VALUATION OF INVENTORY

There are many ways of valuing stock which include FIFO, LIFO and AVCO

First in first out (FIFO)

This method assumes that the first goods to be purchased or manufactured are the first units to be
dispatched. This means that goods sold are valued at the oldest cost price and unsold goods are valued
at the most recent cost price.

Advantages
I. It is easy to apply, as inventory can be computed easily.
II. Inventory value approximates or matches current cost.
III. It is realistic.
IV. Flow of costs tends to be consistent with usual physical flow of goods; it is a logical method to
named procedures of utilising first those materials received first.
V. It is systematic and objective.
VI. It is not subject to manipulation.
VII. Does not result in unrealised profit since materials are issued at actual cost.
VIII. Closing stock is properly valued as it reflects the latest or recent price paid.
IX. It is acceptable for 2 purposes of the Companies Act 199 and IAS 2.
X. It is acceptable to the tax authorities (ZIMRA) for tax purposes

Disadvantages
I. Does not match current cost of goods sold with current revenue.
II. Inventory (or phantom ) profit.
III. In periods of rising prices (inflation) the company pays higher income taxes.
IV. Similar jobs may be charged with materials at different prices.
V. May affect the pricing policy of a firm in that the cost of manufacturing will be low in times of
inflation. For a firm which uses the cost plus mark-up policy, the price quoted may be low.

NB It should be borne in mind that it is difficult to suggest the method which is superior as each method
has its own merits and demerits. The suitability of each method depends upon the prevailing
circumstances.

Last in first out (LIFO)

Here it is assumed that the goods bought or manufactured recently are dispatched at the newest cost
and unsold goods are costed at the oldest unit price. In effect, this method matches inventory valued at
the most recent acquisition cost with current sales revenue.

Advantages
I. Valuation of closing stock is easy especially when there are few transactions and prices are
constant.
II. Does not result in unrealised profit since materials are issued at actual cost.
III. Raw materials and components are charged to production at the latest prices.

Disadvantages
 I. It is based on an unrealistic assumption that the most recently received stock is used or issued
first.
II. Similar jobs may be charged with materials at different prices simply because they are deemed
to be made out of different batches of stock.
III. Closing inventory does not reflect the prevailing or current economic values, in effect, stock will
be understated in the statement of financial position.
IV. I is not acceptable for the purposes of IAS 2 (although it is acceptable for the purposes of the
Companies Act)
V. It is not acceptable to the tax authorities for tax purposes.

Average weighted cost (AVCO)

Where stock is issued in random order it might be reasonable to use AVCO.
In practice, there is a possibility of mixing up materials in the storeroom or warehouse. The AVCO
assumes that stock is so mixed up in the warehouse such that it is not easy to separate stock that was
bought first from that was bought last and effectively making it proper to issue goods or materials at the
average cost of items in store.
The modality of this method is that issue prices are only revised when a new batch or lot of materials is
received.

Advantages
I. When prices fluctuate it gives better results because it tends to smooth out or evens these
fluctuations in prices. This also facilitates comparison of profits of different periods.
II. This method is acceptable for the purposes of IAS 2 and the Companies Act.
III. The valuation of closing inventory closely resembles the latest prices as possible.
IV. The variations in the costing of materials to different jobs are minimised.
V. It is simple to operate as issue prices are not to be calculated each time an issue is made.

Disadvantages
I. There is need to revise the average price after each and every purchase and this may prove to
be laborious.
II. The average prices used are not representative of the amount actually paid for the materials or
goods.

NRV
It is the estimated sales price less all costs expected to be incurred in preparing the item for sale (costs
to sell).
Generally accepted accounting practices (GAAP), particularly IAS 2 requires that inventories be valued
either at cost or at NRV (current market value) whichever is less.

Article and category method of valuation

Separable items of inventory or group of similar items should be valued separately to arrive at cost and
NRV in order to prevent losses on some items from being concealed by the valuations on other items of
inventory. It is a requirement under the Companies Act.

Perpetual
Is one in which balance is maintained of inventory remaining after every receipt and issue of stock.
Periodic
Is one in which only the totals of receipts and issues are recorded at the end of each accounting period
and a new balance calculated at the period end only.

