ILLUSTRATION 4:- On the basis of the data given in illustration 1 and 2, calculate the weighted average price and also the value of closing inventory by weighted average price method.
The computation of weighted average price in the referred example is shown below:
A new average rate would be calculated on receiving a fresh consignment. Answer on that basis would be as under:
Perpetual and Periodic Inventory System and Average Methods of Cost of Inventory
Both Simple Average Method and Weighted Average Method are applied differently in case the entity uses periodic inventory taking or Perpetual inventory taking. In case of periodic inventory taking inventory available for sale during the period is considered together and an average rate is computed and closing inventory is valued using that rate. In case perpetual inventory records are maintained average rate of inventory is computed on each new purchase and next issue is recorded using new average rate.
Illustration 4 above is an example of Weighted average method used in perpetual inventory recording system. In case the entity would have been using periodic inventory recording system, closing inventory would have been valued as below:
Details of purchases/receipt during the period
Accordingly, closing stock of 1,000 pcs. would have been valued at 51,190 @ ₹51.19 per unit.
5.2 NON-HISTORICAL COST METHODS :-Non-historical cost methods do not consider the historical cost incurred to acquire the goods. Non- historical cost methods include Adjusted Selling Price method and Standard Cost method. Adjusted Selling Price method can be explained as follows:
(i) Adjusted selling price method:- This method is also called retail inventory method. It is used widely in retail business or in business where the inventory comprises of items, the individual costs of which are not readily ascertainable. The use of this method is appropriate for measuring inventories of large numbers of rapidly changing items that have similar margins and for which it is impracticable to use other costing methods. The cost of the inventory is determined by reducing from the sales value of the inventory an appropriate percentage of gross margin. The percentage used takes into consideration inventory which has been marked below its original selling price. An average percentage for each retail department is often used. The calculation of the estimated gross margin of profit may be made for individual items or groups of items or by departments, as may be appropriate to the circumstances.
ILLUSTRATION 5:- M/s X, Y and Z are in retail business, following information are obtained from their records for the year ended 31st March, 2016:
Find out the historical cost of inventories using adjusted selling price method.
Determination of cost of purchases:-
Determination of estimated gross profit margin:-
ILLUSTRATION 6:- From the following information, calculate the historical cost of inventories using adjusted selling price method:
Calculation of gross margin of profit:-
Rate of gross margin =
Cost of closing inventory = 50,000 less 20% of ₹50,000 = ₹40,000
(ii) Standard cost method:- This method is used when there is frequent change in the price per unit of the goods and goods are purchased frequently by the business e.g. crude oil. Based on the experience a standard cost is determined on the basis of frequent changes in prices and inventory is valued on that price per unit.
6. INVENTORIES TAKING:- Normally all operations are suspended for one or two days during the financial year and physical inventory is taken for everything in the godown or the store periodically. For the year-end inventory valuation, physical inventory taking is done during the last week of the financial year or during the first week of next financial year. If inventory taking is finished on 26th March, whereas accounting year ends on 31st March purchases and sales between 26th and 31st March are then separately adjusted. Later, a value is put on each item. The principle of cost or Net realizable value, whichever is lower, is applied either for the inventory as a whole or item by item.
Normally, enterprises prefer to perform inventory taking closing day, however, sometimes inventory taking cannot be carried out on the closing day. It is carried out a few days later or sometimes even a few days earlier. In such a case, the actual value of the inventory must be so adjusted as to relate it to the end of the year concerned. For doing so, it will be necessary to take into account the goods that have come in (purchases and sales returns) and those that have gone out (sales and purchase returns) during the interval between the close of the year and the date of actual inventory taking. Further, the adjustment of all goods must be on the basis of cost. Suppose, a firm that closes its books on 31st December, carried out the inventory taking on the 7th January next year and actual inventory was of the cost of ₹7,85,000, during the period January 1 to 7 purchases were ₹1,53,000 and sales ₹2,50,000, the mark up being 25% on cost. The inventory on 31st December would be ₹8,32,000 as shown below:
From the following particulars ascertain the value of Inventories as on 31st March, 2017:
At the time of valuing inventory as on 31st March, 2016, a sum of ₹17,500 was written off on a particular item, which was originally purchased for ₹50,000 and was sold during the year for ₹45,000. Barring the transaction relating to this item, the gross profit earned during the year was 20 percent on sales.
