Chapter 10

Inventory

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FA2

D RECORDING TRANSACTIONS AND EVENTS

3. Inventory
a) Recognise the need for adjustments for inventory when preparing financial
statements. [K]
b) Record opening and closing inventory. [S]
c) Identify and apply the alternative methods of valuing inventory. [K]
d) Explain and apply the IASB requirements for valuing inventories. [S]

e) Recognise which costs should be included when valuing inventories. [K]

f) Explain the use of continuous and period end inventory records. [K]
g) Calculate the value of closing inventory using FIFO (first in, first out) and
AVCO (average cost) - both periodic weighted average and continuous weighted
average. [S]
h) Identify the impact of inventory valuation methods on profit, assets and
capital, including: [S]
(i) periodic weighted average
(ii) continuous weighted average
(iii) FIFO
i) Report inventory in the final accounts. [S]

F3/FFA

D RECORDING TRANSACTIONS AND EVENTS

3. Inventory
a) Recognise the need for adjustments for inventory in preparing financial
statements.[K]
b) Record opening and closing inventory.[S]
c) Identify the alternative methods of valuing inventory.[K]
d) Understand and apply the IASB requirements for valuing inventories.[S]
e) Recognise which costs should be included in valuing inventories.[S]
f) Understand the use of continuous and period end inventory records.[K]
g) Calculate the value of closing inventory using FIFO (first in, first out) and
AVCO (average cost) – both periodic weighted average and continuous weighted
average.[S]
h) Understand the impact of accounting concepts on the valuation of inventory.[K]
i) Identify the impact of inventory valuation methods on profit and on assets.[S]

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 1. Introduction

When a business purchase inventory it is recorded as expenses. But at the end of

the period if it is not sold, then this closing inventory becomes asset. Next year
it is called opening inventory & if it is sold it becomes expenses. This is done
in line with accrual concept. Accrual concept state that “expenses should be
match with the income”. So in a period if we don’t sell an item, then it should
not be treated as expenses. So the closing inventory is deducted from purchase of
the period to find cost of sale.

On the other hand, if we sold previous period’s inventory in this period, then
its value should be treated as expenses in this period. So, opening inventory is
added to purchase for calculating cost of sale. Cost of sale is recorded in the
Statement of Profit and Loss (SPL).

The basic formula is

Cost of Sales = Opening Inventory + Purchase – Closing Inventory

Normally we always find the value of closing inventory; it is automatically become

opening inventory for the next period.

2. Cost of Inventory

IAS 2 INVENTORY set out the rules about how to deal inventory in the financial
statement.

Initially inventory recorded at its cost. Inventory cost include following:

1. Purchase price less

2. Trade discount add
3. Carriage inwards add
4. Any irrecoverable tax (e.g. import duties) add
5. Cost of conversion (material, labour, fixed & variable expenses) add
6. Any other cost directly related to bring the inventory to the present
location and condition for its use.

But at the year end when inventory is reported to financial statement, it should
be valued lower of cost and Net Realisable Value (NRV).

NRB = Selling Price – Selling Cost

Selling cost must not include purchase cost, may include following:

1. Any repair cost for making inventory ready for sale

2. Advertise cost

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 3. Agent commission etc.

Illustration 1

VR Co bought 50 unit of item J & K. purchase price of each unit of J was $200 & K
was $300. 10% discount given by seller. Each unit required $10 carriage cost to
bring in its premise. At the end of the year both items sold 40 units. The normal
selling price is $250 per unit of J and $400 per unit of K. But the demand for the
items decreases. In order to sale the remaining units 25% discount need to offer
on product J & 20% on product K.

Cost will be as follows:

J K

Purchase price 200 300

Less: Trade discount (20) (30)

Add: Carriage inwards 10 10

Cost 190 280

NRB will be as follows:

Selling price 250 400

Less: Discount (62.5) (80)

NRB 187.5 320

For each item we have to separately compare cost with its NRB.

J K

Cost 190 280

NRB 187.5 320

Lower of cost & NRB 187.5 280

Number of inventory 10 10

Value of inventory 1,875 2800

Total value of inventory ($1,875 + $2,800) = 4675

There are other methods of valuing inventory.

a) Expected selling price.

b) Replacement cost- Present cost of replacing the inventory.

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 3. Continuous and period end record

At the yearend business normally count its entire inventory physically, match them
with inventory record. If there is any error, adjust them in record. Then find out
the value of physical inventory and record them in SOFP. This is called yearend
inventory count.

