inventory ie.the
earliest purchases of the period

 Under Weighted Average Cost

◦ The cost per unit is the average unit cost during the period
◦ The weighted average cost is determined as follows:-
 Cost of goods available for sale
 Number of units
◦ The closing inventory & Cost of Goods sold is computed by multiplying the
number of units by the weighted Average cost per unit
 Last in, first out method (LIFO)
Date Received Issued Inventory after each
transaction
2008 10 at $30 each 10 at $30 each $300
January
April 10 at $34 each 10 at $30 each $300
10 at $34 each $340 $640

May 8 at $34 each 10 at $30 each $300

2 at $34 each $68 $400

October 20 at $40 each 10 at $30 each $300

2 at $34 each $68
20 at $40 each $800 $1,168

November 20 at $40 each

2 at $34 each
2 at $30 each 8 at $30 each $240
24
Trading account under LIFO
Sales $1,840

Purchases $1,440
Less Closing In-ry. $(240)
COGS $1,200
Gross Profit $ 640
Average cost method (AVCO)
Date Received Issued Average Number of Total
cost per units in value of
unit of Inventory inventory
inventory

2008 10 at $30 $30 10 $300

January

April 10 at $34 $32 20 $640

May 8 at $32 $32 12 $384

October 20 at $40 $37 32 $1,184

November 24 at $37 $37 8 $296

How to compute COGS and evaluate
Closing Inventory under AVCO.
For January calculations are simple:
10 units x $30=300
For April: 10 x $30 + new inventory
received (10 x $34) = $340
So, 300+340=640;
Then, $640/20 units = $32
to get the average cost
For October,
Inventory 12 x $32=$384 +
inventory received (20 x $40) = 800
$384+800=1,184
$1,184/32=$37 (average cost)
To calculate the Closing Inventory, we
take 8 units left and
8 x $37= $296
Trading account under AVCO
Sales $1,840

Purchases $1,440
Less Closing In-ry. $(296)
COGS $1,144
Gross Profit $ 696
Which one is better?
Under the FIFO method
◦ The first costs into inventory are the first costs out
to Cost of Goods sold
◦ The ending inventory is based on the cost of the
most recent purchases
◦ In periods of rising

!!!

FI
O

FO
F
prices, FIFO reports

FI

!!!
the highest net income.
Which one is better?
If the prices are going up, LIFO reports
the lowest net income, and average cost
falls in the middle.
Calculate Closing Inventory using
FIFO, LIFO, AVCO methods
Bought
March 100 at $16 each
September 220 at $19 each

Sold
December 130 for $24 each
 Inventory & Cost of Goods under FIFO,LIFO & Weighted
Average Inventory Costing per Unit

(I) -Illustrative Data

Opening inventory (10units @ $500 per unit) $5,000
Purchases: No 1 25units @ $700 per unit $17,500
:No 2 25units @ $900 per unit 22,500
Total 40,000
Cost of goods available for sale (60units) 45,000
Closing inventory (20units @ ?
Cost of gods sold (40 units @ ?
(II)Closing Inventory & Cost of Goods Sold
Under FIFO Method:
Cost of goods available for sale (60units) $45,000
Closing inventory (cost of the last 20units from Purchase 2)
Cost of goods sold (cost of the first 40units)
18,000
10units @ $500 per unit(all from the opening inventory) $5,000
25units @ $700 per unit (all of Purchase No.1) 17.500
5units @ $900 per unit (from Purchase No.2) 4,500
Total $27,000
Inventory & Cost of Goods under FIFO,LIFO & Weighted
Average Inventory Costing per Unit

Under LIFO Method:

Cost of goods sold (60 units) $45,000
Closing inventory (cost of the first 20units available)
10units @ $500 per unit (all of opening inventory) $5,000
10units @ $700 (from Purchase No. 1) 7,000
Total 12,000 12,000
Cost of goods sold (cost of The last 40units available)
25units @ $900 per unit (all of purchase No.2) 22,500
15units @ $700 per unit (from purchase No.1) 10,500
Total $33,000
Under Weighted Average Cost Method
Cost of Goods available for sale (60units @ average cost of $750* per unit) $45,000
Closing inventory (20 units @ $750 per unit 15,000
Cost of goods sold (40 units @ $750 per unit) $30,000
*Cost of goods available for sale, $45,000
Number of units available for sale, 60 units = Average cost of $750 per unit
 INCOME EFFECTS OF FIFO, LIFO & WEIGHTED
AVERAGE COST METHODS
When inventory unit costs change, the different methods produce different
cost of goods and closing inventory figures.

The income effects of the 3 inventory methods are summarized as follows:

FIFO LIFO Weighted Average
Sales revenue (assumed) $50,000 $50,000 $50,000
Cost of goods sold:
Goods available for sale (assume)$45,000 45,000 45,000
Closing Inventory $18,000 12,000 15,000

Cost of goods sold 27,000 33,000 30,000

Gross Profit 23,000 17,000 20,000
Thank you

The End

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