Statement of Inventory in trade as on 31st March, 2017
ILLUSTRATION 8:- A trader prepared his accounts on 31st March, each year. Due to some unavoidable reasons, no inventory taking could be possible till 15th April, 2017 on which date the total cost of goods in his godown came to ₹5,00,000. The following facts were established between 31st March and 15th April, 2017.
(i) Sales ₹4,10,000 (including cash sales ₹1,00,000)
(ii) Purchases ₹50,340 (including cash purchases ₹19,900)
(iii) Sales Return ₹10,000.
Goods are sold by the trader at a profit of 20% on sales.
You are required to ascertain the value of inventory as on 31st March, 2017.
Statement of valuation of Inventory on 31st March, 2017
Inventory taking for the year ended 31st March, 2016 was completed by 10th April 2016, the valuation of which showed a inventory figure of ₹16,75,000 at cost as on the completion date. After the end of the accounting year and till the date of completion of inventory taking, sales for the next year were made for ₹68,750, profit margin being 33.33 percent on cost. Purchases for the next year included in the inventory amounted to ₹90,000 at cost less trade discount 10 percent. During this period, goods were added to inventory at the mark up price of ₹3,000 in respect of sales returns. After inventory taking it was found that there were certain very old slow moving items costing ₹11,250, which should be taken at ₹5,250 to ensure disposal to an interested customer. Due to heavy flood, certain goods costing ₹15,500 were received from the supplier beyond the delivery date of customer. As a result, the customer refused to take delivery and net realizable value of the goods was estimated to be ₹12,500 on 31st March. Compute the value of inventory for inclusion in the final accounts for the year ended 30th March, 2016.
SOLUTION:- Statement showing the valuation of Inventory as on 31st March, 2016
ILLUSTRATION 10:- The following are the details of a spare part of Sriram mills:
Find out the value of Inventory as on 31-3-2016 if the company follows First in first out basis.
First-in-First out basis
Therefore, the value of Inventory as on 31-3-2016: 50 units @ ₹40 = ₹2,000
The following are the details of a spare part of Sriram Mills:-
Find out the value of Inventory as on 31-3-2016 if the company follows Weighted Average basis.
SOLUTION:- Weighted Average basis
Therefore, the value of Inventory as on 31-3-2016= 50 units @ ₹38 = ₹1,900
Historical Cost Methods
Non-Historical Cost Methods
There are two principal systems of determining the physical quantities and monetary value of inventories sold and in hand. One system is known as 'Periodic Inventory System' and the other as the 'Perpetual Inventory System'.
TEST YOUR KNOWLEDGE:-
Ques 1: The amount of purchase if
Cost of goods sold is ₹80,700
Opening Inventory ₹5,800
Closing Inventory ₹6,000
Ques 2: Average Inventory = ₹12,000. Closing Inventory is ₹3,000 more than opening Inventory. The value of closing Inventory = ______.
Ques 3: While finalizing the current year’s profit, the company realized that there was an error in the valuation of closing Inventory of the previous year. In the previous year, closing Inventory was valued more by ₹50,000. As a result
(a) Previous year’s profit is overstated and current year’s profit is also overstated
(b) Previous year’s profit is overstated and current year’s profit is understated
(c) Previous year’s profit is understated and current year’s profit is also understated
Ques 4: Consider the following for Q Co. for the year 2015-16:
Cost of goods available for sale ₹1,00,000
Total sales ₹80,000
Opening inventory of goods ₹20,000
Gross profit margin on sales 25%
Closing inventory of goods for the year 2015-16 as
Ques 5: Average Inventory = ₹12,000. Closing Inventory is ₹3,000 more than opening Inventory. The value of closing Inventory = ______.
