Acca f3 Financial Accounting (int) Study Text
Part D Recording transactions and events
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Part D Recording transactions and events 8: Inventory 139 4.6 Inventory valuations and profit In the previous descriptions of FIFO and AVCO the example used raw materials as an illustration. Each method of valuation produced different costs both of closing inventories and also of material issues. Since raw material costs affect the cost of production, and the cost of production works through eventually into the cost of sales, it follows that different methods of inventory valuation will provide different profit figures. An example may help to illustrate this point. 4.7 Example: Inventory valuations and profit On 1 November 20X2 a company held 300 units of finished goods item No 9639 in inventory. These were valued at $12 each. During November 20X2 three batches of finished goods were received into store from the production department, as follows.
10 November 400 $12.50
20 November 400
$14 25 November 400 $15
Goods sold out of inventory during November were as follows. Date Units sold Sale price per unit 14 November 500 $20
21 November 500
$20 28 November 100 $20
What was the profit from selling inventory item 9639 in November 20X2, applying the following principles of inventory valuation? (a) FIFO (b)
AVCO (using cumulative weighted average costing) Ignore administration, sales and distribution costs. Solution (a)
FIFO Issue cost Closing Total inventory $ $ Date Issue costs 14 November 300 units × $12 plus 200 units × $12.50 6,100
21 November 200 units × $12.50 plus 300 units × $14 6,700
28 November 100 units × $14 1,400 Closing inventory 400 units × $15 6,000
14,200 6,000
140 8: Inventory Part D Recording transactions and events (b)
$ $ $ $ 1 November Opening inventory 300 12.000
3,600 10 November 400 12.500 5,000
700 12.286
8,600 14 November 500 12.286 6,143
6,143 200
12.286 2,457
20 November 400 14.000
5,600 600
13.428 8,057
21 November 500 13.428
6,714 6,714
100 13.428
1,343 25 November 400 15.000 6,000
500 14.686
7,343 28 November 100 14.686 1,469
1,469 30 November 400 14.686 5,874
14,326 5,874
Summary: profit FIFO AVCO $ $ Opening inventory 3,600
3,600 Cost of production 16,600 16,600
20,200 20,200
Closing inventory 6,000
5,874 Cost of sales 14,200 14,326
Sales (1,100 × $20) 22,000
22,000 Profit
7,800 7,674
Different inventory valuations have produced different cost of sales figures, and therefore different profits. In our example opening inventory values are the same, therefore the difference in the amount of profit under each method is the same as the difference in the valuations of closing inventory. The profit differences are only temporary. In our example, the opening inventory in December 20X2 will be $6,000 or $5,874, depending on the inventory valuation used. Different opening inventory values will affect the cost of sales and profits in December, so that in the long run inequalities in cost of sales each month will even themselves out. Question
FIFO A firm has the following transactions with its product R. Year 1 Opening inventory: nil Buys 10 units at $300 per unit Buys 12 units at $250 per unit Sells 8 units at $400 per unit Buys 6 units at $200 per unit Sells 12 units at $400 per unit
Buys 10 units at $200 per unit Sells 5 units at $400 per unit Buys 12 units at $150 per unit Sells 25 units at $400 per unit
Part D Recording transactions and events 8: Inventory 141
Using FIFO, calculate the following on an item by item basis for both year 1 and year 2. (i) The closing inventory (ii) The sales
(iii) The cost of sales (iv) The gross profit Answer Year 1 Purchases Sales Balance Inventory Unit Cost of (units) (units) (units) value cost sales Sales $ $
$ 10
10
3,000 300
12
3,000 250
22 6,000
8
(2,400) 2,400
3,200
14 3,600
6
1,200 200
20 4,800
12
(3,100)*
3,100 4,800 8
1,700
5,500
8,000 * 2 @ $300 + 10 @ $250 = $3,100 Year 2 Purchases Sales Balance Inventory Unit Cost of (units) (units) (units) value cost sales Sales $ $
$ B/f
8 1,700
10
2,000 200
18
3,700
5
(1,100)*
1,100 2,000
13 2,600
12 25
1,800
150
4,400
25
(4,400)**
4,400
10,000 0
0
5,500
12,000 * 2 @ $250 + 3 @ $200 = $1,100 ** 13 @ $200 + 12 @ $150 = $4,400
$ $ Year 1 Sales
FIFO 8,000
Opening inventory $ Purchases 7,200 7,200
Closing inventory 1,700
Cost of sales 5,500
Gross profit 2,500
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