what is Inventory:
According to standard (AS)-2 (Revised), issued by ICAI,defines inventories, as assets :(a) held for sale in the ordinary course of business:(b) in the process of production for such sales: or (c) in the form of materials or supplies to be consumed in the production process or in the rendering of service , inventories include goods which are purchased and held for resale, for example, merchandise purchased by a retailer and held for resale computer, software held for resale or land and other property held for resale, inventories also encompass finished goods produced or work-in-progress being produced by the enterprise and include materials, maintenance supplies, consumables and loose tools awaiting use in the production process,
Inventory lifo and fifo methods
objectives of Inventory valuation
- determination of income; main objective of inventory valuation is to determine the cost of goods sold for the a particular accounting period ,, cost of goods sold=opening stock +purchase-closing + direct expenses,, the cost so determined may be matched against sales of the same accounting period, by matching the revenues with the costs, profit or loss can be ascertained,
- To depict true financial position: the financial position of a business enterprises on a particular date is depicted by the balance, sheet an important constituent of assets is the closing inventory . thus for the balance, sheet to depict true financial position of the business enterprise, it is necessary that the closing inventory by valued correctly..
Efect of wrong valuation of inventory
- undervaluation of closing inventory leads to understatements of profit and current assets, it result in depicting financial positions less than what it actually is ,
- overvaluation of closing inventory leads to overstatement of profit and current assets . it result in depicting financial position better than what it actually is,,
Periodic Inventory system
periodic inventory system; under this system stock-taking for each item of material is done only at the end of a specified period,, generally at the end of the accounting year, periodically , all inventory items, physically verified are valued according to the method of valuation , i:e FIFO (first-in-first-out), LIFO (last-in-first-out), etc. the value of the closing inventory arrived at is compute cost of goods sold in the following manner.
cost of goods sold = opening stock (inventory) + purchase-closing stock (inventory) + direct expenses
Advantages of periodic inventory system:
- there is exclusive attention on stock-taking
- periodic stock taking is much less costly than the perpetual stock taking,
- this system is suitable where the business is small
- this system is simple to operate and easy to understand.
- work-in-progress can be physically verified more accurately only if production activity is stopped for some time.
disadvantages of periodic inventory system;
Inventory lifo and fifo methods
- activities like production , purchase and sale are suspended for few days, when stock-taking is carried out,
- the element of surprise, an effective way of control is missing
- since stock-taking is carried out after a time gap, errors and discrepancies may be difficult to detect,
- there is sufficient time to cover up frauds relating to materials,
what is (fifo) method
first-in-first-out: under the fifo, method, the materials received first are issued first. in other words, materials are issued first from the earliest consignment oh hand and are priced at the cost at which that consignment was placed in the store, item in the opening stock are treated to have been issued first, item from the first purchases next, and so on. purchases . in other words, issues are priced in the order of their purchases,
Advantages of (fifo) method;
- it is simple to understand and easy to operate.
- it is a logical method because materials are issued in the order of purchase ,so materials received first are used first.
- the materials are charged at costs only, so the purchase price is recovered in full without any profit or loss on issue .
- the value of closing stock is quite realistic as it is valued at the price of latest purchases ,its value is close to the market price,
- this method is useful where (a) the price are falling , and (b) the consumption rate of materials is low.
Disadvantages of (fifo) method:
- the issue price differs from issue to. issue therefore. cost comparison gets distorted .
- it involves period considerable clerical work.
- during period of rising prices, product costs are understated and profit overstated . the opposite would be the effect when prices fall.
- the issue price may not reflect current price when purchases are frequent.
suitability of (fifo) method;
- this method is suitable where purchases are few in number and prices do not fluctuate too. often
- this method can be conveniently used where the materials is bulky, slow moving and has a high unit cots, because it is easy to identity unit belonging to a particulars purchases lot.
- it is also suited for materials which are subject to deterioration and obsolescence.
what is (Lifo) method
last-in-first-out-method: under lifo, issues are priced on the assumption that materials purchased last are issued first, though actual physical movement of materials may not follow this pattern, issues are priced at the price of the latest purchases of materials remaining unissued as per record .as a result , closing stock gets priced at the earliest purchases of materials lying unissued as per records . the effects of the method are:
- both issues and stock are priced at the actual cost.
- production is charged at more or loss the current market price of the materials used;
- closing stock is valued at the oldest prices,
Advantages of (lifo) method:
- this method is simple to understand and operate.
- materials cost represents recent prices because the materials are issued from the latest purchase. thus, the effect of current market prices of materials is reflected in the cost of sales.
- there is better matching of cost and revenue.
- all issues are priced at the last cost price so. that entire cost prices of materials is recovered from the production.
Disadvantages of (lifo) method:
- like the fifo, method , it may lead to clerical work.
- due to variation, of prices , costs of similar jobs become uncomparable
- stock of materials shown in the balance sheet will not truly reflect the value of the closing stock.
suitability of lifo method:
- the method is suitable for bulky materials with high unit cost.
- the method id suitable where it is important to match the cost of production with current sales revenue and where selling price is fixed on the basis of cost of production.
Example 1: the following is the record of receipts and issues of material X:
|Sept.14th 5,000 unit at Rs,2.50 per unit|
|Sept.16th 12,000 unit at Rs,2.40 per unit|
|Sept.18th 18,000 unit at Rs,2.30 per unit|
|Sept.15th 5,000 units|
|Sept.20th 8,000 units|
|Sept.25th 15,000 units|
the inventory on sept.1st was 1,000 units at Rs 2.60 per unit .on 22nd sept, stock verification revealed a shortage of 600 units. show the stores ledger account using fifo method: also give the treatment of shortage if
- shortage of 600 units is treated as a normal loss
- shortage of 600 units is treated as an abnormal loss.
solution: case:1 shortage of 600 units is treated as a normal loss
STORES LEDGER ACCOUNT FIFO METHOD:
closing inventory: 7,400 units at Rs,2.30 per unit and valued at Rs, 17,020
Example 2: the following are the inventory details of sri mills for the month of october, 2015:
|date||Transaction||units||Price per unit (Rs)|
|15-10-2015||Issues for consumption||600||—|
|20-10-2015||issues for consumption||1,300||—|
|31-10-2015||Issues for consumption||475||—|
prepare stores ledger account and calculate value of closing stock as per lifo method under perpetual system of inventory valuation.
solution: STORES LEDGER ACCOUNT LIFO METHOD;
value of closing stock -lifo method: 400 units @Rs,30 = 12,000