Financial Accounting

4ACCN008C-n
Semester 1, 2023/2024
Lecture 4:End of year adjustments: Stock
 Learning outcomes

Upon successful completion of the session student will be able to:

1.Recognize the need for adjustments for inventory in preparing
financial statements.
2.Record opening and closing inventory.
3.Recognise which costs should be included in valuing inventories.
4.Calculate the value of closing inventory using first in, first out (FIFO),
last in, first out (LIFO) ,and average cost (AVCO) methods

.
End of Year Adjustments
Even if the book-keeping system has been kept up to date there
are always some outstanding matters at the end of the
financial year

Four types of last minute adjustments:

Stock

Depreciation

Accruals and Prepayments

Bad and Doubtful Debts

Accounting concept*

Historic cost – this concept

requires that assets be
recorded at the value of their
original or historic cost even
though this may differ from
current (present) market cost.
Accounting concept**
Example: A plant and machinery is going to be purchased by ABC
incorporation. Initial price was $5,000. ABC incorporation purchased the
machinery for a discounted amount of $4,500. The transportation cost of the
machinery was $20 for which $10 was paid by the dealer and remaining $10
by ABC incorporation. ABC incorporation also paid $15 as installation cost.

What will be the value of these plant and machinery in accounting books?
Stock (Inventory)
Inventory is the term for the goods
available for sale and raw materials used to
produce goods available for sale.
Inventory represents one of the most
important assets of a business because
the turnover of inventory represents one of
the primary sources of revenue generation
and subsequent earnings for the company's
shareholders.
Stock &work in progress
At any point in time most manufacturing and merchandising
enterprises will hold several categories of inventory including:

-goods purchased for resale

-consumable stores(such as oil)
-raw materials and components
(used in production process)
-partly-finished goods (work in
progress)
-finished goods
Inventory - Products being held prior to
sale
Inventory in Accounting
Cost of goods sold (COGS)
COGS is the cost of acquiring
or manufacturing the products
that a company sells during a
period, so the only costs
included in the measure are
those that are directly tied to
the production of the products,
including the cost of labor,
materials, and manufacturing
overhead.
 Classification of costs
Cost includes all the
expenditure incurred in bringing
the product or service to its
present location and condition
This includes :
-Cost of purchase –materials
costs, import duties, freight.
-Cost of conversion –this
includes direct costs and
production overheads.
Cost of goods sold (COGS)
Direct materials are the raw materials that become a part of the finished product.
The direct labor cost is the cost of workers who can be easily identified with the unit of production.
Types of labor who are considered to be part of the direct labor cost are the assembly workers on
an assembly line.
Manufacturing overhead is any manufacturing cost that is neither direct materials cost or direct
labor cost. Manufacturing overhead includes all charges that provide support to manufacturing.
Indirect labor cost: The indirect labor cost is the cost associated with workers, such as
supervisors and material handling team, who are not directly involved in the production.
Indirect materials cost: Indirect materials cost is the cost associated with consumables, such as
lubricants, grease, and water, that are not used as raw materials.
Other indirect manufacturing cost: includes machine depreciation, land rent, property
insurance, electricity, freight and transportation, or any expenses that keep the factory operating.
Cost of goods sold (COGS)
Cost of Goods Sold (COGS)=
= Opening Stock
Add Purchases
Less Return Outwards (purchases returns)
Add Carriage Inwards (transportation costs)
Cost of the goods available for sale
Less Closing Stock
 Example: COGS

Peter buys and sells washing machines. He has been trading for many years.
On 1 January 2020, his opening stock is 30 washing machines, which cost
$9,500. He purchased 50 machines in the year amounting to $15,000. Also he
paid for transportation of the machines $1,000 and made sales totaling $ 20,000.
At the end of the year he has 30 washing machines left in stock with a cost
of $9,600.
Calculate COGS and Gross Profit for the year.
 Accounting concept*

Consistency – once specific

accounting policies have been
adopted, they should be followed
in all subsequent accounting
periods

.
 Valuation of stock - FIFO
In FIFO(first-in-first-out), the
assumption is made for costing
purposes that the first items of
inventory received are the first
items to be sold.
Thus every time a sale is made,
the COGS is identified as
representing the cost of the oldest
goods remaining in inventory.
 Valuation of stock - LIFO
In LIFO(last-in-first-out), the
assumption is made for costing
purposes that the last items of inventory
received are the first items to be sold.

Thus every time a sale is made, the

COGS is identified as representing the
cost of the newest goods remaining in
inventory.
Example:
At 1 January 2020 the company had 550 TV sets in inventory, valued at $350
each. During the year ended 31 December 2020 the following transactions took
place:

1 March Purchased 300 TV sets at $370 each

1 June Sold 570 TV sets for $228,000
1 August Purchased 480 TV sets at $400 each
15 December Sold 115 TV sets for $48,300

What is the value of the company’s COGS as at December 31, 2020 using:

1)FIFO method

2)LIFO method
 Valuation: Average cost
Under the weighted average cost formula, the cost of each item is determined from the
weighted average of the cost similar items at the beginning of the period and the cost of
similar items purchased or produced during the period.
Average cost per unit = Total cost of inventory / No. of units in inventory

For example:
Date Units Rate ($) Cost ($)
Opening Inventory 1 Jun 80 25 2 000
Purchase 1 3 Jun 280 30 8 400
Purchase 2 12 Jun 480 40 19 200
Purchase 3 20 Jun 180 35 6 300
1020 35 900

880 units were sold. Calculate COGS

How stock valuation method will influence profit?
Continuous inventory system
Under Perpetual (Continuous)
Inventory System changes in Inventory
are being tracked continuously and
Inventory account is being updated after
each transactions, either purchase, or
sale.
Perpetual inventory management
system allows to know at each moment
of time how many items were sold and
how many items are left in inventory.
This is precise system, which allows to
control all inventory movements.
Periodic inventory system
Periodic inventory system does not maintain a day-to day record of
inventories or of the cost of goods sold. The COGS and an updated
inventory balance are computed only at the end of the accounting period,
when a physical count of inventory is taken.
Cheaper in most situations than the costs of maintaining continuous
inventory records.

Even if there is a continuous inventory record, there will still be a need to

check the accuracy of the information on record by having a physical
check of some of the inventory lines.
Effect of Stock and adjustments
In P&L account COGS is treated as an expense item.

In Balance Sheet Closing inventory(Stock) is recorded under current

assets
Adjustments:
Opening inventory( Stock)
Dr Cost of Sales
Cr Inventory Asset
Closing inventory( Stock)
Dr Inventory asset
Cr Cost of sales
Lecture Roundup:
1.The cost of goods sold is calculated as:
Opening inventory + purchases – closing inventory.

2. Carriage inwards is included in the cost of purchases. Carriage outwards is a

selling expense.

3.Opening inventories brought forward in the inventory account are transferred to

the profit or loss account, and so at the end of the accounting year the balance on
the inventory account ceases to be the opening inventory value b/f and becomes
instead the closing inventory value c/f.

4.Cost can be arrived at by using first in, first out (FIFO), last in, first out (LIFO) or
weighted average costing (AVCO).
References:

1. Wood, F & Sangster, A (2005) Business Accounting 1, chapters 26, 29.

2. Dyson, J.R (2004) Accounting for Non-Accounting Students, chapter 4.

3. ACCA (2020) Approved Interactive Text. Foundations in Accountancy FFA

2019/2020. BPP Media Ltd, chapter 7,8