STOCK VALUATION

STOCK
Stock (which is also known as inventory)consists of : - Raw materials-goods not yet processed - Work-in progress-partly completed goods - Finished goods- ready for sale The relative proportion's of each time of stock will vary with the type of enterprise. Retailers stock consists mainly or even exclusively of finishing goods. Firms that manufacturer to order will carry little in the way of some finished goods. Where the production is short , there will be little work in progress.

WHY VALUE STOCK?

Stock needs to be valued for

Costing purpose To calculate cost of sales and therefore profit For the construction of a balance sheet in which stock features as a current asset.

The overriding principle is that stock should be valued at the lower of cost of acquisition or net realizable value.

STOCKS AND THE BALANCE SHEET

The balance sheet records the value of stocks at the time the balance sheet was drawn up The problem is that the stock was bought in batches over time and probably at different prices Which value should we use? The choice of method will affect the value of stock recorded in the balance sheet It will also affect the following aggregates in the balance sheet : current assets , net current assets net assets

STOCKS AND THE P&L ACCOUNT

The cost of sales is a negative item on the P&L Account Cost of sales is equal to - Opening stock - Plus purchases - Less closing stock Again the problem is what value to place on the stock when it is purchased at different prices over year. The choice of method will affect the firms declared profits.

METHODS OF STOCK VALUATION

These are methods used to ascertain the year end valuation of stocks: - FIFO :- first in first out - LIFO :- last in first out - AVCO:- weighted average cost If stock is bought in at the same price throughout the year the choice of method is immaterial. In practice , stock is likely to be bought in at different prices over the year.

FIFO FIRST IN , FIRS OUT

This assume that stock is issued in the order in which it is delivered so that remaining stock is valued at the most recent prices. Stock is valued in terms of the earliest batch until all that batch has been used up then it will be valued at he price of the next batch and so on. Issues of stock (cost of good sold ) are based on the cost of oldest remaining stock at the time of issue. This means that closing stock value is based on the most recent stock. This is acceptable to tax authorities because cost are related to those actually incurred and closing stock value is close to current market price.

LIFO LAST IN , FIRST OUT

Assumes is valued that the more recent deliveries are issued first so that closing stock is values at older purchase prices. As the most recent stock is used up , the remaining stock is made up earlier purchases made at older prices. Cost of good sold (issues from stock) is based on the cost of the most recent purchases. Issues are valued at the latest stock price it is all used up - then valuation is based on the next earliest batch . Closing stock is valued on the cost of the oldest goods available. LIFO is not acceptable for tax purpose because it understates profitability.

AVCO- AVERAGE COST

This is the method of stock valuation based on a weighted average of values of stock received over the account period It involves calculating and re-calculating the average cost of total stock every time a new deliver is received Average cost =total stock value/no. units in stock Weighting the average mean taking into account the relative quantities involved Because issues are at average cost, it follow the closing stock should be valued on the same average cost basis

HOW DO WE CALCULATE THE VALUE OF THE CLOSING BALENCE

March 1st 10th Receipts 50 @ 5 25units Issues Balance 50units 25units

19th
22nd 25th 27th

60@ 6
40units 60@ 7 55units

85units
45units 105units 50units

USING ON FIFO

The last stock figure is 50 units-the value of this 50 units will be recorded in an end of the period balance sheet and will be closing balance in the calculation cost of sales What value should we place on the 50 units? On the FIFO principle we assume that the whole of the march 1st and march 19th batches have been used up in the three stock issues recorded The closing balance consist of 50 units of the final batch Valuation :50*7=350

USING LIFO

Half the first batch of the 50 units had been used up on the 10th march 40 out of 60 from the second batch was use up on the 22nd All but 5 units of the final batch was used up on 27th march The closing balance consist of the residue from -march 1st -25 units @5 -march 19th -20 units @6 -march 27th -5 units @7 On the principle of the valuing of the oldest remaining stock we conclude that the value of the closing balance is 125+120+35=280 notice that the closing stock figure is lower than when using FIFO

USING AVCO
AVCO calculation is more complex since they are continually updated Stock is issued At the weight average cost and this impacts upon the weight average in the next round of the calculations

USING AVCO
March 1st 10th receipts 50@ 5 25 issues Balance 50units 25units

19th
22nd 25th 27th

60@ 6
40 60@ 7 55

85units
45units 105units 55units

USING AVCO
March 1st 10th 19th The first batch is value at 50@ 5=250 Half of the batch has issue to leaving 25 units in stock valued at 5 per units The second batch is purchased at 6 per units. The total value of the stock is(6*60)+(5*25)=485 or 5.71 per units 40 units are issued at the average price from 19th march. This leave 45 units @ 5.71 or 256 A batch is purchased at 7 per units. Total value of stock is now 256+420=676 or 6.44 per units. The final issue is made at the above average price per units and it leaves 50 in stock. The total value= 50 * 6.44=322

22nd 25th 27th

COMPARING THE RESULTS

THE CLOSING BALANE WERE AS FALLOWS: -FIFO -350 -LIFO -280 -AVCO-322 As it is based on an average its is not surprising that AVCO figures is between the other two. Remember that the closing figure appears as a current balance on balance sheet and as a positive item in the profit and loss account. The choice of the stock valuations method will impact on the asset value in balance sheet and on the profit figure in the profit and loss account

FIFO
Advantages Realistic and logical Assuming good and valued in order of receipt Easy to calculate closing stock Closing valuation is at the most recent price Acceptable under SSAP 9 and for tax purposes Ensures balance sheet and stock valuation is more accurate Disadvantages Price at which good are issued are not necessarily the latest prices The cost of production is related to out of date prices In time of rising price profit will be shown as being higher This goes against the concept of prudence And increase tax liability

LIFO
ADVANTAGES Goods are issue at most recent prices Production is charged with costs that are close to current economic values DISADVANTAGES Logical assume are issue in reverse order from that in which they are received Closing stock not usually at the most recent priceclosing valued at out of date prices Not acceptable for tax purposes When stock are being run down, issues will dip into old stock at out of date prices

AVCO
ADVANTAGES DISADVANTAGES

Smoothes profit over a number Difficult to calculate of accounting period Issues and stock valuation may Fluctuation in purchased price be at prices which never existed are evened out Issues may not be at current Logical same unit bought at prices ans in times of inflation different time have the value will be below current prices Closing stock valuation close to current market value

IN TIME OF INFLATION
FIFO Shows lower cost Gives a higher value for closing stock Ensure that stock is value at recent prices on the balance sheet LIFO Shows higher cost. Gives a lower value for closing stock Gives a lower value for profits Undervalues stock on the balance sheet