Ques 6: If the profit is 25% of the cost price then it is
(a) 25% of the sales price
(b) 33% of the sales price
(c) 20% of the sales price
Ques 7: Goods purchased ₹1,00,000. Sales ₹90,000. Margin 20% on cost. Closing Inventory = ?
Ques 8: A company is following weighted average cost method for valuing its inventory. The details of its purchase and issue of raw-materials during the week are as follows:
1.12.2015 opening Inventory 50 units value ₹2,200.
2.12.2015 purchased 100 units @ ₹47.
4.12.2015 issued 50 units.
5.12.2015 purchased 200 units @ ₹48.
The value of inventory at the end of the week and the unit weighted average costs is
(a) ₹14,200 – ₹47.33
(b) ₹14,300 – ₹47.67
(c) ₹14,000 – ₹46.66
Ques 9: The cost of sales is equal to
(a) Opening stock plus purchases
(b) Purchases minus Closing stock
(c) Opening stock plus purchases minus closing stock
Ques 10: Inventory is disclosed in financial statements under:
(a) Fixed Assets
(b) Current Assets
(c) Current Liabilities
Ques 11: Accounting Standards do not permit following method of inventory valuation
(b) Average cost
Ques 12: Which inventory costing formula calculates value of closing inventory considering that inventory most recently purchased has not been sold?
(c) Weighted average cost
Ques 13: Valuing inventory at cost or net releasable value is based on which principle
(b) Conser vatism
(c) Going concern
Ques 14: Under inflationar y trend, which of the methods will show highest value of inventor y?
(b) Weighted average
Ques 15: Which of the following methods does not consider historical cost of inventory?
(a) Weighted average
(c) Retail price method
Ques 1: Write short notes on:
(i) Adjusted Selling Price method of determining cost of stock.
(ii) Principal methods of ascertainment of cost of inventory.
Ques 2: Distinguish between:
(i) LIFO and FIFO basis of costing of stock.
(ii) FIFO and weighted average price method of stock costing.
Ques 3: Define inventory. Explain the importance of proper valuation of inventory in the preparation of statements of the business entity.
Ques 1: X who was closing his books on 31.3.2016 failed to take the actual stock which he did only on 9th April, 2016, when it was ascertained by him to be worth ₹2,50,000.
It was found that sales are entered in the sales book on the same day of dispatch and return inwards in the returns book as and when the goods are received back. Purchases are entered in the purchases day book once the invoices are received.
It was found that sales between 31.3.2016 and 9.4.2016 as per the sales day book are ₹17,200. Purchases between 31.3.2016 and 9.4.2016 as per purchases day book are ₹1,200, out of these goods amounting to ₹500 were not received until after the stock was taken. Goods invoiced during the month of March, 2016 but goods received only on 4th April, 2016 amounted to ₹1,000. Rate of gross profit is 33-1/3% on cost.
Ascertain the value of physical stock as on 31.3.2016.
Ques 2: From the following information, ascertain the value of stock as on 31.3.2017:
At the time of valuing stock on 31.3.2016 a sum of ₹60,000 was written off a particular item which was originally purchased for ₹2,00,000 and was sold for ₹1,60,000. But for the above transaction the gross profit earned during the year was 25% on cost.
Ques 3: The Profit and loss account of Hanuman showed a net profit of ₹6,00,000, after considering the closing stock of ₹3,75,000 on 31st March, 2016. Subsequently the following information was obtained from scrutiny of the books:
(i) Purchases for the year included ₹15,000 paid for new electric fittings for the shop.
(ii) Hanuman gave away goods valued at ₹40,000 as free samples for which no entry was made in the books of accounts.
(iii) Invoices for goods amounting to ₹2,50,000 have been entered on 27th March, 2016, but the goods were not included in stock.
(iv) In March, 2016 goods of ₹2,00,000 sold and delivered were taken in the sales for April, 2016.
(v) Goods costing ₹75,000 were sent on sale or return in March, 2016 at a margin of profit of 33-1/3% on cost. Though approval was given in April, 2016 these were taken as sales for March, 2016.
Calculate the value of stock on 31st March, 2016 and the adjusted net profit for the year ended on that date.
