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Inventory Valuation Methods for Accurate Financial Statements

Learn about FIFO, Weighted Average, and Periodic Weighted Average methods in maintaining financial records for accurate inventory valuation. Understand advantages and disadvantages of each method.

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Inventory Valuation Methods for Accurate Financial Statements

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  1. Maintaining Financial RecordsFA 2 B Amrith Thilan B.B.A, ACCA Passed Finalist

  2. ACCA - Maintaining Financial Records (FA 2) Inventory Valuation Aninventory valuation allows a company to provide a monetary value for items that make up their inventory. Inventories are usually the largest current asset of a business, and proper measurement of them is necessary to assure accurate financial statements.

  3. ACCA - Maintaining Financial Records (FA 2) Methods of Inventory Valuation • FIFO • Cumulative Weighted Average • Periodic Weighted Average

  4. ACCA - Maintaining Financial Records (FA 2) First in First Out (FIFO) Method FIFO method assumes that the goods that arrive first are the first to be used. Therefore the costing will also reflect this. Example : 12 March 20X4 : buy 1000 units @ $5 each 21 March 20X4 : buy 500 units @ $6 each 31 March 20X4 : sell 800 units @ $12 each

  5. ACCA - Maintaining Financial Records (FA 2) First in First Out (FIFO) Method (Cont) Solution : Units Sold = 800 x $12 = $9,600 Cost of Units Sold = 800 x $5 = $4,000 Cost of Remaining Units = (200 x $5) + (500 x $6) = $4,000

  6. ACCA - Maintaining Financial Records (FA 2) Cumulative Weighted Average The weighted average method is used to assign the average cost of production to a product. Every time units are added, a new average price is calculated. Any time goods are removed they are removed at the prevailing average. Example : 12 March 20X4 : buy 1000 units @ $5 each 21 March 20X4 : buy 500 units @ $6 each 31 March 20X4 : sell 800 units @ $12 each

  7. ACCA - Maintaining Financial Records (FA 2) Cumulative Weighted Average (Cont) Solution : Sales do not alter the average cost Receipts and sales are handled on a strict time basis

  8. ACCA - Maintaining Financial Records (FA 2) Periodic Weighted Average “Periodic" means that the Inventory account is not updated during the accounting period. Instead, the cost of merchandise purchased from suppliers is debited to an account called Purchases. At the end of the accounting year the Inventory account is adjusted to equal the cost of the merchandise that is unsold. The other costs of goods will be reported on the income statement as the cost of goods sold.

  9. ACCA - Maintaining Financial Records (FA 2) Periodic Weighted Average (Cont) The cost of goods used is given by : So, all units purchased will have the same cost.

  10. ACCA - Maintaining Financial Records (FA 2) Periodic Weighted Average (Cont) Example : 12 March 20X4 : buy 1000 units @ $5 each 21 March 20X4 : buy 500 units @ $6 each 31 March 20X4 : sell 800 units @ $12 each Solution : (1000 x $5) + ( 500 x $6) / (1000 + 500) = $5.33 per unit

  11. ACCA - Maintaining Financial Records (FA 2) Test Your Understanding Costing method, which calculates per equivalent unit cost of all production related work done till calculate date is termed as: A. Weighted average method B. Net present value method C. Gross production method D. Net present value method

  12. ACCA - Maintaining Financial Records (FA 2) Test Your Understanding

  13. ACCA - Maintaining Financial Records (FA 2) Advantages and Disadvantages of the Methods - FIFO Advantages • Permitted by accounting standards as an acceptable approach to inventory valuation. • Closing inventory has a value close to it’s replacement value • Might reflect physical use of stock Disadvantages • Requires care to get it right

  14. ACCA - Maintaining Financial Records (FA 2) Advantages and Disadvantages of the Methods – Average Stock Values Advantages • Averages out stock price fluctuations • Relatively easy to work out • Permitted by financial reporting standards

  15. ACCA - Maintaining Financial Records (FA 2) Other Inventory Valuation Issues Fundamental principle of IAS 2 is inventory must be stated at the lower of cost and net realizable value. Costs should include : Costs of purchase, Costs of Conversion and Other costs incurred in bringing the inventory to the present location and condition. Net realisable value is selling price less estimated cost of completion. Each line of inventory has to have its own cost/NRV comparison carried out separately.

  16. ACCA - Maintaining Financial Records (FA 2) Test Your Understanding Which of the following is a disadvantage of FIFO inventory valuation method ? • Permitted by the accounting standard • Reflects physical use of stock • Requires care to get it right • Closing inventory has a value close to it’s replacement value

  17. ACCA - Maintaining Financial Records (FA 2) Test Your Understanding Which of the following accounting standard is on “Inventory” ? • IAS 16 • IFRS 2 • IAS 1 • IAS 2

  18. Maintaining Financial RecordsFA 2 B Amrith Thilan B.B.A, ACCA Passed Finalist

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