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ACCOUNTANCY FORM SIX TOPIC 4: STOCK VALUATION


 

TOPIC 4: STOCK VALUATION

Concept;

Stock/inventory;

The Tanzania statement of Accounting Guidelines No 2 which deals with the valuation of inventories in the context of the historical cost system states that the term stock/inventories include the following;

  1. Goods or other assets purchased
  2. Consumable stores/consumer goods
  3. Raw materials and components purchased for incorporation in its products for sale
  4. Products and services in intermediate stages of completion
  5. Finished goods
  6. Long-term contract balance
  7. Farms crops
  8. Livestock

CLASSIFICATION AND COST

  • Stock taking; Is the process of determining the quantities of all items of merchandize owned by the business firm at the certain date, usually at the end of accounting period. This involves the actual accounting, measure and weighing of all items of unsold merchandize (stock) in the store.
  • Inventories/stock is classified as assets (currents) in the balance sheet as it is expected that this stock will be sold and be replaced within one accounting period.
  • Accounting for inventories normally follows the cost concept which means stocks are recorded at acquisition cost or whichever is lower.

NOTE;

  1. All items of due stock belonging to the business even those in transit have been included in the inventory figure.
  2. All items of merchandize (stock) recorded in the inventory list are legally owned by the business.

STOCK COSTING METHOD

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

There are two stock/inventory systems which are;

  1. Perpetual stock system
  2. Periodic stock system

Certain assumptions are needed to be made on the flow of goods and their related costs.

  1. First in first out (FIFO); the assumption is that the oldest items in the stock are the first ones sold. Under this method, the ending inventory is assumed to be comprised of the latest purchases. This is a logical assumption for businesses dealing in perishable goods; FIFO represents a natural flow of merchandize.
  2. Last in first out (LIFO); the assumption is that, the most recent items in stock are the first ones sold. Example of these is fashionable goods. Under this method the ending stock is assumed to be comprised of the earliest purchases.
  3. Average cost (AVCO), the stock items has been intermingled, so that the goods sold and the ending stock consists of mixed units. Under this method a weighted average unit cost is calculated for all stock items.

W.A.C= Weighted Average Cost

W.A.C =  (Total cost purchase +  opening stock)/(Total unit)

PERIODIC METHOD

EXAMPLE

Date:purchases

1/1 =   100 units   @ 30/=

5/1 =     50 units   @ 40/=

10/1 =   40 units     @ 50/=

Sales = 2/1 = 90 units @ 60/=

6/1 = 40 units @  70/=

11/1 = 30 units @ 50/=

Required: By using periodic method calculate the value of closing stock by FIFO and LIFO

FIFO; total amount of sales → 160=90+40+30

Amount of purchases =      190  units= 100+50+40
Closing stock=190-160=30 units

30 x 50 = 1500

;. Closing stock of FIFO = 1500
NOTE: Closing stock by FIFO will be valued by the last units value to be purchased.

LIFO; Total amount of sales = 160

Amount of purchases → last in first out  190 =100+ 50 + 40

Closing stock = 190-160

30 x 30 = 900

:. Closing stock of LIFO = 900.
NOTE: Closing stock  by LIFO will be valued at 30@, the value of list units to be purchased

Workings

Total purchase

1/1/   100 units @30=  3000

5/1     50 units @ 40=  2000

10/1    40 units @ 50=  2000

7000

Total sales

2/1   90 units @ 60 =  5400

6/1   40 units @70 =    2800

11/1  30  units 50 =       1500

9700

Prepare financial statement for the year/period ending 31Jan.

Note: Using periodic method by FIFO, LIFO and WAC

  FIFO LIFO WAC
Sales 9700 9700 9700
Less: LOGS


  7000

(1500)

7000

(900)

7000

(1105)

LOGS 5500 6100 5895
Gross profit 4200 3600 3805
 



=36.84
Closing stock value=30 unitsx36.84
=1105

ILLUSTRATION 2

Sinza wholesaler deals in locally made door mats. During 199x, its records show the following transactions related to this particular merchandize.

Stock on hand at 31.12.199x was 70 units (650-580)

Total sales for the year was Tshs.250,000

Using a period inventory system

  1. First-in first-out (FIFO) method

The 70 units on hand will be assigned the following costs;

50 x 340 = 17,000 (Nov purchases).

20 x 330 =   6,600 (August purchases).

