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Understanding Inventory Valuation Methods

Aug 30, 2024

Inventory Valuation Lecture Notes

Introduction

  • Focus on inventory valuation, an important and scoring chapter.
  • Exam questions can range from 5 to 10 marks.

Inventory Basics

  • Definition: Inventory is the stock of goods held for sale.
  • Types of inventory:

    • Trading Inventory: Goods purchased for resale.
    • Manufacturing Inventory: Includes raw materials, work in progress, and finished goods.

Trading Account & Gross Profit

  • Gross profit is calculated as Sales minus Cost of Goods Sold (COGS).
  • COGS includes all factory costs related to goods sold.

Inventory Valuation

  • Importance of valuing inventory to determine profit.
  • Methods of Valuation: Historical cost and Non-historical cost methods.

Historical Cost Methods

  1. Specific Identification Method

    • Used for unique, non-interchangeable items.
  2. FIFO (First-In, First-Out)

    • Assumes the oldest inventory is used first.
    • Calculate closing stock based on newest inventory.
  3. LIFO (Last-In, First-Out)

    • Assumes the newest inventory is used first.
    • Calculate closing stock based on oldest inventory.
  4. Simple Average Method

    • Calculate average of all purchase prices.
  5. Weighted Average Method

    • Considers both price and quantity for averaging.

Non-Historical Cost Methods

  • Adjusted Selling Price Method (Retail Inventory Method)
    • Used when individual item costs are unknown but selling price is known.
    • Calculate cost by subtracting profit percentage from selling price.

Calculation of Gross Profit Percentage

  • Calculate the percentage of profit on sales to determine inventory cost.

Inventory Taking

  • Inventory valuation can be adjusted based on market conditions.
  • Discussed inventory taking and adjustment methods.

Illustrations and Examples

  1. Illustration 8
    • Example of how to adjust and determine cost of goods sold and closing stock.
    • Consideration of normal and abnormal transactions affecting gross margin.

Conclusion

  • Inventory valuation is crucial for accurate financial reporting and profit calculation.
  • Understanding various methods and their applications is key for exams.