Notes on Inventory/Stock Valuation

First in first out (FIFO) method

The first in first out (FIFO) method of costing is used to introduce the subject of
materials costing. The FIFO method of costing issued materials follows the principle
that materials used should carry the actual experienced cost of the specific units used.
The method assumes that materials are issued from the oldest supply in stock and that
the cost of those units when placed in stock is the cost of those same units when issued.
However, FIFO costing may be used even though physical withdrawal is in a different
order.

Advantages of First in First out (FIFO) Costing Method:

1. Materials used are drawn from the cost record in a logical and systematic
manner.
2. Movement of materials in a continuous, orderly, single file manner represents a
condition necessary to and consistent with efficient materials control,
particularly for materials subject to deterioration, decay and quality are style
changes.

FIFO method is recommended whenever:

1. The size and cost of units are large.

2. Materials are easily identified as belonging to a particular purchased lot.
3. Not more than two or three different receipts of the materials are on a materials
card at one time.

Weighted Average Cost

Issuing materials at an average cost assumes that each batch taken from the storeroom
is composed of uniform quantities from each shipment in stock at the date of issue.
Often it is not feasible to mark or label each materials item with an invoice price in
order to identify the used units with its acquisition cost. It may be reasoned that units
are issued more or less at random as for as the specific units and the specific costs are
concerned and that an average cost of all units in stock at the time of issue is
satisfactory measure of materials cost. However, average costing may be used even
though the physical withdrawal is an identifiable order. If materials tend to be made up
of numerous small items low in unit cost and especially if prices are subject to frequent
changes.
Advantages of Average Costing Method:
Average costing method has the following main advantages:

1. It is a realistic costing method useful to management in analyzing operating

results and appraising future production.
2. It minimizes the effect of unusually high or low materials prices, thereby making
possible more stable cost estimates for future work.
3. It is practical and less expensive perpetual inventory system.

The average costing method divides the total cost of all materials of a particular class by
the number of units on hand to find the average price. The cost of new invoices is added
to the total in the balance column; the units are added to the existing quantity; and the
new total cost is divided by the new quantity to arrive at the new average cost. Materials
are issued at the established average cost until a new purchase is recorded. Although a
new average cost may be computed when materials are returned to vendors and when
excess issues are returned to the storeroom, for practical purposes, it seems sufficient to
reduce or increase the total quantity and cost, allowing the unit price to remain
unchanged. When a new purchase is made and a new average is computed, the
discrepancy created by the returns will be absorbed.i
 Practice Question:
Using the information provided by John Doe, we can compute the value of closing inventory, based
on the three inventory valuation methods discussed:

Date Purchases Date Sales

1-Aug 120 units @ $120 6-Aug 100 units @ $140
8-Aug 50 units @ $125 10-Aug 55 units @ $145
16-Aug 20 units @ $140 25-Aug 40 units @ $160
20-Aug 30 units @ $150

From 1st August FIFO

Date Purchase Date of Cost Sale Profit
selling
1st Aug 120 @120= 6th Aug 100 @ 120 = 12000 140*100 = 14000 2000
14400
1st Aug 20 @ 120
8th Aug 50 @ 125 10th Aug 55 55 @ 145 = 7975 1200
20*120=2400
35*125= 4375
Total Cost = 6775
8th Aug 15 @ 125
16th 20 @ 140
Aug
20th 30 @ 150 25th Aug Total Units sold are 40 40 units @ 160 975
Aug
15 @ 125 = 1875 = 6400
20 @ 140 = 2800
05 @ 150 = 750
Total Cost for 40 Units is 5425
20 Aug 25 @ 150
= 3750

Closing inventory value 3750

Date Purchase Date of Cost Sale Profit
selling
1st Aug 120 @120= 6th Aug 100 @ 120 = 12000 140*100 = 14000 2000
14400
1st Aug 20 @ 120 = 2400+6250= 8650
2400
Number of Units = 70
Per unit price = 8650/70 = 123.6
8th Aug 50 @ 125 = 10th Aug 55 units sale @ 123.6 55 @ 145 = 7975 1177
6250
= 6798

8th Aug 15 @ 123.6 15 @ 123.6 = 1854

16 Aug 20 @ 140 = 2800
20th Aug 30 @ 150= 4500
Total Cost 9154
Total No of Units 65
Per unit cost 9154/ 65 = 140.8
65 @ 140.8
25th Aug 40 @ 140.8 = 5632 40 units @ 160 768
= 6400

Using the information provided by John Doe, we can compute the value of closing inventory, based
on the three inventory valuation methods discussed:

Date Purchases Date Sales

1-Aug 120 units @ $120 6-Aug 100 units @ $140
8-Aug 50 units @ $125 10-Aug 55 units @ $145
16-Aug 20 units @ $140 25-Aug 40 units @ $160
20-Aug 30 units @ $150

Ending Inventory 25 @ 140.8= 3520

Cost of goods Sold= Beginning Inventory +
Purchases – Ending Inventory.
*Note: Only the quantity under the sales column is relevant for inventory valuation. The Sales
prices of $140, $145 and $160 are relevant for determining Total Sales.
 Practice Question # 2
The Delta company uses a periodic inventory system. The beginning balance of
inventory and purchases made by the company during the month of July, 2016 are
given below:

 July 01: Beginning inventory, 500 units @ $20 per unit.

 July 18: Inventory purchased, 800 units @ $24 per unit.
 July 25: Inventory purchased, 700 units @ $26 per unit.
The Delta company sold 1,400 units during the month of July.

Required: Compute inventory on July 31, 2016 and cost of goods sold for the month of
July using following inventory costing methods:

 First in, first out (FIFO) method

 Average cost method

Practice Question # 3
Said Company reported the following current-year data for its only product:
 Jan. 1 Beginning Inventory 200 Units @ $10
 Mar. 14 Purchase 350 Units @ $15
 Jul. 30 Purchase 450 Units @ $20
 Oct. 26 Purchase 700 Units @ $25
Said resold its products at $40 per unit on the following dates:
 Jan. 10 Sales 100 units
 Mar. 15 Sales 150 units
 Oct. 5 Sales 310 units
Determine the costs assigned to cost of goods sold and ending inventory using
(a) FIFO and
(b) WAC Method