5- Inventory Valuation

Question 1

Inventory

Answer 1

Inventory is indistinguishable. Items that cannot be told apart.

Question 2

3 possible methods to value inventory

Answer 2

• Based on most recent prices paid
• Based on oldest prices paid
• Based on an average cost

Question 3

Inventory value at end of period equation

Answer 3

= Value at start of period + additions - cost of goods from inventory

• Depends on how cost-of-sales is calculated.

Question 4

Cost of sales from inventory equation

Answer 4

= (Value at start of period + Cost of Additions) - Inventory at end of period

Question 5

Why are cost-of-sales equations easier if they are based on the amount of closing inventory?

Answer 5

• Allows to avoid tracking the cost of individual units sold;
• Needs only measure stock levels at start, end of the period and new additions of inventory;
• Allows to include any unplanned disposals such as wastages, theft etc

Question 6

Closing inventory equation

Answer 6

= Number of remaining units of inventory x price (what price do we apply?)

Question 7

3 methods to determine inventory valuation and hence cost-of-sales for indistinguishable goods

Answer 7

• FIFO
• LIFO
• AVCO

Question 8

FIFO

Answer 8

• First-in First Out
• Cost-of-sales (‘‘First-out’’) based on oldest purchase (‘‘First in prices’’)
• Inventory valuation based on the most recent

Question 9

LIFO

Answer 9

• Last-in First out
• Cost-of-sales (‘‘First-out’’) based on most recent (‘‘Last-in’’) prices
• Inventory valuation based on the oldest

Question 10

AVCO

Answer 10

• Average cost
• Cost-of-sales and inventory valuation both based on average purchase prices.

Question 11

Why choose LIFO?

Answer 11

• FIFO and AVCO are both permitted under IFRS and US GAAP
• LIFO is permitted in the US but prohibited under IFRS
• Most US oil companies choose to use LIFO.
• But…. managers generally prefer to report higher profit and higher asset values
• Given inflation firms should choose FIFO as their inventory valuation method to achieve these goals

Question 12

Difference between inventory value reported and its replacement cost

Answer 12

Replacement costs is the price that the entity would pay to replace existing assets at current market prices with similar assets.
This concept is important :
for company valuation;
inventory wears out and needs to be replaced;
for investment policy.

Question 13

Unrealized gains

Answer 13

An increase in the value of an asset that has not been sold.

Question 14

Unrealized loss

Answer 14

A decrease in the value of an asset or investment that an investor holds rather than selling it and realizing the loss.

Question 15

Other name for unrealized gains and losses

Answer 15

'’Paper’’ profits or losses

Question 16

Why would a business sell stock for less than it cost?

Answer 16

• Physical impairment
• Fall in value- obsolete

Question 17

Net realizable value (NRV) definition

Answer 17

The value of an asset that sellers expect to get, less costs or expenses on selling or disposing of the asset.

Question 18

Net realizable value (NRV) equation

Answer 18

= Expected selling costs - costs related to sale or disposition of assets

Question 19

What does it mean if book value of inventory > net realizable value?

Answer 19

1)Book Value of inventory should be reduced to the Net Realisable Value;
2) Inventory loss will be taken as a higher cost-of-sales

Question 20

What does it mean if book value of inventory < net realizable value?

Answer 20

Book Value of inventory are left unchanged.