Instead of counting entire inventory at a single day, some business count

inventory in a day then match with record and adjust any discrepancy some other in
another day. This process is repeated until all inventories are counted. This is
called continuous or perpetual inventory counting.

4. Different types of inventory valuation method

When business purchases goods their prices normally fluctuate. If all inventory
are identical they is a problem of finding out cost of sales and closing inventory
value. E.g. a business purchases 10 units of inventory @$2 per unit and later
another 20 units @$2.5. Now if business sold 15 units. What will be the cost per
unit and what will be value of remaining units?

According to IAS 2 there are 3 ways of inventory valuation and a business can
choose any one of them.

First In First Out (FIFO)- Those items bought first should be charged in SPL
first. Value of closing inventory will be latest purchase price.

Continuous weighted Average- Each time new inventory is purchased an average cost
need to calculate and cost of sale & closing inventory should be valued at that
price.

Periodic weighted average- At the yearend an average cost is calculated and cost
of sale & closing inventory should be valued at that price.

Illustration 2

1.1.17 Purchased 100 units @$10

3.1.17 Purchased 200 units @$15

5.1.17 Sold 80 units @$30

25.1.17 Purchase 100 units @$20

28.1.17 Sold 250 units @$30.

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FIFO

Date Purchase Sale Rate Balance

1.1.17 100 10 100 @ $10

3.1.17 200 15 100 @ $10

200 @ $15

5.1.17 80 10 20 @ $10

200 @ $15

25.1.17 100 20 20 @ $10

200 @ $15

100 @ $20

28.1.17 20 10

200 15

30 20 70 @ $20

Statement of profit and loss

Selling price is (80+250) * $30 $9,900

Cost of sale (80*10) + (20*10) + (200*15) + (30*20) ($4,600)

Gross profit $5,300

Statement of financial position

Current asset:

Closing inventory 70*$20 $1,400

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Continuous AVCO:

Date Purchase Sale Rate Balance

1.1.17 100 10 100*$10=$1,000

3.1.17 200 15 100*$10=$1,000

200*$15=$3,000

300*$13.33=$4,000

5.1.17 80 13.33 (80)*$13.33=$(1,066)

220*$13.33=$2,934

25.1.17 100 20 100 * $20 =$2,000

320*$15.42=$4,934

28.1.17 250 15.42 (250)*$15.42=$(3,855)

70*$15.42=$1,079

Statement of profit and loss

Selling price is (80+250) * $30 $9,900

Cost of sale ($1,066 + $3,855) ($4,921)

Gross profit $4,979

Statement of financial position

Current asset:

Closing inventory 70*$15.42 $1,079

Periodic AVCO

Cost per unit = ($1,000+$3,000+$2,000)/(100+200+100)= $15

Statement of profit and loss

Selling price is (80+250) * $30 $9,900

Cost of sale (330*$15) ($4,950)

Gross profit $4,950

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Statement of financial position

Current asset:

Closing inventory 70*$15 $1,050

5. Impact of valuation method on profit, inventory value & capital

Now we will analyse the illustration 1 to identify the effect of each valuation
method on profit, inventory and capital.

FIFO CONTINUOUS PERIODIC

AVCO AVCO

Cost of sale 4,600 4,921 4,950

Profit 5,300 4,979 4,950

Inventory value 1,400 1,079 1,050

From our illustration we can observe that the price of goods continuously
increased. So it is an inflationary situation. From the above chart we can see
that cost of sales is lowest in FIFO and highest in Continuous AVCO. This is
happened because FIFO charged earlier inventory which was low value so its cost of
sales decreased. On the other hand continuous AVCO average the price so it’s cost
of sale became higher than FIFO. So in a period of inflation FIFO show lower cost
than continuous AVCO hence higher profit. The situation reverse in the period when
price of goods decrease.

Now if we look at closing inventory value we can see that FIFO shows higher
inventory value than continuous AVCO. This is because item remains in the
inventory are the recent item under FIFO, as their price is higher so the
inventory value. So in a period of inflation FIFO show higher inventory value than
continuous AVCO & the situation reverse in the period when price of goods
decrease.

