Valuation Of Inventory

By Ishita shah Bansari shah Hiral gala Kinjal zalavadia Abhishek Rupareliya Ali asgar

Introduction Cost of Inventory Valuation Inventory System Method of Inventory System Average Price

DATE & NATURE:

AS 2 was issued in June 1981. AS 2 is issued by Institute of Chartered Accountants of India (ICAI). Subsequently, the standard was revised. The revised standard comes into effect in respect of accounting periods commencing on or after 1.4.1999. It is mandatory in nature. Further, it is applicable for all types of enterprises.

The correct financial position of a firm can be determined only if the inventories are valued precisely. The gross profit of a firm is closely associated with the cost of goods sold, whereas the cost of goods sold is directly affected by inventories (both opening and closing). Cost of Goods Sold= Opening stock + Purchases Closing stock and expenses.

DEFINATION:

International Accounting Standard Committee (I.A. S. C) defines inventory as Tangible property: 1. Held for sale in the ordinary course of business, 2. In the process of production of such sale or, 3. To be consumed in the process of production of goods and services for sale. AICPA (American Institute Of Certified Public) defines Inventory in the sense of tangible goods which are held for sale, in process of production and available for ready consumption.

MEANING:

The dictionary meaning of inventory is stock of goods, or list of goods. The word Inventory is understood differently by various authors. In accounting language, it means stock of finished goods only. As per Trading Concern: Inventories under this type encompass products purchased for resale in the existing form, an inventory of supplies such as wrapping paper, cartons and stationery. In Manufacturing Concern, Inventories consists of raw materials, work in process and finished products. Inventory means all the materials, parts, supplies, expense tools and in process or finished products recorded on the books by an organization and kept in its stocks, ware houses or plant for some period of time.

Raw material Work-In-Progress. Consumables Finished goods Spares

Types Of organizations
Manufacturer Hospital Bank Airline Company

Types Of Inventories Held

Raw material; spare parts; semi furnished goods; furnished goods. Number of beds; stock of drugs; specialized equipments.. Cash reserves; tellers. Seating capacity; spare parts, specialized maintenance screw.

Work-in-progress arising under construction contract. Work-in-progress arising in the ordinary course of business for service providers. Financial instruments held as stock in trade. Producers inventories: livestock, agricultural and forest products, mineral oils and gases.

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Determination Of Income: The valuation of inventory is necessary for determining the true income earned by business during a particular period. Gross profit is the excess of sales over cost of goods sold. The goods sold is ascertained by adding opening to and deducting closing inventory from purchases. Liquidity: An inventories constitutes major portion of the current assets, hence its valuation is of vital importance to judge the liquidity of a concern.

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3. Determination Of Financial position:

The inventory at the end of a period is to be shown as a current asset in the balance sheet of the business. In case, the inventory is not properly valued, the balance sheet will not disclose the correct financial position of the business.

4. Backbone: .

Inventory is the major asset for any business enterprise (trading as well as manufacturing). It constitutes more than 75% of the total current assets. It is the backbone of the entire business edifice.

Four major cost components for valuation of inventory It is the purchase price or production cost, can be constant or vary per unit.. It includes cost associated with the processing of purchase order, transportation, inspection for quality, expediting overdue orders etc.

1. Purchase cost/Nominal cost:

2. Ordering cost/set-up cost/Procurement cost:

3. Carrying Cost/Holding cost/Storage cost:

The elements of carrying cost includes opportunity cost, storing cost, obsolescence cost, insurance cost

4. Stock out cost: Means the cost associated with not serving the customers. It can be internal or external.

To determine the physical quantities and rupee value of inventories sold and in hand, the following system are adopted. They are

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Periodic Inventory System

Periodic inventory system is a method of ascertaining inventory by taking an actual physical count (or measure or weight) of all the inventory items on hand at a particular date on which information about inventory is required. The cost of good sold is calculated as Cost Of Good Sold = Opening Inventory + Purchase Closing Inventory These cost of good includes cost of lost goods also.


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Accounting Procedure
Record all purchases on inventories (as debits) to purchase account. No entry is to be made at the time of sale for cost of good sold. Stock of inventory account is made up-to-date by way of adjusting entries.

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2. Perpectual Inventory System It is a system of records that reveals the physical movement of stocks and their current balance. It is a method of recording inventory balances after each purchases and sale takes place. The closing inventory is calculated as a residual factor, which is calculated by using the following equation Closing Inventory = Opening Inventory + Purchases Cost Of Goods Sold


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Accounting Procedure
A separate account for each type of inventory is maintained in a card to record the purchase and sale of each such inventory item. The detailed inventory records for each different item show receipts(purchases), issues(sales) and balance on hand in both quantities and amount. The increases in inventory items are recorded as receipts to respective accounts and the decreases are recorded issues. The balances of the inventory items accounts are known as the Book Inventories of the items on hand. The physical inventory of each item of inventory is also undertaken periodically, at least once a year. Finally, the records maintained under the perpetual inventory system are compared with actual quantities of each item on hand. If any discrepancy arises, it had to be corrected.

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Periodic Inventory System It is based on actual physical count. It is simple method and cost wise it is econmical Inventory is directlys ascertained by applying the methods of valuation of inventories

Perpetual Inventory System

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1.It is based on records 2. It is complex and cost wise it is not economical as recsords have to be maintained. 3.Inventory is ascertained by applying the equation.

The important operation of the inventory management is inventory valuation through stores register inventory valuation under pricing is being executed through the following methods.

