Inventories
By Asok Nadhani
14.1
Inventory
a)
Inventory can be defined as tangible asset held for
sale, or production of goods or services for sale in the ordinary course of
business.
b)
In the case of manufacturing concern, inventory
includes:-
(i)
Finished goods.
(ii)
Work-in-progress.
(iii)
Raw Materials.
(iv)
Stores, and
(v)
Components.
c)
In the case of trading business, inventory means
stock of finished goods.
d)
Closing stock can be determined as follows:
Opening Stock + Net Purchase + Direct
Expenses - Cost of Goods Sold (CoGS) = Closing Stock
14.2 Importance of Inventory Valuation
i)
To
estimate correct gross profit: Gross profit depends on value of
Opening and Closing stock. If value of closing stock is more, gross profit will
be more and if value of closing stock is less, gross profit will be less.
Closing stock of the current year becomes the opening stock of the next year.
Cost of goods sold of the next year will be affected due to valuation of
closing stock of current year. So, correct valuation of stock is very
important.
ii)
For
comparison: If stock is inaccurately valued, comparisons based on
stock will become defective.
iii)
To
determine the true financial position: Closing stock appears
in the asset side of balance sheet. If it is inaccurately valued, balance sheet
will not indicate true financial position.
iv)
Decision-making
by Management: Inventory or stock figures are also required by
management for Decision-making.
14.3 Basis of Inventory Valuation
The basis of valuation of
inventory is calculated as
(1) Cost Price,
(2) Net Realizable Price,
whichever is lower.
- Cost = Money expended
on acquisition of goods.
- Net Realizable Value
= Estimated selling price in ordinary course of business, less estimated cost
of completion and estimated cost necessary to sale.
14.4 Methods of Inventory Valuation
There are 3 basic
principles of valuation of inventory as follows:
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a)
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Cost
Price or Historical Cost Method
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i)
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Specific Cost
Method
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ii)
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First-In-First-Out
Method or FIFO Method
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iii)
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Last-In-First-Out
Method or LIFO Method
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iv)
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Highest In,
First Out Method or HIFO Method
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v)
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Next In, First Out Method
or NIFO Method
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vi)
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Base Stock Price Method
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vii)
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Simple Average
Cost Method
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viii)
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End Of The
Previous Month Average Cost Method
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ix)
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Weighted
Average Cost Method
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x)
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Moving Average
Cost Method
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b)
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Market
Price Methods
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i)
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Replacement Price
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ii)
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Net Realizable Value
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iii)
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Current Selling Price
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iv)
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Discounted Future Cash
receipt
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c)
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Cost
or Market Price, whichever is lower
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i)
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Global or aggregate Method
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ii)
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Item by Item Method
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iii)
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Group Method
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14.4.1
Cost
Price or Historical Cost Method
i)
Cost Price means the cost of materials consumed and
its manufacturing cost, i.e., Cost Price= Purchase cost of Raw Materials +
Direct Expenses + Overheads.
ii)
The purchase cost varies from time to time, and on frequency
or volume of purchase: So, the purchase is determined a various methods as
follows:
iii)
Following are the various methods, under Historical
Cost Method:
14.4.1.1 Specific
Cost Method: Under this method each type of inventory is valued at its
real price. This method is adopted where material is purchased for a specific
job for a specific purpose. This method is also used in a business where small
numbers of items are handled.
14.4.1.2 First-In-First-Out
Method or FIFO Method: Goods purchased first are issued at the price
at which they were acquired. So, the rate of oldest stock-in-hand is applied
for each sale or consumption.
14.4.1.2.1 Merits of
FIFO Method
i)
Unrealized profit does not form part of
accounting records, as materials or goods are recorded at actual cost.
ii)
As stock in hand relates to goods recently
purchased or acquired. Hence stock value remains close to current prices.
iii)
This method justifies the logical reason and
equity point of view, that whatever comes first is used or sold first.