Goods on sale or return basis

If a firm receives goods from its suppliers which are on sale or return basis, these goods should not be
included in the firm stock valuation as they do not belong to the firm but belong to the supplier.

Likewise, if a firm sends goods on sale or return basis to its customers, these goods will still be part of
the firm stock as they still belong to the firm even though they are being held by its customers. This is in
accordance with the realisation concept.

Inventory Systems
Depending on the nature of the business, the type of products sold and the extent of computerisation in
an entity, the entity can either use a perpetual (continuous) inventory system or a period inventory
system. These two inventory systems are both suited to specific situations.

1. Perpetual inventory system

Under this system, detailed records are maintained for the purchase and sale of every item. This means
the inventory records are automatically updated each time a purchase or sale takes place.
Here, information technology is used to instantly track the movement of inventory and send electronic
updates to the central databases.
Retail stores use bar code readers to scan inventory items at the point of sale. A computerised cash
register would then capture and store information on the items sold and then send information to the
company’s central accounts database for it to be updated instantly and provide a running balance of
quantity and cost of items.
This system is best suited for businesses which sell high-volume products and with multiple sales outlets,
since physical inventory counts here may prove to be costly and time consuming.

2. Periodic inventory system or continuous inventory system

With this system, detailed records are not kept for each item of inventory. Instead, regular and random
inventory audits are used to update inventory records.
This system involves counting inventory physically which is in storage from time to time and comparing
with book balances to identify any discrepancies.
On the contrary, the periodic system does not rely on computer technology to update the database like
the perpetual system.
This system is best suited for dealers selling low-volume products that can be tracked easily in person on
a day to day basis.

EXAM TYPE QUESTIONS

Question 1
During the month of May the following were the purchases and sales of Kwality Ltd

Purchases Sales
 Quantity Price Quantity Price
Kilos per kilo Kilos per kilo
$ $
May 1 100 2
5 60 5
8 80 2.5
12 40 3
14 80 5
21 50 3.5
25 100 6
28 100 4
31 100 6

Required
Trading accounts for the month of May showing the gross profit if closing stock is valued on each of the
following bases
a) FIFO [8]
b) LIFO [8]
c) AVCO [9]

Question 3
The accounts of Wellington are prepared on a monthly basis. Owing to staff holidays the usual month
end stocktaking for August 2012 did not take place. The following information was subsequently
obtained:

1) The accounts for the month ended 31 July 2012 showed stock in trade at that date of
$56 800. Stock is always valued at cost price.
2) The stock sheets at 31 July 2012 had been over-added by $850
3) Sales during August 2012 amounted to $42 600. All sales include mark-up of 25%.
4) Goods purchased by Wellington during August 2012 cost $29 800.
5) Returns made by customers during August 2012 amounted to $725 at selling price.
6) Returns of goods to suppliers during August 2012 amounted to $1 350 at cost price.
7) It was decided that a quantity of stock, valued at full cost at 31 July 2012, and which would
normally sell for $2 400, could now only be sold at half cost price.
8) Included in the August 2012 sales figure were goods on sale or return with a sales value of $650.
The customer has still not indicated her intention with regard to the goods.

Requirement
a) Prepare a calculation showing Wellington’s stock valuation at 31 August 2012. Your answer
should commence with the value of stock at 31 July 2012 of $56 800 and end with your stock
valuation at 31 August 2012. [15]

b) Prepare the Trading Account of Wellington for the month ended 31 August 2012 [10]
Question 4
After stocktaking for the year ended 30 June 2013 had taken place, the closing stock of Elegant Boutique
was aggregated to a figure of $87 612. During the course of the audit which followed, the undernoted
facts were discovered:

