Methods of inventory valuationSection 10Objectives 6 and 7

(a) List methods of inventory valuation(b) Calculate the value of closing

inventory(c) Assess the effect of different

methods of inventory valuation on profit

Methods of inventory valuation

• Reasons for valuing unsold inventory:• Business owners value unsold stock at

the end of each financial year so that he or she can calculate the gross profit or loss made on sales

• The ending inventory figure is needed to derive the cost of goods sold, as well as the ending inventory balance to include in a company's balance sheet.

• Look at the following video explaining the concept of ending inventory

Calculate Ending Inventory: Formula & Explanation

Study.com

http://study.com/academy/lesson/calculate-ending-inventory-formula-lesson-quiz.html

Methods of inventory valuation– Businesses may value year end inventory by

using different methods– It is important to value stock using the same

method. Using different methods, will produce large differences in calculating profits

– These methods are• First in first out (FIFO)• Last in first out (LIFO)• Weighted average cost (AVCO)

• This method assumes– that the first goods bought are the first

goods to be sold– The earliest goods purchased are the first to

be recognised as cost of goods sold– Ending inventory is calculated on the latest

units purchased– The latest prices used for the FIFO method

gives the highest valuation of stock and the highest gross profit

First in first out (FIFO)

• Look at the video on the next slide and watch FIFO Inventory method

FIFO inventory methodEducation Unlocked

https://www.youtube.com/watch?v=Wa83L8TvoaM

• This method assumes– That the last goods bought are the first goods

to be sold– The costs of the latest goods purchased are

the first to be assigned to cost of goods sold– Ending inventory is calculated on the oldest

units purchased– LIFO value inventory on older prices give the

lowest value on stock and profit

Last in first out (LIFO)

• Look at the video on the next slide and watch LIFO inventory method

LIFO Inventory method

Education Unlocked

https://www.youtube.com/watch?v=zLAvpS6o25E

• This method makes no assumption about the movement of stock.

• It assumes– That the goods available for sale have the

same average cost per unit– The goods available for sale is allocated on

the basis of the weighted average unit cost– The formula used to calculate the unit cost

is• Total value of goods on hand (goods available

for sale) ÷quantity of goods on hand

Weighted average cost (AVCO)

Methods of inventory valuation• The formula to determine the

value of closing inventory isAverage cost per unit x remaining units

Methods of inventory valuation• Look at the video on the next

slide on Average Cost inventory

Average Cost inventory methodEducation Unlocked

https://www.youtube.com/watch?v=qAWVVw-dC5A

Advantages of each of the inventory valuation methods

FIFO LIFO AVCO

1. Assumes that goods are issued in the order they are received

1. Assumes that goods received last are issued first

1. Makes no assumption about how goods are issued

2. Closing stock is valued on the most recent prices

2. Closing stock is valued on the earlier prices

2. Average price is mainly affected by the amount bought at the different price

• Disadvantages of each of the inventory valuation methods

FIFO LIFO AVCO

If prices are rising, closing stock is valued at the latest prices

If prices are falling, profits will be high

A new average must be calculated with every purchase