The document discusses different methods for valuing inventory, including specific identification, FIFO, LIFO, average cost, retail, and gross profit methods. It compares the LIFO and FIFO methods, explaining that LIFO matches current costs to current revenues while FIFO provides a better measure of inventory value. The document also discusses the impact of errors in inventory valuation and how inventory value should be reported and disclosed in financial statements.

1. Our learning in the Previous Class…

2. We learnt …

3. What costs to be included in inventory?

4. General Rule… The cost of inventories should comprise all costs of purchase , costs of conversion and other costs incurred in bringing the inventories to their present location and condition.

5. COSTS OF PURCHASE… Cost of purchases includes all those expenses that are incurred to bring the raw material at the desired location.

6. COSTS OF CONVERSION … It includes all those expenses that are incurred to convert raw material into work-in-progress and finally, into finished goods. Such a cost is generally called CONVERSION COST. Conversion Cost includes… Direct Labour Cost Indirect Labour Cost (Production) Other fixed production overheads – Fixed or Variable.

7. COSTS OF CONVERSION … Costs of Conversion do not include… Storage Costs , unless those costs are necessary in the production process prior to a further production stage. Administrative Overheads that do not contribute to bringing the inventories to their present location and condition. Selling and Distribution Costs.

8. OTHER COSTS … Other costs are included in the cost of inventories only to the extent that they are incurred in bringing the inventories to their present location and condition.

9. What are inventory systems?

10. If we record transactions related to inventory INSTANTANEOUSLY , then we are using a System of Inventory which is known as … PERPETUAL INVENTORY SYSTEM

11. And, if we are recording transactions related to inventory periodically then, it is called … PERIODIC INVENTORY SYSTEM .

12. How to find the Value of Inventory ?

13. The issue of Inventory Valuation requires… … an assumption about the flow of inventory so that we can judge the flow of cost of inventory!!!

14. COST FLOW ASSUMPTIONS … Four assumptions are made with regard to inventory cost flow: Specific Identification, FIFO , LIFO , and Average Cost .

15. Any question?

16. Now, let’s proceed further…

17. Inventory Cost Flow Methods FIFO The oldest units are sold and the newest units remain in inventory. The cost of the oldest units purchased is transferred to COGS. LIFO The newest units are sold and the oldest units remain in inventory. The cost of the most recent units purchased is transferred to COGS. Average Cost An average cost is computed for all inventory available for sale during the period. COGS is computed by multiplying the number of units sold by the average cost per unit.

18. Compare Inventory Methods: General LIFO gives a better reflection of COGS in the income statement. Therefore, LIFO is a better measure of income. FIFO gives a better measure of inventory on the balance sheet. Therefore, FIFO is a better measure of inventory value.

19. Compare Inventory Methods – During Increasing Prices LIFO provides a proper value of COGS in the income statement and Profits are less. But, it provides undervaluation of inventory on Balance Sheet. It undervalues COGS and provides MORE profit. FIFO provides proper value of inventory in the balance sheet.

20. Compare Inventory Methods – During Decreasing Prices LIFO provides lower value of COGS in the income statement and Profits are more. But, it provides higher value of inventory on Balance Sheet. It provides higher COGS and provides less profit. FIFO provides lower value of inventory in the balance sheet.

21. Interesting things about LIFO ?

22. LIFO Layers Any year in which the number of units purchased exceeds the number of units sold, a new LIFO layer is created in ending inventory. The creation of LIFO layers results in ending inventory at very old prices

23. LIFO Layers Example 20 units from 2004 + 30 units from 2005 20 units from 2004 + 30 units from 2005 + 40 units from 2006

24. LIFO Reserve The difference between the LIFO ending inventory amount and the amount obtained using another method (e.g., FIFO or average cost) Disclosed to aid in comparing companies that use different inventory cost flow assumptions

25. LIFO Liquidation Occurs when the number of units purchased does not exceed the number of units sold. The old LIFO layer costs to flow through cost of goods sold, reducing cost of goods sold and increasing net income

26. Other Methods of Inventory Valuation ?

27. Other Methods of Inventory Valuation… Retail Method Gross Profit Method Standard Cost Method

28. Retail Method Occasionally used for interim period reporting. Needed information includes: Beginning inventory at cost and retail. Net purchases at cost and retail. Net sales.

29. Retail Inventory Method Step 3 Cost to retail ratio Ending inventory at retail Estimated ending inventory at cost = × Step 2 Goods available for sale at retail Goods available for sale at cost = ÷ Cost to retail ratio Step 1 Net sales at retail Goods available for sale at retail – = Ending inventory at retail

30. Retail Inventory Method

31. Retail Inventory Method

32. Retail Inventory Method

33. Gross Profit Method Estimate ending inventory by applying the gross profit ratio to net sales at retail. Useful when inventories have been destroyed, lost or stolen.

34. Example: Gross Profit Method Assume the following data: Beginning inventory, January 1 Rs. 25,000 Purchases, January 1 through January 31 40,000 Sales, January 1 through January 31 50,000 Historical gross profit percentage 40%

35. Gross Profit Method Sales (actual) Rs. 50,000 100% Gross profit (estimate) Rs. 20,000 40% Cost of goods sold (estimate) Rs. 30,000 60% Beginning inventory (actual) Rs. 25,000 + Purchases (actual) 40,000 = Cost of goods avail for sale (actual) 65,000 = Ending inventory (estimate) 35,000 - Cost of goods sold (estimate) 30,000

36. Standard Cost Method Standard costs take into account normal levels of consumption of materials and supplies, labour, efficiency and capacity utilisation. They are regularly reviewed and, if necessary, revised in the light of current conditions. Under this method, the cost of goods sold/issued is calculated at the standard cost and at the end, any variance, if any, needs to be adjusted.

37. What are the impact of ERRORS in Inventory Valuation ?

38. Ending Inventory Errors If ending inventory is ... Cost of Goods Sold is ... Profit is ... Overstated Understated Overstated Understated Overstated Understated

39. How to REPORT Value of Inventory in Financial Statements ? Indian Accounting Standard – AS 2

40. AS-2 Use Specific Identification Method If Specific Identification Method is not applicable the, then the cost of inventories can be determined through – FIFO Weighted Average Cost When it is impractical to calculate, the following methods could be used- Standard Cost Method Retail Method

41. Remember, The value of Closing Inventory in the Balance Sheet is always to be shown at the cost or the Net Realizable Value.

42. How to DISCLOSURE Value of Inventory in Financial Statements ?

43. Disclosure The financial statements should disclose: (a) the accounting policies adopted in measuring inventories, including the cost formula used; and (b) the total carrying amount of inventories and its classification appropriate to the enterprise.