14.4.1.2.2
Demerits of FIFO Method
i)
This method is not suitable when market prices
of materials and goods are continuously increasing. In such a case cost of
production is shown less than what really is, and may lead to loss.
ii)
The jobs, in which same type of materials is
used, cannot be easily compared from cost point of view, if they occur at
different point of time.
iii)
Calculations under this method are
complicated.
14.4.1.2.3
Suitability of FIFO Method
FIFO Method is
most suitable in the following cases:-
-
Materials can be easily identified as
belonging to a specific purchase.
-
Prices of materials do not charge rapidly.
Example: 1
Find out the value of stock under FIFO Method:
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April 1-
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500 units @ of Rs.120/ unit.
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April 10-
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300 units @ of Rs.105/ unit.
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April 15-
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250 units @ of Rs.100/ unit.
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April 25-
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100 Units @ of Rs.95/ unit
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Issue of stock from the inventory during April:
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April 2
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-
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210 Units
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April 7
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-
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285 Units
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April 11
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-
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220 Units
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April 21
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-
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330 Units
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Solution:
Store
Ledger ( FIFO Method)
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Receipts
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Issues
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Balance
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Date
April
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Units
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Rate Rs.
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Amount
Rs.
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Date
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Units
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Rate
Rs.
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Amount
Rs.
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Units
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Rate
Rs.
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Amount
Rs.
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1
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500
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120
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60,000
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500
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120
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60,000
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2
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210
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120
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25,200
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290
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120
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34,800
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7
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285
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120
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34,200
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5
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120
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600
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10
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300
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105
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31,500
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5
300
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120
105
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600
31,500
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11
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5
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120
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600
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85
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105
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8,925
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215
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105
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22,575
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15
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250
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100
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25,000
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85
250
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105
100
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8,925
25,000
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21
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85
245
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105
100
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8,925
24,500
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5
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100
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500
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25
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100
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95
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9,500
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5
100
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100
95
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500
9,500
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Therefore,
Value of Closing Stock= 105 units Rs.10,000.
Note: The inventory
remaining on hand is presumed to consist of most recent purchase cost. It can
be seen that earlier stock is issued first. The materials, earlier purchased @
120 & Rs.105, were first issued. The stock of 105 units in hand consist of
the latest of stock of 100 units @ 95 is remaining and the balance 5 units is
of the next reveal stock @ Rs.100/units.
14.4.1.3
Last-In-First-Out Method or LIFO Method: Under this method
materials or goods which are acquired last will be issued or sold first.
Closing stock represents stock which was acquired earlier.
Merits of LIFO Method
i)
Correct cost of goods sold can be found out
as the latest prices are used for determining the cost.
ii)
Value of closing stock is reasonable as it is
based on cost price.
iii)
It is useful because unrealized profit does
not form a part of financial accounting.
iv)
Useful when prices of materials and goods
have the tendency of rising continuously.
However, LIFO
method is not allowed as per AS-2.
14.4.1.4
Highest In, First out Method or HIFO Method: Under this method
those materials or goods are issued or sold first whose price is highest. Values
of closing stock under this method represent items of lower prices.
Merits
i)
If the market prices are continuously
fluctuating, this method is useful.
ii)
It is suitable because stock value is based
on cost price.
Demerits
i)
The cost of sale may be too high to face
competition. It also involves lot of calculations.
14.4.1.5 Next
In, First out Method or NIFO Method: Under this method,
materials are issued or sold at a price for which order has been given and the
materials or goods have not been received (not at the price at which they were
purchased).
14.4.1.6
Base Stock Price Method: Minimum stocks of goods, known as base stock,
are kept recorded. It is valued at the price which is the price of first
purchased goods or materials. The Base Stock portion of closing stock is valued
at base stock price. The excess is valued according to any method determined by
management.
14.4.1.7
Simple
Average Cost Method: Average price of goods purchased up to the
date of issue is found out, and this average price is applied to compute cost
of goods issued.
This
method is based on the principle that when materials purchased are placed in
stores, their identity is gone. So, average of prices of all the goods in store
is found out and issues are valued at this price. It may result in closing
stock value in negative amount.