Method of Valuation

Cost Price
Specific FIFO LIFO HIFO Base Stock price Price

Average Price

Weighted Average

Simple Average

1. Specific Price Method (SPM)

Materials are issued at the price at which they were originally purchased. It is used when materials are purchased for specific job or work order. It involved earmarking of each materials purchased for a specific job or work order against which materials have been purchased. It is suitable for job industries which carry out individual jobs or contracts against specific orders.

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Advantages of SPM
The cost of materials issued for production purposes to specific jobs represent actual and correct cost. This method is best suited for non standard and specific products.

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Disadvantage of SPM

1. when purchases and issues are numerous. 2. Materials cannot be identified

2. First in First Out (FIFO)

Under this method materials are received first and are issued first. After the first lots of the material purchased is over the next lots is taken up for issue. As such the materials are issued in the order in which they are received in the stores. The pricing of the issue of the first slot is done at the rate of the purchase of the first slot. Similarly the pricing pattern follows for the subsequent lots. The closing stock in the method is value at the latest purchase price. Closing stock is shown at the current prices.

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Advantages of FIFO It is very simple to understand It is issued on basis of purchases The materials are issued at purchase price It is most advantages during the moment of falling prices due to lower cost of replacement through purchases against the issues The closing stock reflects the market price due to recent purchase of materials Disadvantages of FIFO In the periods of rising prices, higher income will be reported resulting in the higher tax liability. In a period when prices are fluctuating the cost of purchase do not represent current market price. In case where production cycle is lengthy true profit cannot be shown in the income statement. This method involves more mathematical work if price is fluctuate.

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3. Last In First Out (LIFO)

Under this method goods which are purchase last are sold first. This assumption is made for purpose of assigning cost and not for physical flow of goods. As such, the goods sold contest of the latest lots, which are valued at the price paid for such lots. Cost of material issued represent the cost of latest purchases. Cost of closing stock is valued at the cost of earlier purchases.


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Advantages of LIFO
Under this method current cost are in tune with the current revenues The closing inventory is valued at lower cost of old purchases which will not reflect the current price level trend. As current cost are matched with the current revenue/lower income may be reported in period of rising prices. As it is based on cost unrealized inventory profit/loss cannot be worked out.

Disadvantages of LIFO
Cost flows do not correspond to the physical flow of goods. 2. Measurment of income is not in confirmity with utilization of income. 3. Value of ending inventory does not reflect current price level. 4. In the period of falling prices, the higher income is reported there by increases tax liabilities.
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Goods received first are issued first. Cost of good sold present cost of earlier purchase. Ending inventory represents cost of recent purchases. Balance sheet shows the ending inventory on a value nearer the current market price.

Goods received last are issued first. Cost of good sold represent cost of recent purchases. Ending inventory represents cost of earlier purchase. Balance sheet is distorted because ending inventory is understated at old costs.

4. Highest First Out Method.

This method seek to issue material of production using the cost. In other word material having prices are issued first without connecting the gain. The logically understanding this method is that when market price of material is fluctuating, the product can easily absorb the cost of material and provide product cost.

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Advantages
Suitable for cost plus contracts. Its used during a period of shortage of material

5. Base stock method

This method proceeds on the assumption that a minimum quantity of inventory must be held at all times to use in case emergency arises. Such minimum quantity of inventory known as base stock.

This method can be applied in industries where:

Raw materials used are basic and homogeneous. Work of processing takes a long time

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Advantages of BSM
It involves less clerical work in valuing the closing inventory. The figure of net income is reliable from long-run viewpoint. Inventories are consistently shown in balance sheet at conservative value. Unrealized profits are eliminated.

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Average Price Method

It is the method by which the value of total assets or expenses is assumed to be equal to the average cost of the total assets or expenses. Under this method, it is assumed that the cost of inventory is based on the average cost of the goods available for sale during the period. It is computed by dividing the total cost of goods by the total units which gives a weighted average unit cost for the units of the closing inventory.

There are commonly used average cost methods: 1.Simple average 2.Weighted-average cost method

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Simple Average Method (SAM)

This method material issues are charged at the price of the material purchased and in stock.

Average price =Total of unit prices of all lots in stores Total number of unit prices

Advantages on SAM

1 The method is simple and easy to understand. 2 It gives reasonably accurate results, when prices do not vary and quantity purchased are similar. 3 A purchase at a higher or lower rate does not disturb the price to a great extent.

Disadvantages on SAM

1. The method does not give accurate results when prices fluctuate and purchase quantites vary on time. 2. The method is unscientific as it pays no regard to the reletive quantities held at each price. 3. Since materials are not charged at actual cost, profit or less will arise on material. 4. Verification of closing stock becomes difficult.

2. Weighted Average Price Method(WAPM)

In this method price of material issues is calculated by taking in to account both quantity and value of material in stock.

WAP=Total cost of material in stock Total quantity of materials in stock

ADVANTAGES OF WAPM 1.It is easy to calculated and operate. 2.When prices vary widely , it event out the variations. 3.Closing stock value is acceptable and can be used in the financial accounts. 4.It reduces the number of calculation if receipts are not numerous, as each issue is charged at the same price until a fresh lot of material is received.

DISADVANTAGES OF WAPM 1.Profit or less in issue may arise as issues are not valued at actual cost. 2.Closing stock is not at current cost.

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The accounting policies adopted in measuring inventories, including the cost formulas used. The total carrying amount of inventories and its classification appropriate to enterprise. Information about the carrying amount held in different classifications of inventories and raw material and components, work in progress, finished goods, stores and spares and loose tools. In accordance with AS-1 disclosure must includes a change in the accounting policy with respect to inventory and its effects on the financial statement of the current accounting period.