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Your Task 1

During January 2017 Bilu & Co purchased and sold following goods

Date Details Quantity Price per unit

1.1.17 Purchase 100 2

2.1.17 Purchase 150 3

3.1.17 Sale 70 5

4.1.17 Purchase 200 1.5

5.1.17 Sale 80 5

6.1.17 Sale 150 5

Required:

a) Using FIFO method identify the cost of sales and closing inventory value?
b) Using continuous AVCO methods identify the cost of sales and closing
inventory value?
c) Using periodic AVCO methods identify the cost of sales and closing
inventory value?

Your Task 2

During February 2017 Bilu & Co purchased and sold following goods

Date Details Quantity Price per unit

1.2.17 Opening inventory 150 from previous your task

2.2.17 Sale 90 5

3.2.17 Purchase 140 3

4.2.17 Purchase 200 3.5

5.2.17 Sale 280 5

6.2.17 Purchase 150 4

Required:

a) Using FIFO method identify the cost of sales and closing inventory value?
b) Using continuous AVCO methods identify the cost of sales and closing
inventory value?

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 c) Using periodic AVCO methods identify the cost of sales and closing
inventory value?
d) Prepare SOFP & SPL?

Your Task 3

During March 2017 Nadim & Co purchased and sold following goods

Date Details Quantity Price per unit

1.3.17 Opening inventory 270 from previous your task

2.3.17 Sale 140 10

3.3.17 Purchase 190 9

4.3.17 Purchase 100 6

5.3.17 Sale 230 10

6.3.17 Sale 150 10

Required:

a) Using FIFO method identify the cost of sales and closing inventory value?
b) Using continuous AVCO methods identify the cost of sales and closing
inventory value?
c) Using periodic AVCO methods identify the cost of sales and closing
inventory value?
d) Prepare SOFP & SPL?

Your Task 4

During April 2017 Nadim & Co purchased and sold following goods

Date Details Quantity Price per unit

1.4.17 Opening inventory 40 from previous your task

2.4.17 Purchase 170 8

3.4.17 Purchase 190 7

4.4.17 Sale 210 10

5.4.17 Purchase 330 6

6.4.17 Sale 400 10

Required:

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 a) Using FIFO method identify the cost of sales and closing inventory value?
b) Using continuous AVCO methods identify the cost of sales and closing
inventory value?
c) Using periodic AVCO methods identify the cost of sales and closing inve
ntory value?
d) Prepare SOFP & SPL?

6. Question pattern in exam

Following are the common patter of question asked in exam.

Illustration 3

The yearend inventory value of P ltd is $289,000.

Following items included at cost in the above inventory value.

Item A Cost is $4,000 but expected selling price is $3,500

Item C Cost is $6,000 but expected selling price is $7,200

What is the corrected year-end inventory value?

The inventory is included at cost but if NRV is lower than cost then NRV should be
included at inventory figure not the cost.

For Item A the NRV is lower so the cost of $4,000 need to deduct from total
inventory value and NRV need to added with total inventory value.

For Item B the cost is lower than NRV & cost is included in the inventory figure
so no adjustment is needed.

To adjusted inventory value will be $289,000 - $4,000 + $3,500 = $288,500

Illustration 4

The yearend inventory value of P ltd is $289,000.

Following items not included at cost in the above inventory value.

Item A Cost is $4,000 but expected selling price is $3,500

Item C Cost is $6,000 but expected selling price is $7,200

What is the corrected year-end inventory value?

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As the above items is not included in the total inventory value. So first for each
item we have to identify what value is lower (cost or NRV) then we should include
it with the total figure.

For Item A the NRV is lower so the NRV need to added with total inventory value.

For Item B the cost is lower than NRV & the cost need to add with total inventory
value.

To adjusted inventory value will be $289,000 + $3,500 + $6,000 = $298,500

Illustration 5

The yearend inventory value of Hasan & co was $99,600. An inventory costing $4,000
included in this amount but the NRV was $3,800.

a) If it is not corrected what will be affect on profit and closing inventory

value?
b) If it is corrected what will be affect on profit and closing inventory
value?

Answer

a) Closing inventory should be lower by $200. At present closing inventory is

overvalued by $200. Closing inventory reduce the cost of sales. That means
COS will be reduced $200 more than it should be so profit will be $200 more
than it should be. Closing inventory value will be $200 higher in SOFP.
b) If the error is corrected closing inventory will reduced by $200 so COS
will increase by $200 so profit will be reduced by $200. Also closing
inventory in SOFP will be $200 lower.

