FB563: Intermediate Management Accounting

Lecture 2

Material (inventory) Valuation and Process

Costing
Ian Tomlinson
i.tomlinson@ucfb.com
Aims and Objectives

• Understand (Material) Inventory calculations requirements

• Be able to calculate inventory using FIFO, LIFO and AVCO
• Analyse the different methods
• Understand the need for process costing
• Know some key definitions with regards to process costing
Stock Valuation

• Inventory /Material that changes in cost but is identical and

cannot be differentiated

• Can be valued in different ways

We have strict standards on this…

• IFRS102 is the main financial reporting standard that UK businesses must comply with
and it is line with current UK GAAP (Generally Accepted Accounting Principles) which
are based on International Accounting Standards.
• Companies Act 2006 says we must comply with current UK accounting Standards.
IAS 2 – Cost of Inventory

Fundamental principle of IAS 2

CONSERVATIVE
• Inventories are required to be stated at the lower of cost and net realisable value
(NRV).
• Cost should include all-:
• costs of purchase (including taxes, transport, and handling) net of trade discounts received
• costs of conversion (including fixed and variable manufacturing overheads) and
• other costs incurred in bringing the inventories to their present location and condition.
First in first out (FIFO)

• Assumes that the first goods purchased will be the first ones to be issued for use/sale

In Hold Issued
FIFO – advantages

• Realistic
• Easy to use by everybody
• Issue prices based on the prices that have actually been paid for the stock
• Closing stock valuation at most recent prices paid
• Acceptable method for inland revenue purposes, IAS2 and Companies Act 1985
FIFO – Disadvantages
• Issues from stock are not at the most recent
prices and this could influence the costing of work

• In times of rising prices, FIFO shows higher profit

figures earlier, goes against concept of prudence

• Can be cumbersome as list prices need to be

maintained
Last in first out (LIFO)

• Assumes that the goods received most recently will be the first ones issued for use

IN
Holding Issued
OUT
LIFO – advantages

• Value of closing stock is based on the prices actually paid for the stock
• Issues are valued at the most recent prices
• Easy to calculate
LIFO – disadvantages

• It is less realistic than FIFO since it assumes that most recent purchases will be
issued before the older stock
• Illogical
• Most recent prices are not used for stock valuation
• Closing stock not usually at most recent prices
• It is unacceptable for taxation purposes and under IAS2
Weighted average cost
(AVCO)

• Recalculates the average cost of goods held in stock each time a new delivery of
stock is received.
• Issues are then made at the weighted average cost
AVCO – advantages

• Prices are averaged so it recognises that issues from stock have equal value to the
business
• Variations in issue prices are minimised, marked changes are ironed out
• It allows comparison of profit figures to be made on a more realistic basis
AVCO – advantages

• Closing stock valuations are fairly close to the latest prices paid

• It is an acceptable basis for the purposes of IAS2 and the Companies Act 1985
AVCO – disadvantages

• It requires a new calculation each time stock is purchased

• The price charged for issues will not agree with the price paid to purchase the
stock
 Example Question
• Prepare LIFO and FIFO stores ledgers for Product X

• 10 units bought Jan 2016 at a cost of £2 each

• 20 units bought in Feb at a cost of £3 each

• 16 units issued in March

Store Card
Store Card LIFO
Receipts Issues Balance
Date Quant Price Value Quant Price Value Quant Price Value
2016
Jan 10 2 10 2 20
Feb 20 3 10 2 20
20 3 60
30 80
March 16 3 48 10 2 20
4 3 12
14 32
Store Card FIFO
Receipts Issues Balance
Date Quant Price Value Quant Price Value Quant Price Value
2016
Jan 10 2 10 2 20
Feb 20 3 10 2 20
20 3 60
30 80
March 10 2 20
6 3 18 14 3 42
Question

• Prepare LIFO and FIFO stores ledgers for Product X

• 20 units bought Jan 2017 at a cost of £3 each
• 10 units bought in Feb at a cost of £3.50 each
• 8 units issued in march
• 10 units bought in April cost of £4 each
• 16 Units sold in May
LIFO
Receipts Issued Balance
Date Quant Price Value Quant Price Value Quant Price Value

Jan 20 3 60 20 3 60

Feb 10 3.5 35 20 3 60
10 3.5 35
30 95

Mar 8 3.5 28 20 3 60
2 3.5 7
22 67

Apr 10 4 40 20 3 60
2 3.5 7
10 4 40
32 107

May 10 4 40 16 3 48
2 3.5 7
4 3 12
FIFO
Date Quant Price Value Quant Price Value Quant Price Value

Jan 20 3 60 20 3 60

Feb 10 3.5 35 20 3 60
10 3.5 35
30 95

Mar 8 3 24 12 3 36
10 3.5 35
22 71

Apr 10 4 40 12 3 36
10 3.5 35
10 4 40
32 111

May 12 3 36 6 3.5 21
4 3.5 14 10 4 40
16 61
Process Costing

• A method of costing used in Manufacturing where there is Mass production

through one or more processes.

Process • Cost
• Note it is the process that is costed
1

Process • Cost
2

Process • Cost per Unit

to pass on to
3 customer
Calculating

• The total costs of all processes are averaged over the units of production

• Cost per Unit = Costs of Inputs

Expected output in Units
Normal Loss

“This is the term used to describe normal expected wastage under usual operating
conditions. This may be due to reasons such as evaporation, testing or rejects.”
ACCA 2011
Abnormal Loss or Gain

“Abnormal loss This is when a loss occurs over and above the normal expected loss.
This may be due to reasons such as faulty machinery or errors by labourers.”
ACCA 2011

“Abnormal gain This occurs when the actual loss is lower than the normal loss. This
could, for example, be due to greater efficiency from newly-purchased machinery.”
ACCA 2011
So it is important to
• Manage your inventory to keep costs low.

• A business aims to hold the optimum stock level to minimise costs whilst ensuring
efficient production and uninterrupted sales.

• Systems such as Just in Time (J.I.T) are popular – you don’t want to keep too much
stock but you don’t want to run out either – you want to arrive just in time so it can go
onto the production floor or is there ready to ship to the customer.
• We want a small buffer stock and want to set up systems so that we re-order in
time given the time is takes our supplier to get materials to us (Lead-time)

• There are various models to this- Economic Order Quantity Model, Maximum and
Minimum stock levels and Re-order levels.
Questions
Reading
• Bhimani, A., Horngren, C., Datar, S., and Rajan, M. (2015) Management and Cost
• Accounting. 6th edn. Harlow: Pearson. Chpt 4
• Drury, C. (2015) Management and Cost Accounting. 9th edn. London: Cengage.
Chpt 5
• Horngren, C., Sundem, G., Stratton, W., Burgstahler, D., and Schatzberg, (2016)
• Introduction to Management Accounting. Harlow: Pearson. p709-pp714
 Seminar

• Using Spreadsheets

• Looking at costing questions

Question 1

• Jan Opening Stock 50 Units at £2 each

• Feb bought 10 at £3
• Mar sold 36 at £4.60
• Apr bought 10 at £3.50
• May Sold 25 at £5

• What will be the effect on profit using each method?

Question 2

• Jan Opening Stock 40 Units at £3 each

• Feb bought 20 at £3.60
• Mar sold 36 at £6
• Apr bought 20 at £3.75
• May Sold 25 at £6

• What will be the effect on profit using each method?