14.4.1.8
End of
Previous Month Average Cost Method: Under this method the
price of issue of material of current month is the average price of the last month.
It may result in closing stock value in negative amount.
14.4.1.9
Weighted
Average Cost Method: Under this method quantity of materials are
multiplied by their respective rates of purchased. Product of all purchases is
totaled up and divided by total of quantities, thus weighted average cost is
found out.
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(i) Weighted
Average Price Per Units
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=
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Total cost of goods purchased during the
period
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Total quantity purchased during the period.
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(ii) Closing
Stock
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=
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Stock Units x Weighted Average Price Per Units.
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14.4.1.10 Moving Average Cost Method: According
to this method, weighted average price of materials purchased before the date
of issue, is found out. Value of issue of materials is computed applying such averages
price.
14.4.2 Market Price Methods
Here the stock is valued at Market Price. However, this
may lead to unrealized profit. Hence, it is normally used for managerial
purpose and not for stock value in books of accounts.
Stock value under this method may be computed in any of
the following ways:-
14.4.2.1 Replacement Price: Replacement
price means the price at which goods could be purchased in the market on the
valuation date of stock.
14.4.2.2
Net Realizable Value: It is the estimated selling price at which
goods could be sold on the date of valuation of closing stock (the sales
expenses to be incurred).
14.4.2.3
Current Selling Price: This is the price at which goods are
available in the market on the date of valuation of stock.
14.4.2.4
Discounted Future Cash receipt: If goods are to be delivered at a
future date (over long period), present value of the amount to be received at a
future date is completed by discounting it at a reasonable interest rate. Stock
is valued at this discounted future rate.
14.4.3 Cost or Market Price, whichever is
lower
Ordinarily
stock is valued at cost or market price whichever lower, applying methods are
like:
14.4.3.1
Global or aggregate Method: Total of Cost Prices or market prices of each
type of stocks are aggregated and stocks are valued at the lower of there two
aggregates.
14.4.3.2
Item by Item Method: Cost price and market price of each item is
found out stock is valued at lower of them for each item.
14.4.3.3
Group Method: Stocks are grouped into various groups according to their
nature or type. Lower amount of each group aggregate is treated as value of
closing stock.
Example:
2 (FIFO Method, LIFO
Method, Weighted Average Method)
The
following are the details of a part of Sriram Mills:
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01.01.1993
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Opening stock Nil.
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01.01.1993
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Purchases
100 units @ Rs.30 per unit.
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15.01.1993
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Issued for consumption 50 units.
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01.02.1993
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Purchases
200 units @ Rs.40 per unit.
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15.02.1993
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Issued for consumption 100 units.
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20.02.1993
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Issued
for consumption 100 units.
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01.03.1993
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Purchases 150 units @ Rs.50 per unit
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15.03.1993
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Issued
for consumption 100 units.
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Find
out the value of stock as on 31.03.1993 if the company follows:
(1)
First-In-First-Out basis.
(2)
Last-In-first-Out basis, and
(3)
Weighted average basis.
[C.A.
Solution:
(1) Sriram
Mills.
Store
Ledger (FIFO Method)
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Date
1993
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Purchases
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Issues
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Balance
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Quantity
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Rate Rs.
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Value Rs.
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Quantity
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Rate
Rs.
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Value Rs.
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Quantity
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Rate
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Value Rs.
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Jan. 01
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100
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30
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3,000
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100
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30
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3,000
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Jan. 15
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50
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30
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1,500
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50
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30
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1,500
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Feb. 01
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200
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40
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8,000
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50
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30
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1,500
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200
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40
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8,000
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Feb. 15
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50
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30
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1,500
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150
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40
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6,000
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50
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40
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2,000
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Feb. 20
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100
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40
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4,000
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50
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40
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2,000
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Mar.01
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150
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50
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7,500
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50
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40
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2,000
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150
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50
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7,500
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Mar. 15
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50
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40
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2,000
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100
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50
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5,000
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50
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50
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2,500
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Value of Closing Stock.