Illustration 6

The closing inventory of Amir & co has been overstated by $600.

a) If the error is not corrected what will be the affect on the financial
statement of current year and next year.
b) If the error is corrected what will be the affect on the financial
statement of current year and next year.

Answer

a) If the error not corrected the current year closing inventory will be
higher so COS will be lower hence profit will be higher. This year closing
inventory will be next year opening inventory. So if the error in not
corrected next year opening inventory will be higher so the COS will be
higher hence profit will be lower.

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 b) If the error is corrected this year closing inventory will decrease so COS
will increase hence profit will decrease. On the other hand, next year
opening inventory will decrease so COS will decrease hence profit will
increase.

Illustration 7

The yearend of Fima & co was 31.12.2017. Due to some problem the inventory was
counted on 5.1.2018 & the value was $47,900. During the period of 31.12.2017 &
5.1.2018 following transaction took place

Purchase $6,000

Purchase return $4,000

Sale $10,000

Sale return $3,000

The profit margin is 20%.

Calculate the inventory value at 31.12.2017.

Answer

First let’s look to a simple formula

Opening inventory + Purchase – Purchase Return – Sale + Sale Return = Closing

Inventory

In the question we are given the value of inventory on 5.1.2018 & we have to find
out the value of inventory at 31.12.2017. So inventory of 5.1.2018 will be treated
as closing inventory and inventory of 31.12.2017 will be treated as opening
inventory. We got our closing inventory we can find out the opening inventory by
rearranging the formula.

But one thing we have to adjust before doing this. We know the inventory value
include cost not profit but in the question sale and sale return include profit.
So first we have to find out the cost element of sale and sale return. We can do
this by removing profit from the value.

For sale it would be $10,000 – ($10,000 * 20%) = $8,000

For sale return it would be $3,000 – ($3,000 * 20%) = $2,400

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Now we will put all the values in the formula

Opening inventory = Closing inventory – Purchase + Purchase Return + Sale – Sale

Return

= $47,900 - $6,000 + $4,000 + $8,000 - $2,400

= $51,500

Your Task 5

At the yearend inventory value was $6,925. Included this figure following item was
recorded

a) An inventory which cost was $600 & NRV $520

b) Inventory that could be sold at $700 but agent fee needs to pay $290. The
cost of the item was $500.
c) An inventory cost $300 & expected selling price $420 and selling cost $80.

What is the correct figure for inventory at year end?

Your Task 6

The yearend inventory value of Gomez & Co was $9,370. Following items found at
yearend and not included in the above value

a) Item A cost $320 & expected NRV $250

b) Item B cost $920 & expected NRV $1,200

What is the correct figure for inventory at yearend?

Your Task 7

Closing inventory of Shoyeb & Co was understated at yearend by $900. Which of

following is correct?

a) Profit will increase by $900

b) Profit will decrease by $900

Your Task 8

Closing inventory of Shoyeb & Co was overstated at yearend by $700. It was not
corrected. Which of following is correct?

a) Current year profit will increase by $700

b) Current year profit will decrease by $700

Which of the following statement is correct?

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Your Task 9

Closing inventory of Hanaf was understated by $600. If it is corrected at yearend

then which of the following will be correct?

a) Current year profit will increase by $600

b) Current year profit will decrease by $600

Your Task 10

The purchase price of the inventory increased during the year. Which of the
following method of inventory valuation will show higher profit?

a) FIFO
b) AVCO

Your Task 11

The purchase price of the inventory increased during the year. Which of the
following method of inventory valuation will show higher inventory value?

a) FIFO
b) AVCO

Your Task 12

The purchase price of the inventory decreased during the year. Which of the
following method of inventory valuation will show higher inventory value?

a) FIFO
b) AVCO

Your Task 13

The purchase price of the inventory decreased during the year. Which of the
following method of inventory valuation will show higher profit?

a) FIFO
b) AVCO

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Your Task 14

The yearend of Mustak & Co is 31.12.2014. The inventory was counted at 10.1.2015 &
the total value was $79,690. During the period between 31.12.2014 & 10.1.2015
following transaction took place

Purchase $9,000

Sale $15,000

Sale return $19,000

Purchase return $5,000

The profit margin was 25%.

What was the inventory value at 31.12.2014?

Your Task 15

The yearend of Rubi & Co is 31.10.2016. The inventory was counted at 8.11.2016 &
the total value was $93,450. During the period between 31.10.2016 & 8.11.2016
following transaction took place

Purchase $7,000

Sale $16,000

Sale return $8,000

Purchase return $9,000

The profit margin was 30%.