23,600

Note that in this method it is assumed that the ending inventory consists of units from the most recent purchases

The cost of goods sold will be calculated as follows;

Total purchases                             208,000

Less; ending inventory                   23,600

Cost of goods sold                        184,400

2. Last-in-first-out(LIFO) Method

The 70 units on hand will be assigned to the following costs;

60x 300 = 18,000 (Jan purchases)

10/70  x 310 = 3,100  (March purchases)

21,100

Note that in this method it is assumed that the ending inventory consists of units from the earliest

The cost of goods sold will be calculated as follows;

Total purchases                                          208,000

Less; Ending inventory                                 21,100

Cost of goods sold                                      186,900

3. Average cost (AVCO) method;

This method will use a weighted a average cost for the year calculated as follows;

Weighted Average cost = Total cost of purchases + opening stock

Tshs. 208,000/ =   320/=

650 units

The ending inventory will be assigned this cost which is 70 units @ shs. 320 = 22,400

The cost of goods sold will be;

Total purchases                                   208,000

Less; ending inventory                              22,400

185,600

-Note that the goods sold have the same shs. 320 unit cost (580 units. @ 320= 185,600).

COMPARISON OF INVENTORY COSTING METHOD UNDER PERIODIC SYSTEM


FIFO LIFO AVCO

shs shs shs
Sales 250,000 250,000 250,000
less ; cost of goods sold


Purchases 208,000 208,000 208,000
less ; Ending inventory 23,600 21,000 22,400

184,400 186,900 185,600

65,600 63,100 64,400

During the period of rising prices as in this illustration. The FIFO method results in the highest gross profit. This is due to assigning the most recent prices (Higher prices) to the ending inventory. This means the cost of goods sold is assumed to be from the earlier purchases (lower prices).

STOCK LEDGER CARD

  1. PERPETUAL SYSTEM OF INVENTORY

-Physical movement of stock.

ILLUSTRATION 3

On 2nd may, M.LTD received 500 units at 20/=

8th may received; 300 units at 22/=

10th issued 400 units at –

15th issued 200 units at –

20th received 600 units at 22/=

25th issued 300 units at –

27th received 200 units at 26/=

30th issued 100 units at –

Standard price for each unit for the month of May was 24/= each, market price of these materials on 3rd June is 27 per unit and 400 units were purchased on that day.

Calculate closing stock under periodic method applying FIFO, LIFO and Average cost (weighted average).

USING A PERPETUAL INVENTORY SYSTEM

  1. First-in-first-out (FIFO)Method

A stock record card for the door mats will be maintained as in the next and page.

                                                   STOCK CARD

DATE PURCHASES/ RECEIVED SALES/ISSUED BALANCE
  QTY UNIT COST TOTAL COST QTY UNIT COST TOTAL COST QTY UNIT COST TOTAL COST
2-May 500 20 10,000


500 20 10,000
8-May 300 22 6600


300 22 6600



16,600


800
16,600
10-May          –            –          – 400 20 8000 100 20 2000







300 22 6,600







400
8600
15-May          –            –              – 100 20 2000 200 22 4,400




100 22 2200









200
4,400
20-May 600 25 15,000              –              –                – 200 22 4,400







600 25 15,000







800
19,400
25-May              –              –              – 200 22 4400






100 25 2500 500 25 12,500







500
12,500
27-May 200 26 5200          –            –                  – 500 25 12,500







200 26 5,200







700
17,700
30-May              –            –                  – 100 25 2500 400 25 10,000







200 26 5,200







600
15,200


Purchases 36,800 COGS
21,600 600
15,200
  1. By LIFO method (Last In First Out)

                                                  STOCK CARD

DATE PURCHASES SALES BALANCE
  QTY UNIT COST TOTAL COST QTY UNIT COST TOTAL COST QTY UNIT COST TOTAL COST
2-May 500 20 10,000    –            –            – 500 20 10,000
8-May 300 22 6,600    –            –            – 300 22 6600







800
16,600
10-May        –            –                – 300 22 6600






100 20 2000 400 20 8,000







400
8000
15-May          –          –              – 200 20 4000 200 20 4,000










20-May 600 25 15,000        –            –              – 200 20 4,000







600 25 15,000







800
19,000
25-May          –                –                  – 300 25 7500 200 20 4,000







300 25 7,500







200 26 5,200







700
16,700
30-May        –                –                – 100 26 2600 200 20 4,000







300 25 7,500







100 26 2,600







600
14,100

3.By Average Method

Date Purchases/Received Sales/Issued Unicost Balance
Cash Unit cost Cost Q R   Q R Cost
2 May