Ques 4: Physical verification of stock in a business was done on 23rd June, 2016. The value of the stock was ₹48,00,000. The following transactions took place between 23rd June to 30th June, 2016:
(i) Out of the goods sent on consignment, goods at cost worth ₹2,40,000 were unsold.
(ii) Purchases of ₹4,00,000 were made out of which goods worth ₹1,60,000 were delivered on 5th July, 2016.
(iii) Sales were ₹13,60,000, which include goods worth ₹3,20,000 sent on approval. Half of these goods were returned before 30th June, 2016, but no information is available regarding the remaining goods.
(iv) Goods are sold at cost plus 25%. However goods costing ₹2,40,000 had been sold for ₹1,20,000.
Determine the value of stock on 30th June, 2016.
Ques 5: From the following information ascertain the value of stock as on 31st March, 2016 and also the profit for the year:
At the time of valuing stock as on 31st March, 2015, a sum of ₹17,500 was written off on a particular item, which was originally purchased for ₹50,000 and was sold during the year at ₹45,000. Barring the transaction relating to this item, the gross profit earned during the year
ANSWERS / HINTS
1. (c) 2. (c) 3. (b) 4. (c) 5. (c) 6 (c) 7. (c) 8. (a) 9. (c) 10. (b) 11. (c) 12. (a) 13. (b) 14. (a) 15. (c)
1(i) Adjusted selling method is also called retails inventory method. It is used widely in retail business or in business where the inventory comprises of items, the individual costs of which are not readily ascertainable. The historical cost of inventory is estimated by calculating it in the first instance at selling price and then deducting an amount equal to the estimated gross margin of profit on such stocks.
(ii) The specific identification method, First-In–First-Out (FIFO) and weighted average cost formulae are the principal methods of ascertaining the cost of inventory. The cost of inventories of items that are not ordinarily interchangeable and goods or services produced and segregated for specific projects should be assigned by specific identification of their individual costs under the specific identification method.
2 (i) Under FIFO method of inventory valuation, inventories purchased first are issued first. The closing inventories are valued at latest purchase prices and inventory issues are valued at corresponding old purchase prices. In other words, under FIFO method, costs are assigned to the units issued in the same order as the costs entered in the inventory. During periods of rising prices, cost of goods sold are valued at older and lower prices if FIFO is followed and consequently reported profits rise due to lower cost of goods sold.
On the other hand, under LIFO method of inventory valuation, units of inventories issued should be valued at the prices paid for the latest purchases and closing inventories should be valued at the prices paid for earlier purchases. In other words, closing inventories are valued at old purchase prices and issues are valued at corresponding latest purchase prices.
2(ii) Under the First-In-First-Out (FIFO) method of valuation of stock, the actual issue of goods is usually the earliest lot on hand. Hence, the stock in hand will therefore consist of the latest consignments. The closing stock is valued at the price paid for such consignments.
The weighted average price method is not a simple average price method. Under this method of valuation of stock, a stock ledger is maintained, recording receipts and issues on daily basis. A new average would be calculated on receiving fresh consignment. The average price thus calculated after considering arrival of new consignment with the previous value of stock and dividing the preceding stock value and the cost of new arrival with the total units of preceding and new arrival will give the weighted average price.
3. Inventory can be defined as assets held
The significance of inventory valuation arises due to the following reasons:
(i) Determination of Income
(ii) Ascertainment of Financial Position
(iii) Liquidity Analysis
(iv) Statutory Compliance
Statement of Valuation of Physical Stock as on 31st March, 2016
Note: The value of closing stock on 31st March, 2017 may, alternatively, be found out by preparing Trading Account for the year ended 31st March, 2017.
Profit and Loss Adjustment Account
Calculation of value of inventory on 31st March, 2016
Answer 4:- Statement of Valuation of Stock on 30th June, 2016
1. Calculation of normal sales:-
10,80,0002. Calculation of gross profit:-
Statement of Valuation of Stock as on 31st March, 2016
Statement showing Profit for the year ended 31st March, 2016