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100
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5,000
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||||||
(2) Sriram
Mills.
Store
Ledger (LIFO Method)
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Date
1993
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Purchases
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Issues
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Balance
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||||||
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Quantity
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Rate
Rs.
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Value
Rs.
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Quantity
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Rate
Rs.
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Value
Rs.
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Quantity
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Rate
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Value
Rs.
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Jan. 01
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100
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30
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3,000
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100
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30
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3,000
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Jan. 15
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50
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30
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1,500
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50
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30
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1,500
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Feb. 01
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200
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40
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8,000
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50
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30
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1,500
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200
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40
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8,000
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Feb. 15
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100
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40
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4,000
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50
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30
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1,500
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100
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40
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4,000
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Feb. 20
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|
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100
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40
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4,000
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50
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30
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1,500
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Mar. 01
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150
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50
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7,500
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50
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30
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1,500
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150
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50
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7,500
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Mar. 15
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100
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50
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5,000
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50
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30
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1,500
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50
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50
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2,500
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Value of Closing Stock.
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100
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4,000
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||||||
(3) Sriram
Mills.
Store
Ledger (Weighted Average Method)
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Date
1993
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Purchases
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Issues
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Balance
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||||||
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Quantity
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Rate Rs.
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Value Rs.
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Quantity
|
Rate
Rs.
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Value Rs.
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Quantity
|
Rate
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Value Rs.
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Jan. 01
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100
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30
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3,000
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100
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30
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3,000
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Jan. 15
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50
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30
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1,500
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50
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30
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1,500
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Feb. 01
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200
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40
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8,000
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250
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38
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9,500
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Feb. 15
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100
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38
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3,800
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150
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38
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5,700
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Feb. 20
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100
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38
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3,800
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50
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38
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1,900
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Mar. 01
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150
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50
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7,500
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200
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47
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9,400
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Mar. 15
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100
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47
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4,700
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100
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47
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4,700
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Value of Closing Stock.
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100
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4,700
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14.5
Valuation of stock on the Date of Balance Sheet
When stock-taking is done few days before or after the date of Balancing
Sheet, some adjustments are necessary to find out the value of stock on the
date of balance sheet.
1.
Stock-taking before the date of Balance Sheet If stock-taking
has been done on 25th December, 2009 while balance sheet is prepared
on 31st December, 2009, following adjustments are made to find out
the value of stock on the date of balance sheet:-
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Stock as on stock taking date
(e.g. at
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xx
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Add:
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Purchases during the stock taking date to balance sheet date (i.e.
period from 25th December up to
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xx
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Add:
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Sales returns during the period stock taking date to balance sheet
date (i.e. from
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xx
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xx
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Total
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xx
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Less:
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(i)
Sales from stock taking date to balance sheet
date (i.e. from
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xx
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(ii)
Purchases returns from stock taking date to
balance sheet date (i.e. from
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xx
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xx
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Closing Stock on the date of Balance Sheet (i.e.
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xx
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2.
Stock-taking after the date of Balance Sheet If stock-taking has been done on 15th
January, 2009 following adjustments are made out the value of closing stock on
the date of Balance sheet, i.e., 31st December, 2009.
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Stock at
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xxx
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Add:
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(i)
Sales (at cost) from balance sheet date to stock
taking date (i.e. period from 1st January, to
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xxx
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(ii)
Purchases returns from balance sheet date to
stock taking date (i.e. period from
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xxx
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(iii)
Under-casting in stock (if any) from balance
sheet date to stock taking date.