8 May

500

300

20

22

10,000

6,600




500

300

20

22

10,000

6,600








800 20.75 16,600
10 May


400 20.75 8300 400 20.75 8300
15 May


200 20.75 4150 200

200

20.75

20.75

4150

4150

20 May 600 25 15,000


600 25 15,000







800 24 19,150
25 July


300 24 7200


27 May 200 26 5200


500

200

24

26

11,950

5200








700 24.5 17,150
31 May


100 24.5 2450


PURCHASES  36,000 Cost of goods sold 22,100 600 24.5 14,700

14,700= Closing stock

ESTIMATING STOCK

When a business firm does not maintain a perpetual inventory system, It has no way of determining the actual stock or inventory on hand unless the physical stock taking is done on a particular date. This will cumbersome and costly if it has to be done several times during an accounting period.

In order to avoid these inconveniences, the business will use an estimated figures its ending inventory.

There are occasions when it is necessary to estimate inventory. For-example when goods are lost or due to theft, a brokerage or natural deterioration or evaporation.

There are two common approaches to estimate stock;

  1. Gross profit method
  2. Retail method
  1. GROSS PROFIT METHOD

This method of estimation uses Gross profit margin or average mark up in order to determine the cost of goods sold (cost of sales).

*Margin = profit/selling price.

* Mark up = profit/cost price.

ILLUSTRATION 1

ABC LTD TRADING A/C FOR THE YEAR ENDED 30/06/2009

Sales 780,000

less; Return inwards  30,000 750,000




less; cost of goods sold


opening stock 120,000

Add; purchases 660,000 780,000




less; closing stock 180,000 600,000
Gross profit
150,000

Calculate;

  1. Gross margin in percentage
  2. Average mark up in percentage

Solution;

  1. Gross profit margin = profit/selling price x 100%

=     25%

ILLUSTRATION 2

Assume in illustration (i.) in the previous page during July, August, September ABC has made;

Purchases                                               240,000

Net sales                                                 350,000

Calculate inventory on 30th September, use gross profit method to estimate the

Given data;-

Stock as at 30th/6                                     180,000

Purchases                                                 240,000

Sales                                                       350,’000

Margin                                                         20%

Calculate closing stock.

sales
 350,000
Opening stock  180,000
Add ; purchases  240,000
cost of goods available for sale  420,000
less ; Closing stock 140,000
Cost of goods`sold

Gross profit
70,000



ILLUSTRATION 3

On 1st January 2004, J.M valued his stock at cost, 12,300. During the first week of January 2004, his transactions in his stock were as follows;

Purchases                                                8,100

Sales                                                       13,600

Returns inwards                                       800

Returns outwards                                     300

He sells his goods at 25% above cost of goods available for sale.

Calculate the cost of his stock at 7th January 2004

Sales
13,600
less ; Return inwards
800 12,800
less ; cost of goods sold


Opening stock 12300

Add ; purchases 8100


20,400

less ; Returns outwards 300

 Cost of goods available for sale 20100

less; closing stock 9860

Cost of goods sold.

10,240
 Gross profit

 2560

Gross profit P2?800x
Chane mark-up→Margin
25% →20%
20%x12,800→Gross profit Tshs 2560

RETAIL METHOD

  • This estimation technique is employed to business with large amount of stocks of relatively low unit’s values.
  • Usually all items are quoted at retail prices

Example of business using retail method is;

  1. Large chain store
  2. Supermarket

This method employs the following steps;

  1. obtain the cost of goods available for sale
  2. if sales figure is given taking the value of goods available for sale at retail the sales figure should give the value of closing stock at retail
  3. the value of closing stock at retail can be converted to an approximate cost figure by using the ratio of cost retail value worked out at (a) above.

ILLUSTRATION

On 1st June;                                                 COST                   RETAIL

Opening stock                                           180,000                   288,000

30th; purchases                                         145,000                    212,000

30th; sales                                                       รข”€                       170,000

Calculate;

  1. cost retail ratio
  2. closing stock at retail value
  3. Conversion of closing stock at retail value to cost.

