INVENTORIES

Inventories Defined
According to Accounting Standard 2 on Valuation of Inventories, issued by the
Institute of Chartered Accountants of India, Para 1,
Inventories are tangible property held (i) for sale in the ordinary
course of business, or (ii) in the process of production for such
sale, or (iii) for consumption in the production of goods or services
for sale.

Components of Inventory
For a manufacturing firm, raw materials, semi-finished goods and finished goods.
For merchandising firm, only the finished goods


INVENTORY VALUATION METHODS

The following are the methods of inventory valuation. There are mainly four
commonly used methods in the valuation of inventory. Accountants generally accept all these
four methods, but each of these is based on a different cost flow assumption.
To illustrate the four methods, the following data will be assumed for an accounting
period:

Units Unit Cost ( Rs.) Total Cost (Rs.)
Jan. 1 Beginning Inventory 100 2 200
Mar. 27 Purchase 100 3 300
June 12 Purchase 100 4 400
Sept. 19 Purchase 100 5 500
Nov. 30 Purchase 100 6 600

Available for sale 500 2,000
Sold 350

Dec. 31 Ending Inventory 150









1. Specific Identification Method
This method assigns specific costs to each unit sold and each unit on hand. This
method may be used if the units the ending inventory can be identified as coming from
specific purchases. The specific identification method is particularly suited to inventories of
high-value, low-volume items such as jewellery. Each unit in inventory must be identified
with an identification tag.

To illustrate, assume that December 31 inventory consisted of 60 units from March 27
purchase, 70 units from the June 12 purchase, and 20 units from the September 19 purchase.
The cost of ending inventory is then computed as follows:
60 units from the purchase of March 27 at Rs.3 Rs.180
70 units from the purchase of June 12 at Rs.4 280
20 units from the purchase of September 19 at Rs.5 100
________
Ending Inventory 560
________
The cost of goods sold is computed by subtracting the ending inventory from the cost of
goods available for sale, as shown below:

Cost of goods available for sale Rs.2,000
Less Ending inventory 560
________
Cost of goods sold 1,440
________

2. First-in, First-out (FIFO) Method
This method assumes that the first units acquired are the first units sold. Therefore
the cost of the units in the ending inventory is that of the most recent purchases. Although
the FIFO method is a cost flow assumption, physical flow often follows the first-in first-out
rule.

In the previous illustration the cost of the 150 units in the ending inventory would be
Rs.850, computed as follows:
50 units from the purchase of September 19 at Rs.5 Rs.250
100 units from the purchase of November 30 at Rs.6 600
Ending Inventory 850

Under FIFO method, the cost of goods sold is Rs.1,150 which is computed as follows:

Cost of goods available for sale Rs.2,000
Less Ending Inventory 850
Cost of goods sold 1,150




3. Last-in, First-out (FIFO) Method
The last in first out method assumes that the last units acquired are the first units sold.
Therefore the cost of the units in the ending inventory is that of the earliest purchases.

Under the LIFO method, the cost of 150 units in the ending inventory would be
Rs.350, computed as follows:
100 units from the purchase of January at Rs.2 Rs.200
50 units from the purchase of March 27 at Rs.3 150
Ending inventory 350

The cost of goods sold is Rs.1,650, computed as follows:

Cost of goods available for sale Rs.2,000
Less Ending Inventory 350
Cost of goods sold 1,650

4. Weighted-Average Cost Method
This method assumes that the goods available for sale are homogenous. Average cost
is computed by dividing the cost of goods available for sale, which comprise the cost
of the beginning inventory and all the purchases, by the number of units available for
sale. The weighted-average unit cost that results from this computation is applied to
the units in the ending inventory.

In the previous illustration, the unit cost under this method would be Rs.4, computed
as under:

Cost of goods available for sale Rs.2,000
Number of units available for sale 500
Weighted-average unit cost Rs. 4
Ending Inventory: 150 units @ Rs.4/- Rs. 600

The cost of goods sold is Rs.1,400, computed as follows:

Cost of goods available for sale Rs.2,000
Less Ending Inventory 600
Cost of goods sold 1,400