INVENTORY VALUATION (IAS 2) - [fifo lifo] accounting and cost accounting.

INVENTORY VALUATION

According to IAS 2 the following are the terms used

Inventories are assets:
•    Held for sale in the ordinary course of business.
•    In the process of production of such sale; or
•    In the form of materials or supplies to be consumed in the production process or in the rendering of services.

Inventories encompass

•    Goods or other assets purchased for resale;

•    Consumable stores;

•     Raw materials and components purchased for incorporation into products for sale.
•    Products and services in intermediate stages of completion;

•    Finished goods;

•    Long term contract balances;

•    Farm crops;

•     Livestock;

COST OF INVENTORIES

The cost of inventories should comprise:

. * all costs of purchase • costs of conversion and costs incurred in bringing the inventories to their present location and condition.

The cost of purchases will include the "purchase price, important duties, transport and handling costs and any other directly attributable costs less trade discounts, rebates and subsidies".

COST OF INVENTORIES

• Accounting for inventories normally follows the "cost concept" which means inventories are recorded at acquisition cost.

Classification Inventories in the statement of financial position

Inventories are classified as current assets in the statement of financial position as it is expected that this merchandise will be sold and replaced within one accounting period.

Measurement

•  Inventories should be measured at the lower of cost and net realizable value.
•   NET REALIZABLE VALUE Is the estimated selling price in the ordinary course of business less estimated cost of completion and the estimated costs necessary to make the sale.

illustration(comment for link)

INVENTORY VALUATION SYSTEMS

The two principal inventory systems are:

A. Periodic - System of inventory control in which no continuous record of changes (receipts and issues of inventory items) is kept.

B. perpetual - System of inventory control in which the number of units of any inventory item (and the total value of inventory) on any day can be obtained from the stock records. In this method (1) all additions (purchases) and withdrawals (sales or consumption) are recorded in inventory cards as they occur to provide a running balance of quantity and cost of items,

INVENTORY VALUATION SY...CONT.

• The perpetual inventory system is often used by trading firms with fewer sales transactions of merchandise with relatively high unit cost. For example; motor vehicles, office equipment, household appliances, furniture, etc.

PHYSICAL STOCKTAKING

• Physical stocktaking or the taking of a physical inventory of merchandise is the process of determining the quantity of all items of merchandise owned by the business firm at a certain date, usually the end of the accounting period. This involves the actual accounting, measuring and weighing of all items of unsold merchandise in the store, shop or warehouse.

INVENTORY COSTING METHODS

• After determining the quantity of the merchandise inventory at the end of the accounting period, (the balance sheet date), the next step is to assign a cost to each item of merchandise in order to arrive at the value of the ending inventory to be presented in the financial statements.

INVENTORY COSTING METHODS

• There are four inventory costing methods

A. First in First Out method—(FIFO)

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

B. Last in First Out—(LIFO)

Assumes that the items of inventory which were purchased or produced last are sold first, and consequently the items remaining in the inventory at the end of the period are those first produced or purchased, 

C. Specific Identification method

INVENTORY METHOD RECOMMENDED BY IAS 2

                       

• IAS recommends use of FIFO and AVCO and Prohibit the use of LIFO method.

                       

• LIFO method allocates cost on the basis of earliest purchases first and only after inventory from earlier purchases are issued completely is cost from subsequent purchases

TOTAL                        allocated Therefore value of inventory using

LIFO will be based on outdated prices. This is the reason the use of LIFO method is not allowed for under IAS 2

ESTIMATING INVENTORIES

  

       A.     Companies often require interim statements (financial statements prepared for periods of less than one year),             but they only annually take a physical count of inventory.

     B.     Companies may require an inventory estimate if some casualty such as fire or flood makes taking a physical count impossible.

• Companies sometimes need to determine the value of inventory when a physical count is impossible or impractical. Inventory sometimes requires estimation for two reasons.

WAYS OF ESTIMATING INVENTORIES

• Two ways of estimating inventory levels are the gross profit method and the retail inventory method.
a. Gross profit method. The gross profit method estimates the value of inventory by applying the company's historical gross profit percentage to current-period information about net sales and the cost of goods available for sale.

b. Retail inventory method. Retail businesses track both the cost and retail sales price of inventory. This information provides another way to estimate ending inventory.
-The procedure for determination under this method is as follows:
1. Beginning inventory and purchases must be recorded at both cost and selling prices.

2.    Total goods available for sale are then computed on both bases (at cost and Retail prices).

3.    Work out ratio of cost to retail value
4.    Sales for the period are deducted from the goods available for sale at selling price.( Ending inventory at selling/retail price)
5.    The value of ending inventory at cost will be determined by converting ending inventory at retail by ratio of cost to retail value.

DIFFERENCES BETWEEN GROSS PROFIT AND RETAIL METHOD

*    The major difference between the gross profit method and the retail method is that the former uses the historical gross profit rates, and the latter uses the percentage markup from the current period.
•    The gross profit method uses past experience as a basis, whereas the retail method uses current experience. The gross profit method is usually less reliable, because past situations may be different from current ones.

DIFFERENCES BETWEEN GROSS PROFIT AND RETAIL METHOD

• Both Gross Profit and Retail Inventory Method are useful because they allow the accountant to prepare interim financial statements more frequently without taking the time to physically count the inventory.
^! However, the annual physical count is always necessary.