INVENTORY VALUATION

INTRODUCTION
By definition, inventory is the term used to describe the assets of a company that are intended for sale in the ordinary course of business, or are in the process of being produced for sale, or are to be used currently in producing goods to be sold. Inventory in a business is a list of goods or products that is held in stock. It takes a lot of time to keep inventory, but failure to do so could result in major financial disasters. Depending on size of your business, there are people whose sole job is to keep track of inventory. In a small business, this would not have to be their only task.

Treatment In Financial Statement

Inventory is converted into cash within companys operating cycle and therefore, is regarded as a current asset. In the balance sheet, inventory is listed immediately after Accounts Receivable, because it is just one step farther removed from conversion into cash than customer receivables. Being an asset, it is shown in the balance sheet at its cost. As items are sold for this inventory, their costs are transferred into cost of goods sold, which is offset against sales revenue in the income statement.

Effect On Company

Having no inventory or having wrong inventory can lead to many problems. Because inventory is reflected in the companys books, a business owner may take decisions based on this inventory numbers he sees in the books. If the number is wrong, he may take wrong decision which lead to loss to the company. In order to prevent this from happening in your business, there are ways to keep proper inventory that any sized business can use.

Classifying Inventories
Inventories can be classified according to the types of the business: (1)MERCHANDISE INVENTORY:It has two common characteristics : (a)They are owned by the company (b)They are in the form ready for sale to the customers in the ordinary course of business. Inventory sold becomes the cost of merchandise sold. It is the ready-to-sell inventory of merchandising firms. E.g.: canned foods, meat, dairy products etc.

Classifying Inventories
(2) MANUFACTURING INVENTORIES:Merchandise that needs to be produce in order to sell is called manufacturing inventory. Although products may differ, manufacturers normally have three inventory accounts, each of which is associated with a stage of production process: raw material inventory work in process inventory finish goods inventory.

1. 2. 3.

Stage Of Production Process

Raw material inventory: It consist of goods that ultimately become part of manufactured product but not yet entered the production process. e.g. the raw materials of automobile manufacturer generally includes sheet metal, paints, etc.

Stage Of Production Process

(2)Work in process inventory: It consists of units in the production process that require additional work before becoming finish goods. (3)Finish goods inventory: It consist of units that have been completed and are available for sale at the end of the accounting period.

Inventory Valuation Methods

There are mainly three types of valuation methods. First-in-first-out(FIFO) Last-in-first-out(LIFO) Average cost method(AVCO).

Example
1st April Opening stock- 100 kg @ Rs.10 5th April purchases- 200 kg @ Rs. 11 10th April purchases- 80 kg @ Rs. 11.50 14th April Issued to A Department- 120 kg 21st April purchases 150 kg @ RS. 12 28th April issued to B department 230 kg

(A) First-in-first-out
The FIFO method assumes that company uses the goods in the order in which it purchases them. Materials are issued at the oldest consignment prices till it is exhausted. Then after, materials are issued at next consignment price and so on.

FIFO Example
DATE RECEIPTS QTY APR 1 5 10 100 200 80 RATE 10 11 11.50 ISSUES AMOUN QTY T 1000 2200 920 RAT E AMOUN T BALANCE QTY RATE AMOUNT

100 100 200 100 200 80

100 20 10 11 1000 220

10 10 11

1000 1000 2200

10 1000 11 2200 11.50 920 11 1980 11.50 920 11 1980 11.50 920 12 1800

14

180 80 180 80 150

21

150

12

1800

(B)Last-in-first-out
In this method materials are issued at last consignment prices. Then after, materials are issued at immediately preceding consignment price and so on.

LIFO Example
DAT E RECEIPTS
QTY Ap. 1 100 5 10 200 80 RATE 10 11 11.50

ISSUES
AMOUNT QTY 1000 2200 920 RAT E

BALANCE
AMOUN QTY T 100 100 200 100 200 80 RATE 10 10 11 10 11 11.50 10 11 10 11 12 AMOUNT 1000 1000 2200 1000 2200 920 1000 1760 1000 1760 1800

14 21 150 12 1800

80 40

11.50 920 11 440

100 160 100 160 150

(C)Average cost
In this method inventories are issued at average price. Inventories are charged at the price which falls between FIFO and LIFO. Thus, Average Cost method is moderates, the FIFO and LIFO prices.

Average cost example

DATE RECEIPTS ISSUES BALANCE

QTY
Ap. 1 5 10 14 21 22 150 100 200 80

RAT E
10 11

AMOUN T
1000 2200

QTY

RAT E

AMOU T

QTY
100 300 380

RATE
10 10.67 10.84 10.84 11.27 11.27

AMOUNT
1000 3200 4120 2820 4620 2028

11.50 920 120 12 1800 230 11.27 2592 10.84 1300

260 410 180

Merits And Demerits Of FIFO

1.
2.

MERITS Logical and systematic manner Movements of materials in a continuous manner represents a consistent with effective material control. DEMERITS Frequent purchase of materials at different price. Added costing difficulty arises.

1. 2.

Merits And Demerits Of LIFO

1.

2.

3.

4.

MERITS It is appropriate for matching cost and revenue. It is simple to operate and easy to understand. It facilitates complete recovery of material cost. It is most suitable when prices are rising.

Merits And Demerits Of LIFO

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2.

3. 4.

DEMERITS Useless in the context of current condition. Comparison of cost of similar job is not possible. Calculations becomes complicated. It involves considerable clerical work.

Merits And Demerits Of AVCM

1.

2.
3.

MERITS It is useful to management in analyzing operating results and appraising future production. It is practical n less expensive It minimizes the effect of unusually high or low material cost.

Merits And Demerits Of AVCM

1.

DEMERITS Market efficiency is sacrificed by not equating quantity demanded (QD) to quantity supply (QS).