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Chapter 7:
Inventory
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What you will learn?

 Definition of inventory, cost of goods sold

 Measurement of inventory

 Valuation of inventory

 Recognition and presentation

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Definition
Inventory

Inventories are assets:

Held for sale in the ordinary course of business

In the process of production for such sale

In the form of materials or supplies to be consumed in

the production process or in the rendering of services

Example:
 Goods purchased and held for resale
 Finished goods produced
 Work in progress (WIP) being produced
 Materials and supplies awaiting use in the production
process (raw materials)
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Definition
Cost of goods sold (COGS)

COGS = Opening inventory + purchases – Closing inventory

The cost of goods sold is found by applying the following formula

$
Opening inventory value X
Add cost of purchases (or, in the case of a
manufacturing company, the cost of production) X
X
Less closing inventory value (X)
Cost of goods sold X
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Definition
Example: Cost of goods sold

On 1 January 20X6, the Grand Union Food Stores had goods in

inventory valued at $6,000. During 20X6 its proprietor
purchased supplied costing $50,000. Sales for the year to 31
December 20X6 amounted to $80,000. The cost of goods in
inventory at 31 December 20X6 was $12,500.

What is the gross profit for the year?

$ $
Sales 80,000
Opening inventories 6,000
Add purchases 50,000
56,000
Less closing inventories 12,500
Cost of goods sold 43,500
Gross profit 36,500
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Definition
Exam focus point: Cost of goods sold

The financial year of Mitex Co ended on 31 December 20X1. An

inventory count on 4 January 20X2 gave a total inventory value of
$527,300.
The following transactions occurred between January 1 and January 4.
$
Purchases of goods 7,900
Sales of goods (gross profit margin 40% on sales) 15,000
Goods returned to a supplier 800
What inventory value should be included in Mitex Co’s financial
statements at 31 December 20X1?

A. $525,400 B. $527,600

C. $529,200 D. $535,200
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Definition
Exam focus point: Cost of goods sold

C. $529,200
Closing inventory balance

$
Inventory count, 4 January 20X2 527,300
Purchases since end of year (7,900)
Cost of sales since end of year (15,000 x 60%) 9,000
Purchase returns since end of year 800
Inventory at 31 December 20X1 529,200

Opening inventory balance

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Definition
Cost of carriage inwards and outwards

Cost of
carriage usually added to the cost of purchases
inwards

Cost of
is a selling and distribution expense in
carriage
the statement of profit or loss
outwards
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Definition
Example: Cost of carriage inwards and outwards

On 1 July 20X5, Clickety had clocks in inventory valued at

$17,000. During the year to 30 June 20X6 the purchased more
clocks at a cost of $75,000. Carriage inwards amounted to
$2,000. Sales for the year were $162,100. Other expenses of
the business amounted to $56,000 excluding carriage
outwards which cost $2,500. The value of the goods in
inventory at the year end was $15,400.

Prepare the statement of profit or loss of Clickety Clocks for

the year ended 30 June 20X6.
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Definition
Example: Cost of carriage inwards and outwards

STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 30 JUNE 20X6

$ $
Revenue 162,100
Opening inventory 17,000
Purchases 75,000
Carriage inwards 2,000
94,000
Less closing inventory 15,400
Cost of goods sold 78,600
Gross profit 83,500
Carriage outwards 2,500
Other expenses 56,000
58,500
Profit for the year 25,000
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Definition
Exam focus point: Cost of carriage inwards and outwards

Which of the following costs may be included when arriving at

the cost of finished goods inventory for inclusion in the financial
statements of a manufacturing company?
1 Carriage inwards
2 Carriage outwards
Cost of goods procedure
3 Depreciation of factory plant
4 Finished goods storage costs
5 Factory supervisors’ wages

A. 1 and 5 only B. 2, 4 and 5 only

C. 1,3 and 5 only D. 1,2,3 and 4 only

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Definition
Exam focus point: Cost of carriage inwards and outwards

Which of the following costs may be included when arriving at

the cost of finished goods inventory for inclusion in the financial
statements of a manufacturing company?
1 Carriage inwards
2 Carriage outwards
3 Depreciation of factory plant
4 Finished goods storage costs
5 Factory supervisors’ wages

C. 1,3 and 5 only

Carriage outwards and storage are distribution costs.

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Measurement of inventory

Inventory

lower of
Net realisable value Cost

Fair value Purchase cost

Cost to sell Cost of conversion

Other cost bringing the

inventories to present
location and condition
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Measurement of inventory
Net realisable value (NRV)

Situations in which NRV is likely to be less than cost:

An increase in costs or a fall in selling price

A physical deterioration in the condition of inventory

Obsolescence of products

Errors in production or purchasing

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Measurement of inventory
Cost of inventory

Costs of
Purchase cost Other costs
conversion
incurred in
bringing the
Purchase price Costs directly inventories to
related to the
units of their present
Import duties production location and
condition
Other directly (abnormal
attributable
Fixed and amounts,
cost
variable
production selling costs...)
Trade discount overheads
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Measurement of inventory
Exam focus point
The closing inventory at cost of a company at 31 January 20X3
amounted to $284,700.
The following items were included at cost in the total:
1 400 coats, which had cost $80 each and normally sold for $150
each. Owing to a defect in manafacture, they were all sold
after the reporting date at 50% of their normal price. Selling
expenses amounted to 5% of the proceeds.

