Methods of Inventory Valuation - FIFO , LIFO , Average (playlist)
Knowledge Bomb 31 - Inventory valuation doing FIFO , LIFO , Weighted average
Playlist Link - https://www.youtube.com/playlist?list=PL_16BSQMjAHO8O2FUMqzYPMRZsykngW6u
This playlist shows in detail the various methods for valuing the inventory .Usinf very very simple examples we do the inventory valuation usin the various methods
There are various method methods of valuing the closing stock , some of which include the FIFO (First in First out method) and the LIFO (Last in first out method )
Please look at the attached picture to understand the example ,
In this small example we buy the first lot of 10 pens at 10 Rs each on June 2013 and then buy the second lot of 10 identical pens at 50 Rs each on February 2014 (Prices have gone up considerably , shit !)
I manage to sell just 10 pens on march 2014 for Rs 52 each ....Now , the accounting year ends ...i still have 10 pens left ((Market price at this point of time for each pen is 55 Rs
Lets look at how the valuation is done for this pens using the various methods
(1) FIFO ( FIRST iN, FIRST out method)
What happens here is that it is assumed that what we bought first has been sold first . So when we sell on March 2014 , it is assumed that it sold from the stock bought on June @ 10 Rs each
So , what remains is the stock bought on Feb @ 50 Rs Each and 10 pens So , value is 10 x 50 = 500 Rs
At this point , the net realisable value is = 10 x 55 = 550
So , closing stock wil be valued at lesser of the net relaisable value or the cost (using FIFO )---so lesser of 500 or 550 ,so closing stock using FIFO method is 300 Rs
Closing stock using FIFO method = 500 Rs
Still note , how close our FIFO approximates the market price ,so it is relevant for accounting principles
(2) LIFO (LAST IN, LAST OUT)
Here it is assumed that what is bought last leaves the system first So when we do our sale of March , it is assumed that the sale is of the pens bought in Februrary @ 50 Rs
What remains therefore is the stock bought at June and so the cost translates to 10 x 10 = 100 Rs
Now , net realiisable value = 10 x 55 = 550 ( VALUE OF INVENTORY AT MARKET PRICE ---MARKET PRICE IS 55 RS AND WE HAVE 10 PENS REMAINING )
So , closing stock wil be valued at lesser of the net relaisable value or the cost (using LIFO )---so lesser of 100 or 550 ,so closing stock using LIFO method is 100 Rs
Closing stock using LIFO method = 100 Rs
See , how value is not anywhere reflective of the market price and this happens because we are valuing stock at the prices that we paid when we first bought them on account of last in first out policy
So many accounting standards don't permit use of LIFO , because it undermines the cost of the good sold and so can be used by the business to manipulate profits in a wrong manner
(3) Weighted Average Method
When we use weighted average , then each time we buy the stock , if the price changes then we take the average of the cost for valuing the inventory ..Here pens have been first bought on June 2013 , 10 pens @ 10 Rs each
and then again pens have been bought on Feb 2014 10 pens @ 50 Rs ,
so weighted average is =( 10 x 10 +10 x 50 /(10+50) = 30
The weight of the pens in each purchase is 10 in number so when we take average we divide by the total weight (here 10 +10 ...=20 )
So , the inventory will be valued at this cost i.e 30 Rs ....(note how unlike FIFO and LIFO we are not valuing directly at cost but weighted average and so this style of finding the cost of the inventory is called weighted average ,
Again here the net realisable value i.e market price is 10 pens @ market price = 10 x 55 = 550 Rs
So , closing stock wil be valued at lesser of the net relaisable value or the cost (using any of the methods )---so lesser of 300 or 550 ,so closing stock using weighted average method is 300 Rs
Closing stock using weighted average method = 300 Rs
So , basically this methods i.e FIFO , LIFO , Weighted average are nothing but accounting principles to value what remain's,
Selection of LIFO , FIFO , WEIGHTED AVERAGE
We need to be prudent as to which accounting method to use to value our invfnetory ...some like LIFO are actually not allowed in many standards ,
But think of it , there may be some products where prices don't increase but rather decrease or waver invariably not following a pattern
Using LIFO when prices decrease and weighted average when prices vary invariably and FIFO when prices increase would be a prudent way of accounting the inventory ,
There you go life , finally understood something that i could never do when small ,
Hope this helps ,
Amlan Dutta
Knowledge Bomb 31 - Inventory valuation doing FIFO , LIFO , Weighted average
Playlist Link - https://www.youtube.com/playlist?list=PL_16BSQMjAHO8O2FUMqzYPMRZsykngW6u
This playlist shows in detail the various methods for valuing the inventory .Usinf very very simple examples we do the inventory valuation usin the various methods
There are various method methods of valuing the closing stock , some of which include the FIFO (First in First out method) and the LIFO (Last in first out method )
Please look at the attached picture to understand the example ,
In this small example we buy the first lot of 10 pens at 10 Rs each on June 2013 and then buy the second lot of 10 identical pens at 50 Rs each on February 2014 (Prices have gone up considerably , shit !)
