STRATEGY FOR VALUATION OF INVENTORY

Objective

Valuatoin Of Inventory objective is to

formulate the method of computation
of cost of inventories, to determine the
value of inventory at which,the inventory
is to be shown in balance sheet till its’ sale
and recognition as revenue.
 Definition
Inventories are “assets:
a)held for sale in the ordinary course of business
b)in the process of production for such sale; or
c)in the form of materials or supplies to be
consumed in production process or in rendering
of services.’’
 Inventories
1.Finished goods:
-purchase or
-produced completely but remaning unsold
2.Work-in-progress:
-units introduced into the production process
but are yet to be completed.
3.Raw Materials,Components,Stores and spares:
-Raw materials-goods that are yet to be introduced
into the production process.
-Stores and spares-factory supplies such as cleaning
materials,and machinery spares.

Manufacturing concern- inventory consists of all of the 3 components.

Trading concern-inventory consists of finished goods.
 Effect of an inventory error on profit
• An error in the value of the year end inventory
will distort:
-Cost of goods sold.
• -Gross profit.
-Net profit,current assets.
Overvaluation of closing stock leads to:
-overstatement of current year profits and
-understatement of profits of succceeding years
and vice –versa.
 Valuation of Inventory
• “Inventories should be valued at lower of cost
and net realisable value.’’
• Cost: cost includes
-cost of purchase
-cost of conversion
-other cost necessary to bring the inventory in present
location and condition.
• Net realisable value(NRV):NRV is “the estimated selling price
in the ordinary course of business less the estimated cost of
completion and the costs necessary to make the sale.”
 Inventory costing method
• The three commonly used methods for arising
historical costs to inventory and goods sold
include:
1.First-in,first-out(FIFO)
2.Last-in,first-out(LIFO)

3.Weighted-average cost(WAC)
• Others include: specific identification,standard
cost and retail method.
 First- in, first-out(FIFO)
• Assumes materials received first in the stores
are the first to be issued(or sold)and
therefore,materials in stock are the materials
purchased last.
• Inventory items are issued at the oldest price
listed in the stores ledger until the first batch is
fully utilized.
• This does not mean that the physical flow is
FIFO.
 Last-in First out(LIFO)
• Assumes that the materials or goods received
last in the stores are the first to be issued or
sold.
• Therefore the cost of the units in the ending
inventory is that of the earliest purchases.
 Weighted Average Cost Method
• This methods is based on the presumption that
once the materials or goods are put into a
common bin, they lose their separate
identity.Hence,the inventory consists of no
specific batch of goods.
• The inventory is thus priced at weighted
average price i.e. average prices paid for the
goods,weighted according to the quantity
purchased at each price.
 Weighted Average vs. FIFO vs. LIFO: Example

Consider this example: Say a furniture store and you purchase 200 chairs for Rs.
10/unit. The next month, you buy another 300 chairs for Rs. 20 each. At the end of
an accounting period assume you sold 100 total chairs. The weighted average costs,
using both FIFO and LIFO considerations are as follows:
• Example: 200 chairs @ 10 = Rs. 2,000. 300 chairs @ Rs. 20 = Rs. 6,000. Total number
of chairs =500.

• Weighted Average Cost: Cost of a chair: Rs. 8,000 divided by 500 = Rs. 16/chair. Cost
of Goods Sold: Rs. 16 x 100 = Rs. 1,600. Remaining Inventory: Rs. 16 x 400 = Rs. 6,400
• FIFO: Cost of goods sold: 100 chairs sold x Rs. 10 = Rs. 1,000. Remaining Inventory:
(100 chairs x Rs. 10) + (300 chairs x Rs. 20) = Rs.7,000
• LIFO: Cost of goods sold: 100 chairs sold x Rs. 20 = Rs. 2,000. Remaining Inventory:
(200 chairs x Rs. 10) + (200 chairs x Rs. 20) = Rs.6,000
While valuing inventories following cost shall
be excluded
• Abnormal amount of wasted materials,labour,or
other production costs.
• Storage costs, unless those cost are necessary in
the production process prior to a further
production storage.
• Administrative overheads that do not contribute
to bringing the inventories to their present
location and condition.
• Selling and distribution costs.