What was the inventory value at 31.10.2016?

Your Task 16

Elena has following inventory at the yearend & their cost, estimated selling price
& selling cost.

Product name Quantity Cost per Selling price Selling cost

unit per unit per unit
Alfa 100 1200 1300 120
Beta 120 800 1000 0
Gama 430 350 300 0
Youga 260 400 450 40
Throne 80 1800 2000 250
Calculate what amount will of closing inventory at the year end?

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Your Task 17

Bela has following inventory at the yearend & their cost, estimated selling price
& selling cost.

Product name Quantity Cost per Selling price Selling cost

unit per unit per unit
Superman 1000 15 14 0
Batman 1200 8 8 2
Ironman 400 3 3 0
Hitman 200 14 18 3
Noman 800 8 10 1
Calculate what amount will of closing inventory at the year end?

Your Task 18

Following transaction took place in ICPA.

Purchase 200 units @ $5

Purchase 300 units @ $6
Sale 150 units
Purchase 400 units @ $8
Sale 100 units
Sale 300 units
Purchase 700 units @ $7
Purchase 200 units @ $9
Sale 100 Units

Find out the value of closing inventory & cost of goods issue under FIFO,
Continuous & periodic average methods?

Your Task 19

Following transaction took place in ICPA.

Opening inventory 200 Unit @ $8

Purchase 100 units @ $9
Purchase 200 units @ $10
Sale 250 units
Purchase 400 units @ $11
Sale 200 units
Sale100 units
Purchase 800 units @ $7
Sale 200 units.

Find out the value of closing inventory & cost of goods issue under FIFO,
Continuous & periodic average methods?

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Exam style question 1
Janet valued her inventory at 30 June at its cost of $22,960. This includes some
items which cost $1,950 which have been difficult to sell. Janet intends to have
these items repacked at a cost of $400. She can then sell them for $900.
What will be the value of closing inventory in Janet’s accounts at 30 June?
A $20,610
B $21,510
C $22,310
D $24,260

Exam style question 2

Ruth started trading a year ago. She sells her products at a mark up of 30%. In
the first year of trading, she bought goods for $25,800. Her sales in the year
were $30,888.
What is the value of Ruth’s closing inventory?
A $1,569
B $2,040
C $3,750
D $5,700

Exam style question 3

Which of the following statements regarding inventory valuation is correct?
A Inventory valuation should exclude profit which has not yet been earned
B All items held in inventory should be valued at cost
Inventory should be valued at anticipated selling price less any cost which
C
will be incurred
The purchase price of items which have been held for the longest period is
D
an acceptable method for valuing inventory

Exam style question 4

According to IAS 2 Inventories, which TWO of the following costs should be included
in valuing the inventories of a manufacturing company?
(1) Carriage inwards
(2) Carriage outwards
(3) Depreciation of factory plant
(4) General administrative overheads
A 1 and 4
B 1 and 3
C 3 and 4
D 2 and 3

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Exam style question 5
A company values its inventory using the FIFO method. At 1 May 20X5 the company
had 700 engines in inventory, valued at $190 each. During the year ended 30 April
20X6 the following transactions took place:
1 July Purchased 2005 500 engines at $220 each
1 November 2005 Sold 400 engines for $160,000
1 February 2006 Purchased 300 engines at $230 each
15 April 2006 Sold 250 engines for $125,000

What is the value of the company’s closing inventory of engines at 30 April 20X6?
A $188,500
B $195,500
C $166,000
D $106,000

Exam style question 6

When Frank prepared his year end accounts, he made a calculation error and
overstated the value of his closing inventory.
What is the effect of this error on the profit for the year and the net assets at
the year end?
A Both profit and net assets will be understated
B Both profit and net assets will be overstated
C Profit will be understated and net assets will be overstated
D Profit will be overstated and net assets will be understated

Exam style question 7

At 1 January 2003 Wasan had 250 units of a particular item in inventory these were
valued at $155 per unit. During January, the purchase and sale of item ware:

Date Purchase Sale

5 January 175 units

10 January 140 units at $158 per unit

17 January 130 units

22 January 110 units at $160 per unit

28 January 105 units

Wasan values inventory on the periodic weighted average basis.

What is the value of Wasan’s inventory at 31 January 2003 (to the nearest $1)?

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 A. $14,125
B. $14,190
C. $14,400
D. $14,299

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