Part D Recording
transactions and events
8: Inventory
137
A business may be continually purchasing consignments of a particular component. As each consignment
is received from suppliers they are stored in the appropriate bin or on the appropriate shelf or pallet,
where they will be mingled with previous consignments. When the storekeeper issues components to
production he will simply pull out from the bin the nearest components to hand, which may have arrived in
the latest consignment or in an earlier consignment or in several different consignments. Our concern is to
devise a pricing technique, a rule of thumb which we can use to attribute a cost to each of the components
issued from stores.
There are several techniques which are used in practice.
FIFO (first in, first out). Using this technique, we assume that components are used in the order in
which they are received from suppliers. The components issued are deemed to have formed part of
the oldest consignment still unused and are costed accordingly.
AVCO (average cost). As purchase prices change with each new consignment, the average price of
components in the bin is constantly changed. Each component in the bin at any moment is
assumed to have been purchased at the average price of all components in the bin at that moment.
If you are preparing
financial accounts you would normally expect to use FIFO
or average costs for the
valuation of inventory.
IAS 2 (revised) does not permit the use of LIFO. You should note furthermore that
terms such as AVCO and FIFO refer to
pricing techniques only. The
actual components can be used in any
order.
To illustrate
the various pricing methods, the following transactions will be used in each case.
TRANSACTIONS DURING MAY 20X7
Market value per unit on
Quantity
Unit cost
Total cost
date of transactions
Units
$
$
$
Opening balance 1 May
100
2.00
200
Receipts 3 May
400
2.10
840
2.11
Issues 4 May
200
2.11
Receipts 9 May
300
2.12
636
2.15
Issues 11 May
400
2.20
Receipts 18 May
100
2.40
240
2.35
Issues 20 May
100
2.35
Closing balance 31 May
200
2.38
1,916
Receipts mean goods are received into store and issues represent the issue of goods from store. The
problem is to put a valuation on the following.
(a)
The issues of materials
(b)
The closing inventory
How would issues and closing inventory be valued using each of the following in turn?
(a) FIFO
(b) AVCO
4.4 FIFO (first in, first out)
FIFO assumes that materials are
issued out of inventory in the order in which they were delivered into
inventory, ie issues are priced at the cost of the earliest delivery remaining in inventory.
The cost of issues and closing inventory value in the example, using FIFO, would be as follows (note that
OI stands for opening inventory).
Key terms
138
8: Inventory Part D Recording transactions and events
Date of issue
Quantity
Value issued
Cost of issues
Units
$
$
4 May
200
100 OI at $2
200
100 at $2.10
210
410
11 May
400
300 at $2.10
630
100 at $2.12
212
842
20 May
100
100 at $2.12
212
1,464
Closing
inventory value
200
100 at $2.12
212
100 at $2.40
240
452
1,916
Note that the cost of materials issued plus the value of closing inventory equals the cost of purchases plus
the value of opening inventory ($1,916).
4.5 AVCO (average cost)
There are various ways in which average costs may be used in pricing inventory issues. The most
common (cumulative weighted average pricing) is illustrated below.
The
cumulative weighted average pricing method calculates a weighted average price for all units in
inventory. Issues are priced at this average cost, and the balance of inventory remaining would have the
same unit valuation.
A new weighted average price is calculated whenever a new delivery of materials into store is
received. This is the key feature of cumulative weighted average pricing.
In our example, issue costs and closing inventory values would be as follows.
Total inventory
Date
Received
Issued
Balance
value
Unit cost
Price of issue
Units
Units
Units
$
$
$
Opening
inventory
100
200
2.00
3 May
400
840
2.10
500
1,040
2.08 *
4 May
200
(416)
2.08 **
416
300
624
2.08
9 May
300
636
2.12
600
1,260
2.10 *
11 May
400
(840)
2.10 **
840
200
420
2.10
18 May
100
240
2.40
300
660
2.20 *
20 May
100
(220)
2.20 **
220
1,476
Closing inventory
value
200
440
2.20
440
1,916
* A new unit cost of inventory is calculated whenever a new receipt of materials occurs.
** Whenever inventories are issued, the unit value of the items issued is the current weighted average
cost per unit at the time of the issue.
For this method too, the cost of materials issued plus the value of closing inventory equals the cost of
purchases plus the value of opening inventory ($1,916).