INTERNATIONAL

ADVANCED LEVEL
ACCOUNTING

LECTURE NOTE
- VALUATION OF INVENTORY -

DIFFERENT VALUATION OF INVENTORY

De$inition Advantages Disadvantages
FIFO assumes that items • Relevant. Closing • Out-of-date. Price of
purchased .irst are inventory valuation inventory can be out of
also sold .irst. based on the most date, i.e., selling price
recent prices paid for can’t re.lect most
that inventory, so that recent cost
the information is • Contrary to in$lation.
more relevant If prices are rising,
• Realistic. It re.lects cost of sales will be
the physical reduced, and gross
movement of pro.it increased,
inventory (most of the resulting in higher tax.
time) • Contrary to prudence
• Acceptable. It is concept, by increasing
widely accepted by IAS pro.it and asset
and tax authorities valuation.
• Easy. It is easier to
compute

LIFO assumes that items • Up-to-date. Selling • Not acceptable. It is

purchased most price will re.lect up-to- not accepted by IAS
recently are sold date costs and some tax
.irst. • Closer to authorities
replacement cost. If • Overvaluation. When
prices are falling, prices are falling,
issues will be close to remaining inventory
the current will be overvalued
replacement cost • Cost differences.
• Easy. Fairly easy to Identical items of
compute inventory may be
issued to production at
different costs
• Understatement. May
understate cost of
sales (not sensible)

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NET REALISABLE VALUE (NRV)

NRV = selling price – additional cost
(saleable value) (expenses needed before completion of sale)

• It complies with prudence concept, as inventory is valued at the lower of costs or net
realisable value, ensuring that the statement of .inancial position does not overstate
the value of the inventory (as value of closing inventory will be reduced and so
increase the cost of sales and so decrease of gross pro.it).



INVENTORY VALUATION: PERIODIC VS. PERPETUAL

Periodic • Keeps detailed information of inventory levels.
Perpetual • Totals up receipts and issues of inventory and compute a new
balance only at the end of the accounting period.


Illustration
A company, Global Sales Inc., had used a perpetual inventory system, the timing of
purchases and sales would affect the amounts of costs of sales and inventory. Below is a
record of the purchases, sales, and quantity of inventory on hand after the transaction in
2018.

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• The amounts for total goods available for sales and sales are the same under either
perpetual or periodic system in the .irst year of operation.

• The carrying amount of the closing inventory, however, may differ as the perpetual
valuation will apply LIFO continuously throughout the year. Under periodic system, it
was assumed that the closing inventory was composed of 80 000 units of the oldest
inventory (which cost 110 AED per kg). It is shown as follows:















• Let’s look at the difference of carrying amounts between using adopting perpetual or
periodic inventory valuation:

Perpetual system
Sales = Units sold × selling price
= 520 000 × 240 AED
= 124 800 000 AED
Cost of sales = 58 000 000 AED – 76 000 000 AED
= 50 400 000 AED
Gross pro.it = 124 800 000 AED – 50 400 000 AED
= 74 400 000 AED
Closing inventory = 7 600 000 AED

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Periodic system
Sales = 520 000 × 240 AED
= 124 800 000 AED
Cost of sales = Cost of purchases during the year
= (20 000 × 110 AED) + (200 000 × 100 AED) +
(300 000 × 90 AED)
= 49 200 000 AED
Gross pro.it = Sales – Cost of sales
= 124 800 000 AED – 49 200 000 AED
= 75 600 000 AED
Closing inventory = 80 000 × 110 AED
= 8 800 000 AED

In this illustration, the closing inventory amount is lower under the perpetual
inventory valuation as only 20 000 kg of the oldest inventory with the highest costs is
assumed to remain in inventory. The cost of sales is higher, and the gross pro.it is
lower under the perpetual system compared to the periodic system.


INVENTORY METHOD CHANGES

Companies on rare occasion change inventory valuation methods. According to concept
of consistency, once a method is adopted, the same basis should be used in the .inancial
statements until some “good reason” occurs to change it.

A reference should be made in the notes that accompany the .inancial statements
(sometimes a retrospective restatement is required) as to the effect of the change on the
reported pro.its - if the amount involved is material.