a) Some goods stored outside had been included at their normal cost price of $570. They had
however, deteriorated and would require an estimated $120 to be spent to restore them to
their original condition after which they could be sold for $800.
b) Some goods had been damaged and were now unsaleable. They could, however be sold for
$110 as spares after repairs estimated at $40 had been carried out. They had originally cost
$200.
c) One stock sheet had been over-added by $126 and another under-added by $72.
d) Elegant Boutique had received goods costing $2 010 during the last week of June 2013 but
because the invoices did not arrive until July 2013, they had not been included in stock.
e) A stock sheet total of $1 234 had been transferred to the summary sheet as $1 243.
f) Invoices totaling $638 arrived during the last week of June 2013 (and were included in purchases
and creditors) but because of transport delays, the goods did not arrive until late July 2013 and
were included in closing stock.
g) Portable generators on hire from another company at a charge of $347 were included, at this
figure in stock.
h) Free samples sent to Elegant Boutique by various suppliers had not been included in stock at the
catalogue price of $63.
i) Goods costing $418 sent to customers on a sale or return basis had been included in stock by
Elegant Boutique at their selling price, $602.
j) Goods sent on sale or return basis to Elegant Boutique had been included in stock at the amount
payable ($267) if retained. No decision to retain had been made.
Requirement
Prepare a schedule amending the stock figure as at 30 June 2013. State your reason for each
amendment or for not making an amendment [20]

Question 5
Monica, a clothing retailer, valued her stock on 30 June 2013 at $71 600. All her goods are sold at a
mark-up of 20%.
On reviewing the results of the stock-take, the following adjustments need to be made:

1) On 12 May 2013, goods costing $4 600 were sent on sale or return basis to a customer. On 5
July, the customer returned all the goods to Monica.
2) Some shoes, with a sales value of $240, were proving unpopular. It was decided to sell them at
half the cost price.
3) A pair of trousers, with selling price of $90, had been omitted from the stock records.
4) A total of one stock sheet, of $6 400, had been carried forward to the next stock sheet as $4 600
5) Several dresses, with a total selling price of $3 600, were ‘out of fashion’ and unsaleable.
6) Twenty shirts had been included at their selling price of $24 each.
7) Three tops, costing a total of $120, were shop soiled and would need to be sold for $30 each.
Requirement
Commencing with the original stock value of $71 600 at 30 June 2013, calculate the revised value of
stock at that date [20]
Question 2
Cash-talk Ltd prepares control accounts at the end of each month. For March 2009, balances and
transactions were as follows:

Opening creditors-Cr 7 660

Opening debit balances on creditors’ ledger 100
Opening debtors-Dr 17 100
Opening credit balances on debtors’ ledger 100

Transactions for the month

Cash sales 30 000
Credit sales 42 100
Discount received 960
Credit notes issued to customers 890
Discount allowed 700
Cheques from customers dishonoured 470
Provision for bad debts 120
Payments to suppliers 23 750
Credit purchases 33 650
Cheques from credit customers 29 420
Cash refund to customer 270
Bad debts written off 1 100
Set – offs 3 500
Closing credit balances on debtors’ ledger 140
Closing debit balances on creditors’ ledger 80

Required
a) Prepare debtors and creditors control accounts for Cash-talk Ltd for March 2009 [20]
b) List five errors that do not affect a trial balance [5]

CONTROL ACCOUNTS AND ERRORS

Correction of errors
In order for one to be able to correct errors made, there is need to memorise the following four points;
1. A transaction which has been omitted from a book of original entry will also be omitted from the
personal account in the ledger and from the control account.
Examples
 A credit note issued to a customer was not recorded in the books
 A sales or purchases invoice was entirely omitted from the books
How to correct
 Adjust both the ledger balances and control account

2. A transaction copied incorrectly into a book of original entry will lead to an error being repeated
both in the personal account in the ledger and the in the control account.
Examples
 A sales or purchases invoice of $450 was incorrectly recorded as $405
 A credit note for $228 was entered in the journal as $282
How to correct
 Adjust both the ledger balances and control account
 3. A transaction copied incorrectly from a book of original entry to a personal account will only
affect the personal account and not the control account.
Examples
 An incorrect amount posted to the personal accounts
 A correct amount posted to the wrong side of the personal accounts
How to correct
 Adjust the personal account only

4. An error in the addition of a book of original entry affects the control account but not the
personal account in the ledger.
Examples
 Sales or purchases day book was overcast or under cast
 The discounts allowed or received column in the cash book was overcast
How to correct
 Adjust the control account only