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xxx
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(iv)
Goods in transit (if any) from balance sheet date
to stock taking date.
|
xxx
|
xxx
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xxx
|
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Less:
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(i)
Purchases from balance sheet date to stock taking
date (i.e. period from 1st January, to
|
xxx
|
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|
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(ii)
Sales Returns (at cost) from balance sheet date
to stock taking date (i.e. period from 1st January,
|
xxx
|
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(iii)
Any over-casting in stock from balance sheet date
to stock taking date.s
|
xxx
|
|
|
|
(iv)
Goods held on consignment basis (if any) from balance
sheet date to stock taking date.
|
xxx
|
xxx
|
|
|
Closing Stock on the date
of Balance Sheet
|
|
xxx
|
14.6
Methods of Stock-Taking
14.6.1 Periodic
Inventory System
According to this system, stock is taken after the close
of according period. Physical counting or weightment of stock is done and then
it is recorded in cost sheet. These sheets contain columns for (i) Serial No.,
(ii) Particulars of Inventory, (iii) No. of units or weight, (iv) Price per
unit or kg., etc., (v) value.
Total of balance column indicates the total mount of
stock.
Weaknesses
of this System
(1)
If business is big one, stock-taking may take
a long time, during which suspension of regular stock movement will not be practicable.
(2)
Employees of stores remain busy in this work,
therefore issues from stores are not made to various departments and business may
suffer.
(3)
It does not disclose loss in stock, which
might have been caused due to theft, deterioration.
However, mostly small business find this system of
stock-taking most suitable.
14.6.2
Perpetual
Inventory System
Stock-taking is done continuously throughout the
accounting period. Under the system, receipt and issue of material continues as
per requirements and recorded in store ledger, which show complete movement of
stock items. At intervals, store ledger balance is compared with physical stock
of materials.
Merits of
Perpetual system
(1)
Purchases and issues do not remain suspended
during stock-taking period.
(2)
There remains strict control of stock.
(3)
Loss or destruction of material is detected
early.
14.6.3 Difference
between Periodic Inventory System and Perpetual Inventory System
|
Sl. No.
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Periodic
Inventory System
|
Perpetual
Inventory System
|
|
1.
|
It is done once in a year i.e., normally at the end of
the accounting period.
|
It is done continuously throughout the accounting
period.
|
|
2.
|
Physical stock-taking is done.
|
It is based on records, physical stock-taking is also
simultaneously done.
|
|
3.
|
Preparation of final accounts may be delayed as entire
task in carried not at the end of financial period.
|
Final accounts may be prepared earlier, as only a small
portion of work is left one at the end of the year.
|
|
4.
|
Control on stock is lenient.
|
Better control on stock.
|
|
5.
|
Discrepancies are found out at a very late stage.
|
Discrepancies are detected early stage.
|
|
6.
|
This system is very economical, particularly for small
organizations.
|
This system is relatively costly, small organization
may not afford it.
|
Example 3. A trader
prepares his account on 31st March each year. Due to some avoidable
reasons, no stock-taking could be possible till 15th April, 2010 , on which date
total cost of goods in his godown came to Rs.50,000.
The
following facts were established between 31st March and 15th April, 2010 .
(i)
Sales Rs.41,000 (Including cash sales
Rs.10,000)
(ii)
Purchase Rs.5,034 (Including cash purchase
Rs.1,900)
(iii)
Sales Return Rs.1,000
(iv)
On 15th March goods of the sale
value of Rs.10,000 were sent on sale or return basis to customer, the period of
approval being four weeks. He returned 40% of the goods on 10th
April approving the rest. The customer was billed on 16th April.
(v)
A trader has received goods costing Rs.8,000
in March, for sale on consignment basis, 20% of the goods had been sold by 31st
March, and another 50% by the April. These sales are not included in above
sales.
Goods are sold by the trader at a profit of 20% on sales.
You are required
to ascertain the value of inventory as on 31st March, 2010 .
(Adapted CA
PE-I May, 2003)
Solution:
1.
Calculation
of Cost of goods sold after 31st March, till stock-taking:
|
|
Rs.
|
|
Sales
|
41,000
|
|
Less:
Sales return
|
1,000
|
|
|
40,000
|
Goods
were sold at a profit of 20% on sales, cost of goods sold = [Rs.40,000 x
(80/100)] = Rs.32,000.
