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Valuation of Inventory
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Session Agenda
Definition of Inventory
Measurement of Inventory
Components of cost
Net realisable value
Cost formula
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I. Inventories
Inventories are assets:
(a) held for sale in the ordinary course of business;
(b) in the process of production for such sale; or
(c) in the form of materials or supplies to be consumed in
the production process or in the rendering of services.
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Examples of Inventory for Retail Stores
Shirt, Jeans etc. for WESTSIDE
Nokia handsets for Nokia Priority Dealer
Fruits, Grocery items etc. for Reliance Fresh
LCD, TV etc. for CROMA
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II. Measurement of Inventories
Inventories should be valued at the lower of cost and net
realisable value.
Cost of Inventories
The cost of inventories should comprise all costs of
purchase, costs of conversion and other costs incurred inbringing the inventories to their present location and
condition.
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a. Component of cost
i. Cost of Purchase
a. Invoice Price
b. Transport inwards + insurance (if borne by buyer)
c. Any other incidental expensesd. Less subsidy/cost borne by any other person
ii. Cost of Conversion
iii. Other Costs
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Contd.
For example at a company's year end, if an unfinished
good that already cost Rs. 25 is expected to sell for
Rs.100 to a customer, but it will take an additional Rs.20to complete and Rs.10 to advertise to the customer, its
NRV will be
NRV = Rs.100 - Rs.20 - Rs.10 = Rs.70 > Rs. 25
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In this year's balance sheet, since the cost of the good
(Rs.25) is less than its NRV (Rs.70), the cost of the goodwill get recorded as the cost of inventory.
In next year's income statement after the good was sold,
this company will record a revenue of Rs.100, Cost of
Goods Sold of Rs.25, and Cost of Completion and
Disposal of Rs.20+Rs.10 = Rs.30. This leads to a profit of
Rs.100-Rs.25-Rs.30 = Rs.45 on this transaction.
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Cost Formulas
Specific identification
FIFO
LIFO
Weighted Average
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Inventory of eggs with a Restaurant
Purchased 2000 units @ Rs.2.50 per unit on March 1
Sold 1000 units @ Rs. 3.50 per
unit on March 11
Purchased 3000 units @ Rs.1.50 per unit on March 19
Sold 2500 units @ Rs. 2.50 perunit on March 21
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Fruit Store
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Art Gallary
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Furniture
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Specific identification
According to this method each identified items ofinventory is assigned specific cost and hence the namespecific identification.
In simple words cost is attributed to each item in theinventory individually that is identifiable specifically.
Here the point is to be noted that each item of inventorymust be identifiable otherwise specific assignment ofcost will not be possible.
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FIFO, LIFO, Weighted Average
However, when inventory items are not heterogeneousare are ordinarily interchangeable i.e. have similarnature and use then inventory at the year is usuallyvalued using a particular cost assumption
formula like First-in, First-out (FIFO) or Last-in, First-out (LIFO).
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Another alternative method for inventory valuation
is weighted average method which averages the value of
inventory held at the start of the period and value of
inventory purchased or produced during the period.
AS 2 allows the use of specific identification method, FIFO
method and weighted average cost method to value ending
inventory.
Its up to the management of the entity select the method of
inventory valuation by considering relevant factors.
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FIFO
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LIFO
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Weighted Average
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Class Exercise
Opening Inventory @ Rs. 12 per unit
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Class Exercise
Calculate the cost of material consumed for the period
using
FIFO
LIFO
Weighted Average
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FIFO
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LIFO
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Weighted Average
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Comparing 3 Methods
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Details Of Component X
Units Rate
Opening Balance 50 10
Purchase 1 100 10.1
Purchase 2 150 10.2
Consumption 1 100
Purchase 3 50 10
Consumption 2 100
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Class Exercise
Calculate the cost of material consumed for the period
using
FIFO
LIFO
Weighted Average
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