Question 1
The balance on the sales ledger control account at 31 December 2014 was. This does not agree with the
total of the list of the sales ledger balances on that date of . On examining the accounts, you discover
the following
I. A debtor’s account had been under cast by $785.
II. No entry was made in the personal account to write off a debt worth $650. This had been
correctly recorded in the control account.
III. A balance of $362 was omitted from the list of sales ledger balances at 31 December.
IV. A sales invoice for $3 505 had been overlooked.
V. Returns inwards had been overcast by $250.
Required
a) Prepare an amended sales ledger control account.
b) Prepare a statement amending the total of the sales ledger balance.

Question 2
The total of the balances in Amos’ purchases ledger amounts to 4 , which does not agree with the
closing balance of the control account of $ .
The following errors were subsequently uncovered.
I. The purchases invoice for $428 had been completely omitted from the books.
II. A purchases ledger account had been overcastted by $90. A credit balance of $105 had been
omitted from the list of creditors.
III. Discount received column had been under casted by $765.
IV. A payment of $286 was entered in the creditors’ account but was omitted from the cash book.
V. A credit balance of $490 in the purchases ledger had been set-off against a contra entry in the
sales ledger, but no entry had been made in the control accounts.
Required
a) Draw up an amended purchases ledger control account
b) Reconcile the purchases ledger balances with the new control account balance.

Question 3
The total of the balances in the sales ledger at 31 December 2012 amounted to $ ,which does not agree
with the closing balances on the control account.
The following data was made available
$
Sales ledger balances – 1 Sept 2011- DR 36 800
CR 4 200
Credit sales
Credit returns inwards
Cash sales
Cash and cheques received from CR customers
Interest charged on customers’ overdue accounts
Bad debts written off
Discount allowed to credit customers
Bad debts recovered
Debit balances transferred to the purchases ledger

On examination of the account the following discrepancies were revealed:

I. A credit sale of $5 200 had been entered in the sales day book as $2 500.
II. A debit balance of $380 had been set off against a balance in the purchases ledger but no entry
had been made in the control account.
III. The discount allowed column in the cash book was overstated by $3 620.
IV. A receipt of $560 correctly accounted for in the cash book had been omitted from the
customer’s account.
V. A credit balance of $830 had been omitted from the schedule of debtors.
VI. A sales ledger account had been understated by $1 650.
VII. A customer’s account who owed $320 had been closed as he had been declared bankrupt.
However, this debt had not been written off in the control account.
VIII. The total of a page in the sales day book was carried forward as $980 instead of $890.
Requirement
a) Draw up a sales ledger control account for the year ended 31 August 2014 prior to the discovery
of errors.
b) Prepare an amended sales ledger control account.
c) Draw up
A statement reconciling the amended sales ledger control account balance with the total of the sales
ledger.

Question 4
The following debtors total account has been prepared by Trevor, who has limited bookkeeping
knowledge.
Sales Ledger Control Account
Balance b/d C ash sales
Sales returns Provision for bad debts
Credit sales Bad debts written off
Cash refunds to cash customers Dishonoured cheques
Set offs Discount allowed
Balance c/d
The sales ledger balances amounted to which does not agree with the closing balance in the control
account. After further investigation you discover the following additional mistakes.
I. A sales invoice for $16 850 had not been entered in the sales journal.
II. A debtor’s account had been overstated by $13 800.
III. Goods worth $8 900 returned by a debtor had been correctly recorded in the Returns Inwards
journal but credited to the debtor’s account as $9 800.
IV. Cash $5 280 received from a debtor had been posted to the wrong side of his account.
V. The discount allowed column in the cash book had been overstated by $6 870.
VI. A balance due of $3 580 from Aaron had been omitted from the list of debtors.
VII. Bad debts $800 written off in the control account had not been accounted for in the debtor’s
account.
VIII. A receipt of $24 200 was correctly recorded in the cash book but no entry had been made in the
debtor’s account.
Required
a) Prepare a corrected sales ledger control account.
b) Draw up a statement amending the sales ledger balances to reconcile it with the balance of the
control account.

