Inventory Valuation

Rajesh Pathak
GIM, Goa
Inventories (IND AS 2)
 Inventories are assets:
– held for sale in the ordinary course of business (FG);

– in the process of production for such sale (WIP); or

– in the form of materials or supplies to be consumed in the

production process or in the rendering of services (RM)
Valuation Principle
 Inventories shall be measured at the lower of cost and
net realisable value (NRV).
– Conservatism Concept

– Net realisable value is the estimated selling price in the ordinary

course of business less the estimated costs of completion and the
estimated costs necessary to make the sale.
Valuation of Inventories (cont.)
 Costs of Inventory
– The cost of inventories shall comprise all costs of purchase, costs of
conversion and other costs incurred in bringing the inventories to
their present location and condition.
» Product costs
» Period costs
» Other manufacturing costs
Cost not included in Inventory
 abnormal amounts of wasted materials, labour or other production costs;

 storage costs, unless those costs are necessary in the production process
before a further production stage;

 administrative overheads that do not contribute to bringing inventories to

their present location and condition; and

 selling costs.

 Challenge:
– Application of matching concept when dealing with interchangeable
inventories at varying costs.
Valuation Techniques
– Specific identification
» specific costs are attributed to identified items of inventory
» inappropriate when there are large numbers of items of inventory that are
ordinarily interchangeable

– First In, First Out (FIFO)

» assumes that the items of inventory that were purchased or produced first are
sold first, and consequently the items remaining in inventory at the end of the
period are those most recently purchased or produced.

– Average Cost
» the cost of each item is determined from the weighted average of the cost of
similar items purchased or produced during the period.

– Last In, Last Out (LIFO):

» exactly reverse to FIFO method
LIFO
 Not part of Ind AS2

 Effects during inflationary market

– Can LIFO and FIFO produce same effects?

 Requires reporting of LIFO Reserve

– Helps in reconciliation with FIFO based statement.
Accounting Requirements
 When inventories are sold, the carrying amount of those inventories shall be
recognised as an expense in the period in which the related revenue is
recognised.

 The amount of any write-down of inventories to net realisable value and all
losses of inventories shall be recognised as an expense in the period the
write-down or loss occurs.

 The amount of any reversal of any write-down of inventories, arising from an

increase in net realisable value, shall be recognised as a reduction in the
amount of inventories recognised as an expense in the period in which the
reversal occurs.

 The financial statements shall disclose the accounting policies adopted in

measuring inventories, including the cost formula used.
Practical
 Case-Lewis Corporation (6-2)
     Year        
2009
FIFO: COGS 1,840 @ $20.00 = $36,800.00
Soln.  
 
 
 
600
380
@
@
20.25
21.00
=
=
12,150.00
7,980.00
    2,820 @     $56,930.00
             
  Inventory 420 @ 21.00 = 8,820.00
    400 @ 21.25 = 8,500.00
    200 @ 21.50 = 4,300.00
    1,020       $21,620.00
             
COGS 200 @ $21.50 = $4,300.00
LIFO:
    400 @ 21.25 = 8,500.00
    800 @ 21.00 = 16,800.00
    600 @ 20.25 = 12,150.00
    820 @ 20.00 = 16,400.00
    2,820       $58,150.00
             
  Inventory 1,020 @ 20.00 = $20,400.00
             
AVERAGE COST: COGS 2,820 @ $20.456 = $57,685.92
             
  Inventory 1,020 @ 20.456 = $20,865.12
 FIFO: COGS 420 @ $ 21.00 = $ 8,820.00
      400 @ 21.25 = 8,500.00
Year 2010       200 @ 21.50 = 4,300.00
      700 @ 21.50 = 15,050.00
      700 @ 21.50 = 15,050.00
      660 @ 22.00 = 14,520.00
      3,080       $66,240.00
             
  Inventory 40 @ 22.00 = $ 880.00
      1,000 @ 22.25 = 22,250.00
      1,040 @     $23,130.00
               
  LIFO: COGS 1,000 @ $ 22.25 = $22,250.00
      700 @ 22.00 = 15,400.00
      700 @ 21.50 = 15,050.00
      680 @ 21.50 = 14,620.00
      3,080       $67,320.00
               
    Inventory 20 @ $ 21.50 = $ 430.00
      1,020 @ 20.00 = 20,400.00
      1,040 @ 20.00 = $20,830.00
Tax Savings
2009 Sales $95,880 $95,880

  COGS 56,930 58,150

  Gross Margin 38,950 37,730

  Tax Expense 15,580 15,092

  Net Income $23,370 $22,638

       
2010 Sales $110,110 $110,110

  COGS 66,240 67,320

  Gross Margin 43,870 42,790

  Tax Expense 17,548 17,116

  Net Income $ 26,322 $ 25,674

Q3.
FIFO COGS 490 @ $23.00 = $11,270
    700 @ 23.50 = 16,450
    1,510 @ 24.00 = 36,240
    2,700       $63,960
             
  Inventory 400 @ $24.00 = $9,600
             
LIFO: COGS 1,910 @ $24.00 = $45,840
    150 @ 22.50 = 3,375
    20 @ 21.50 = 430
    620 @ 20.00 = 12,400
    2,700       $62,045
             
  Inventory 400 @ 20.00 = $8,000
Q4 and Q5:
 Do yourselves
Let’s Play Quiz
 In times of rising prices, which method is most
suitable for valuing the issues that would reflect the
cost of production to reflect the current market prices:

– Last in First out.

 In times of falling prices, which method would reflect
the valuation of closing stock to reflect the current
market prices:
– FIFO
 Inventory is valued at cost or market price, whichever
is lower for the following accounting concept:
– Conservatism
 The following system gives a continuous information
about the quantum and value of inventory
– Perpetual method
 The following method is used by most organizations
because it satisfies most of the conditions of a good
method of valuing material issues
– WAM
 Which of the following is not true about inventory?
– In inflationary market LIFO method of valuation results in lower
taxes.
– LIFO Reserve is the difference of LIFO value inventory from FIFO
or Average value.
– LIFO reserve is the cumulative difference of COGS between LIFO
and FIFO or Average method since the LIFO is adopted by the
company.
– LIFO valuation of inventory, in no circumstances, can result in
higher tax payments.
 Thanks