Solution

Cost to retail ratio

COST                     RETAIL

Opening stock                                     180,000                  288,000

Add; purchases                                   145,000                  212,000

325,000                 500,000

Ratio = cost/Retail x 100

= 325,000 x 100

500,000

= 65%

Closing stock at retail value


COST RETAIL
Opening stock 180,000 288,000
Add; purchases 145,000 212,000

325,000 500,000
Less; Net sales
170,000
 Closing stock
330,000



Conversion of closing stock at retail value to cost

Closing stock = 330,000

65    x 330,000

100

= 214,000

Conversion of closing stock = 214,000

WEAKNESS OF ESTIMATION METHOD

  1. The stock estimation technique covered has assumed that the gross profit margin is stable in the period of estimation.
  2. They also assume that closing stock will be representative of all items which were available for sale.
  3. If these assumptions are not true, then misleading values will be produced.
  4. These techniques have to take accounts of realities encountered if they are to yield/ to get/to gain acceptable approximation.

On 1st April 2012; Stock at cost was                 30,000/=

Purchases           15,000/=

Sales                 10,000/=

The normal rate of Gross profit on cost price is 25% however it is known that allowances of 2,000/= have been made to customers.

Calculate;

– Closing stock estimate as at 30th April 2012.

Exercise 2.

Due to administrative reasons W.mahwa, the wholesaler, had to take his stock on 28th December 2004, on which date it was valued at cost at 73,260. The following transactions took place in the next 3 days.

  1. Sales book                               3400
  2. Cash sales                               1940
  3. Purchases book total             2310
  4. Returns inward book            220
  5. Returns outward book        170
  6. Carriage inward                    425

A detailed examination of the books also revealed the following information

  1. Sales book includes one invoice for 280/= against which goods were delivered on 2nd January 2005.
  2. Cash sales includes sales of an item that had a cost value of 42/= but was sold for 36/= as it has been damaged in store
  3. All purchases made had been dully received from supplier
  4. A customer returned books that has been invoiced to him at 80/= on 29th December 2004 but was issued with a credit loan on 3rd January 2005
  5. Carriage inward was paid in respect of goods bought in December 2004
  6. Stock with a cost value of 295/= had stayed in store for too long and estimated to have realizable value of only 178/=.
  7. Goods costing 126 were returned to a supplier on 30th December 2004 but the credit note was received four days later.
  8. No records have been made of drawings in the form of goods by the owner of this business, W. Mahwa of 203.
  9. The usual gross profit margin is 33% on cost.

Calculate the cost, net realizable value whichever is the lowest of the stock of 31st December 2004.

INSURANCE CLAIM

ILLUSTRATION 1

J.A has insured a stock for 10,000/=. On 31st March 2008 when the total cost value of stock in his store was 12,000, his store caught fire, the value of stock salvaged from fire was 3,000/=. Calculate the amount he can claim from the insurance company.

NOTES

If stock is not fully insured, that is if the value of stock in store is more than the sum insured, insurance company paid the following portion of the value of stock destroyed from fire

Insurance claim = 10,000  x 9,000

12,000

Insurance claim = 7,500

  • Owner J.A of the go down should claim 7,500 before his insurance company.

ILLUSTRATION 2

Stock on 31st March 2005 (last year end)        6200/=

Debtors on 31st March 2005 was                     4600/=

Creditors on 31st March 2005 was 5400

Receipt from debtors (1st April to 5th May) was  5700/=

Discount allowed to debtors                               100/=

Discount received from creditors                        180/=

Payment to creditors                                       5120/=

Stock donated to a charity (cost value)              340/=

Stock salvaged from fire                                   600/=

Gross profit margin 25% cost

Calculate;

  1. The cost value of stock in store on 5th May 2005 considering that on that day debtors amounted to 6500 and creditors to 4900.
  2. The amount to be claimed from insurance company

Solution; Exercise 2.

STOCK AS AT 28TH DECEMBER 2004

WORKINGS

  • NOTE (i)

Sort out all items concerning with sales

Cash sales                         1940

Credit sales                       3400

5340

Less; goods not delivered           280

5060

Less; damaged value                      36

Net sales                   5024

5024 x 75% =                 3768

Add; cost before damage         42

           COGS                             3810

NOTE (ii)

Stock with a cost value =       295

Less; Realizable value         =     (178)

Loss in value of stock                   117

ESTIMATION OF STOCK

Stock as at 28th December 2004
73,200
Add; purchases 2310
       Carriage inwards 425
(80 x 75%) 60
Cost of value of Return inwards

(220 x 75%) 165 2960


                                                                                                     76,160
Less; cost of goods sold .(note (i)) 3810
         Return outwards 126
         Return outward book value 170
         Drawings 203
Loss value in stock (note (ii)) 117 -4426
      Closingstock
  71743















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