Question 4
The following figures appeared in the purchases ledger control account of Bright and Co Ltd on 31 May
2015.
Creditor’s balances 1 June 2014 48 970
Debtor’s balances 1 June 2014 450
Credit purchases
Discount received
Purchases returns
Cheque payments to creditors
Cash refunds from creditors
Contras: sales ledger

The control account closing balance failed to agree with the total of the purchases ledger balances.
Subsequent investigations revealed the following errors
I. $4 800 paid to Dray, a supplier, had been correctly entered in the cash book but had been
entered in Ray’s account as $8 400.
II. The purchases day book had been overcast by $1 700.
III. Discount received column total of $2 980 had been posted to the wrong side of the discount
received account.
IV. A credit balance of $678 had been omitted from the list of creditors’ balances.
V. The return of goods purchased on credit for $720 had been completely omitted from the book.
VI. A payment of $9 668 cash to Christie had been treated as a receipt from Christine, a supplier.

Required
a) Show how the purchases ledger control account would appear before making any corrections.
 b) Prepare statement amending the balance on the control account.
c) Prepare a statement reconciling the amended balances with the totals as shown by the list of
balances.

CONTROL ACCOUNTS (ALSO KNOWN AS TOTAL ACCOUNTS)

A control account is an account which provides a check on the numerical accuracy of the personal
accounts or subsidiary ledgers (both the sales and the purchases ledger). In effect, a control account is a
summary of all the accounts in the subsidiary ledger. It should be noted that the control account is not
part of the double-entry system.

Forms of Control accounts

There are two types of control accounts, which are:
1) Sales ledger control account or Debtors total accounts or Receivables control account
2) Purchases ledger control account or Creditors total account or Payables control account

Preparation of control accounts

The main sources of information needed to construct the sales ledger control account are as follows:
Sales ledger control account
Information Sources
Opening balance of debtors Trial balance at the end of the previous period or
Debtors account in the sales ledger.
Credit sales Sales daybook or journal
Returns inwards and allowances Returns inwards journal or daybook
Discount allowed Cash book or general ledger
Cash and cheque received from customers Cash book
Bad debts written off General journal
Cash refunds to credit customers Cash book
Dishonoured cheques Cash book
Discount allowed disallowed General journal
Any charges to debtors General journal
Closing balance of debtors Debtors balance in the sales ledger
To purchases ledger General journal

Accounting treatment of set- offs

Some entities might have customers who are also suppliers. In such a case there will be an account for
this entity or an individual both in the sales ledger control account (as a customer) and in the purchases
ledger control account (as a supplier). It could appear sensible for them to off-set the debts outstanding
rather than sending a cheque to each other.
For example, if firm A owes firm B $20 and firm B owes firm A $30, then it would be sensible for firm A
to offset the debt and accept $10 from firm B in full settlement of both debts.
Therefore, as a general rule, set- offs will appear in both control accounts as follows:

a. On the credit side of the sales ledger control account.

b. On the debit side of the purchases ledger control account.

Trade discounts and cash discounts

Trade discounts are not recorded in the control accounts. Entries in the control account should be net of
trade discount. Cash discounts are recorded in both the ledger and control accounts.

Usefulness of maintaining control accounts

a. They save time in locating errors. Reliance on the trial balance is not good enough as one would
have to check the main ledger and the trial balance.
b. It can be used to prevent the perpetration of fraud. This can be effective if the control accounts
are prepared by a different person from the one who maintains the personal account (unless
both the ledger clerks and the person responsible for maintaining the control accounts collude
or connive).
c. This can expedite the determination of the closing debtors and creditors figures.
d. Figures provided by the control accounts may assist in the preparation of financial statements.

Purchases ledger control account

Opening balance
Credit purchases
Returns outwards or allowances
Discount received
Cash and cheques paid to creditors
Closing balance of creditors
Contras to sales ledger
Trial balance at the end o the previous period or creditors’
account in the purchases ledger
Purchases day book or journal
Returns outwards journal or daybook
Cash book or general ledger
Cash book
Creditors account in the purchases ledger
General journal