2 800 skirts, which had cost $20 each. These two were found to
be defective. Remedial work in February 20X3 cost $5 per
skirt, and selling expenses for the batch totalled $800. They
were sold for $28 each.
What should the inventory value be according to IAS 2 Inventories
after considering the above items?

A. $276,400 B. $281,200

C. $282,800 D. $329,200
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Measurement of inventory
Exam focus point

B. $281,200

Original value at 31 January 20X3: $284,700

$
 Coats - Cost 400 x $80 32,000
- NRV ($75 x 95%) x 400 28,500
NRV < Cost => Adjustments is made for $3,500

 Skirts:
At 31 January 20X3 the skirts were correctly valued at costs
incurred to date of $20 per skirt which was lower than the NRV of
$22 (= $28 - $5 - $800/800).
Therefore no adjustment is required for the value of the skirts.
Value of inventory after considerations = $284,700 - $3,500 = $281,200
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Valuation of inventory
Calculation cost of inventory

Method Key points Conditions

For costing purposes, the The cost of closing

FIFO – first items of inventory inventory is the cost of
first
in first received are assumed to the most recent
out be the first ones sold. purchases of inventory.

The cost of an item of The average cost can be

inventory is calculated by calculated periodically or
AVCO –
Average taking the average of all continuously.
cost
inventory held.
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Valuation of inventory
Example
TRANSACTIONS DURING MAY 20X7
Quantiy Unit cost Total cost
Units $ $

Opening balance 1 May 100 2.00 200

Receipts 3 May 400 2.10 840

Issues 4 May 200

Receipts 9 May 300 2.12 636

Issues 11 May 400

Receipts 18 May 100 2.40 240

Issues 20 May 100
Closing balance 31 May 200

1,916

How would issues and closing inventory be valued using FIFO and
AVCO ?
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Valuation of inventory
Example: FIFO

Date of issue Quantity Value issued Cost of issues

Units $ $
4 May 200 100 OI* at $2 200
100 at $2.10 210
410
11 May 400 300 at $2.10 630
100 at $2.12 212
842
20 May 100 100 at $2.12 212
1,464
Closing 200 100 at $2.12 212
inventory value
100 at $2.40 240
452
1,916
* OI= opening inventory
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Valuation of inventory
Example: AVCO
Total
inventory
Date Received Issued Balance Value Unit Cost of
cost issue
Units Units Units $ $ $
Opening inventory 100 200 2.00
3 May 400 840 2.10
500 1,040 2.08*
4 May 200 (416) 2.08** 416
300 624 2.08
9 May 300 636 2.12
600 1,260 2.10*
11 May 400 (840) 2.10** 840
200 420 2.10
18 May 100 240 2.40
300 660 2.20*
20 May 100 (220) 2.20** 220
1,476
Closing inventory
value 200 440 2.20 440
1,916
* A new unit cost of inventory is calculated whenever a new receipt of materials.
** Whenever inventories are issued, the unit value of the items issued is the
current weighted average cost
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Valuation of inventory
Example: AVCO

The weighted average cost under the periodic method for May is:

= Total cost/(Opening quantity + Total quantity received)

= 1,916/(100 + 400 + 300 + 100)

= $2.13 per unit

This gives a valuation of 200 x $2.13 = $426.00

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Valuation of inventory
Exam focus point
A company values its inventory using the first in, first out (FIFO)
method. At 1 May 20X2 the company had 700 engines in inventory,
valued at $190 each.
During the year ended 30 April 20X3 the following transactions took
place:
20X2
1 July Purchased 500 engines at $220 each
1 November Sold 400 engines for $160,000
20X3
1 February Purchased 300 engines at $230 each
15 April Sold 250 engines for $125,000
What is the value of the company’s closing inventory of engines
at 30 April 20X3?

A. $188,500 B. $195,500

C. $166,000 D. None of these figures

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Valuation of inventory
Exam focus point

A. $188,500 FIFO method

Quantiy Unit cost
Units $

Opening balance 1 May 700 190

Purchased 1 July 20X2 500 220

Sold 1 November 20X2 400

Purchased 1 Feb 20X3 300 230

Sold 15 April 250

Closing balance 30 April 850

$
Closing balance (= 850 units)
300 units x $230 69,000
500 units x $220 110,000
50 units x $190 9,500
850 units 188,500
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Recognition and presentation

Accounting methods

Perpetual inventory Periodic inventory

system system

determine the amount

Records the sale or of inventory at the end
Definition purchase of inventory of each accounting
immediately period or in specified
periods

 Better information  Cheaper in most

for inventory control
 Excessive build-up of
certain lines of
inventory whilst
Pros and having insufficient
cons inventory of other  Need to check the
lines is avoided
 Less work is needed
to calculate inventory
at the end of the
accounting period
situations than the
costs of
maintaining
continuous
inventory records
accuracy of the
information
recorded by having
a physical check of
some of the
inventory lines