I manage to sell just 10 pens on march 2014 for Rs 52 each ....Now , the accounting year ends ...i still have 10 pens left ((Market price at this point of time for each pen is 55 Rs
Lets look at how the valuation is done for this pens using the various methods
(1) FIFO ( FIRST iN, FIRST out method)
What happens here is that it is assumed that what we bought first has been sold first . So when we sell on March 2014 , it is assumed that it sold from the stock bought on June @ 10 Rs each
So , what remains is the stock bought on Feb @ 50 Rs Each and 10 pens So , value is 10 x 50 = 500 Rs
At this point , the net realisable value is = 10 x 55 = 550
So , closing stock wil be valued at lesser of the net relaisable value or the cost (using FIFO )---so lesser of 500 or 550 ,so closing stock using FIFO method is 300 Rs
Closing stock using FIFO method = 500 Rs
Still note , how close our FIFO approximates the market price ,so it is relevant for accounting principles
(2) LIFO (LAST IN, LAST OUT)
Here it is assumed that what is bought last leaves the system first So when we do our sale of March , it is assumed that the sale is of the pens bought in Februrary @ 50 Rs
What remains therefore is the stock bought at June and so the cost translates to 10 x 10 = 100 Rs
Now , net realiisable value = 10 x 55 = 550 ( VALUE OF INVENTORY AT MARKET PRICE ---MARKET PRICE IS 55 RS AND WE HAVE 10 PENS REMAINING )
So , closing stock wil be valued at lesser of the net relaisable value or the cost (using LIFO )---so lesser of 100 or 550 ,so closing stock using LIFO method is 100 Rs
Closing stock using LIFO method = 100 Rs
See , how value is not anywhere reflective of the market price and this happens because we are valuing stock at the prices that we paid when we first bought them on account of last in first out policy
So many accounting standards don't permit use of LIFO , because it undermines the cost of the good sold and so can be used by the business to manipulate profits in a wrong manner
(3) Weighted Average Method
When we use weighted average , then each time we buy the stock , if the price changes then we take the average of the cost for valuing the inventory ..Here pens have been first bought on June 2013 , 10 pens @ 10 Rs each
and then again pens have been bought on Feb 2014 10 pens @ 50 Rs ,
so weighted average is =( 10 x 10 +10 x 50 /(10+50) = 30
The weight of the pens in each purchase is 10 in number so when we take average we divide by the total weight (here 10 +10 ...=20 )
So , the inventory will be valued at this cost i.e 30 Rs ....(note how unlike FIFO and LIFO we are not valuing directly at cost but weighted average and so this style of finding the cost of the inventory is called weighted average ,
Again here the net realisable value i.e market price is 10 pens @ market price = 10 x 55 = 550 Rs
So , closing stock wil be valued at lesser of the net relaisable value or the cost (using any of the methods )---so lesser of 300 or 550 ,so closing stock using weighted average method is 300 Rs
Closing stock using weighted average method = 300 Rs
So , basically this methods i.e FIFO , LIFO , Weighted average are nothing but accounting principles to value what remain's,
Selection of LIFO , FIFO , WEIGHTED AVERAGE
We need to be prudent as to which accounting method to use to value our invfnetory ...some like LIFO are actually not allowed in many standards ,
But think of it , there may be some products where prices don't increase but rather decrease or waver invariably not following a pattern
Using LIFO when prices decrease and weighted average when prices vary invariably and FIFO when prices increase would be a prudent way of accounting the inventory ,
There you go life , finally understood something that i could never do when small ,
Hope this helps ,
Amlan Dutta
Comments
Post a Comment