2. Calculation of Cost of stock with customer on
approval basis:
|
|
Rs.
|
|
Goods sent on approval or return
basis
|
10,000
|
|
Less: Return from customer on
approval (or return) basis
|
4,000
|
|
|
6,000
|
Therefore,
Cost of stock with customer on approval = Rs.[6,000 x (80/100)] = Rs.4,800.
3. Calculation of Stock belonging to consignors:
Goods received on consignment basis Rs.8,000. Out of
them, 20% of the goods had been sold by 31st March, and another 50%
by the April. So (50% + 20%) = 70% of the goods have been sold. Therefore, stocks
remaining to consignors = (100% - 70%) = 30%. Value of stock = Rs.(8,000 x
30/100) = Rs.2,400.
Valuation
of Stock
As on 31st March, 2010
|
|
|
Particulars
|
Rs.
|
Rs.
|
||
|
|
1.
|
Stock
to godown on 15th April
|
|
50,000
|
||
|
|
2.
|
Add:
|
(a)
|
Cost
of goods sold after 31st March, till stock-taking [Wn.1]
|
32,000
|
|
|
|
|
|
(b)
|
Cost
of stock with customer on approval [Wn.2]
|
4,800
|
36,800
|
|
|
|
|
|
|
|
86,800
|
|
|
3.
|
Less:
|
(a)
|
Cost
of goods purchased after 31st March till stock-taking is made
|
5,034
|
|
|
|
|
|
(b)
|
Stock
belonging to consignors [Wn.3]
|
2,400
|
7,434
|
|
|
|
|
|
|
|
79,366
|
Example: 4
From the following information ascertain the value of stock as on 31st March, 2004
and also the profit for the year:
|
Particulars
|
Rs.
|
|
Stock as on 01.04.2003
|
14,250
|
|
Purchases
|
76,250
|
|
Manufacturing Expenses
|
15,000
|
|
Selling Expenses
|
6,050
|
|
Administrative Expenses
|
3,000
|
|
Financial Charges
|
2,150
|
|
Sales
|
1,24,500
|
At the time of valuing stock
as on 31st March,
2003 , a sum of Rs.1,750 was written off on a particular item, which
was originally purchased for Rs.5,000 and was sold during the year at Rs.4,500.
Barring the transaction relating to this item, the gross profit earned during
the year was 20% on sales.
Compute Stock value as on
31.3.2004 and
Profit for the financial
year 2003 - 2004
(CA PE-I May, 2004)
Solution:
Valuation
of Stock
As
on 31st March,
2004
|
|
Particulars
|
|
Rs.
|
Rs.
|
|
|
Opening Stock
|
|
14,250
|
|
|
Add:
|
Written off last year
|
|
1,750
|
16,000
|
|
|
Purchases
|
|
|
76,250
|
|
|
Manufacturing Expenses
|
|
|
15,000
|
|
|
Cost of production
|
|
|
1,07,250
|
|
Less:
|
Cost of Goods sold
|
|
|
|
|
|
Sales
|
1,24,500
|
|
|
|
|
Less: Abnormal Sales
|
4,500
|
|
|
|
|
|
1,20,000
|
|
|
|
|
Less: Gross Profit @ 20%
on sales
|
24,000
|
|
|
|
|
|
96,000
|
|
|
|
|
Add: Cost of Abnormal
Sales
|
5,000
|
|
|
|
|
|
|
|
1,01,000
|
|
|
Value of Closing Stock.
|
|
|
6,250
|
Statement
of Profit for the F.Y 2003-04
|
|
Particulars
|
Rs.
|
Rs.
|
|
|
Gross Profit
|
|
24,000
|
|
Less:
|
Loss on
|
500
|
|
|
|
Administrative Expenses
|
3,000
|
|
|
|
Selling Expenses
|
6,050
|
|
|
|
Financial Charges
|
2,150
|
11,700
|
|
|
Profit for the year, 2003-04
|
|
12,300
|
