Chapter 9 Stock Flashcards
9.1 Importance of recognition of closing stock
The valuation methods for stock are important since stock impacts profits. Opening stock increases the cost of goods sold in the profit and loss account while closing stock decreases this expense. Stock is also important from a tax point of view.
FRS 102 Section 13 – this deal with the valuation of stock and work in progress and its basic requirement is that stock should be valued at the lower of cost and estimated selling price less costs to complete and sell (also known as net realisable value or NRV).
It suggests any method of arriving at cost is acceptable providing it gives a reasonable approximation to actual cost. Cost involves all costs of purchase and conversion that have been incurred to get the stock to its present location and condition.
Estimated selling price less costs to complete and sell considers any further costs which need to be incurred before the stock is sold. It is calculated as expected selling price less all further costs to completion less selling and distribution costs.
Estimated selling price less costs to complete and sell is used when lower than cost. If this figure is lower than cost, it is expected the stock will be sold at a loss, the business must anticipate this loss, so it is not overstating one of the assets of the business.
9.1 Importance of recognition of closing stock - determining the cost of closing stock
Determining the cost of closing stock – the methods for determining the cost of closing stock are FIFO, average cost and weighted average cost. The FIFO method (first in first out), assumes the oldest stock is sold first. The average cost method takes an average purchase price over a period of time and allocates this to closing stock. The weighted average cost takes the weighted average purchase price, calculated after each purchase and sale. This comes after all purchases and sales for the year have been dealt with and it becomes the cost per unit to value closing stock.
Year end valuation or continuous inventory – many different products are purchased and sold by a business and a stock valuation for the accounts may be obtained in one of two ways.
• A physical stock count is undertaken at year end and each type of article held valued at, perhaps, the most recent price or another suitable price. The resulting total value will be used in the accounts
• A stores ledger system is maintained which records, for each type of unit held, the quantities in, out and remaining and the cost of those units in a form
9.2 Accounting for stock
There are two sets of accounting entries for stock as follows:
Closing stock –
• Set up a balance sheet asset account for stock at the end of the accounting period
• Debit the stock asset account and credit the profit and loss account with the value of closing stock thus reducing the cost of sales in the profit and loss account by the value of the unsold closing stock
• Carry down the balance on the stock asset account. This is the stock figure that appears in the balance sheet at the end of the accounting period
The cost of sales appears in the profit and loss account as follows:
£
Opening stock X
Purchases X
Less: closing stock (X)
Opening stock –
Then at the next accounting period end:
• Credit the stock asset account to remove the last accounting period’s closing stock and debit the profit and loss account to increase the cost of sales expense (thus reversing the above entry)
• The transfer to the profit and loss account (debit) will represent the opening stock of the period which has been sold in the accounting period
After removing the opening stock, the stock account is now empty prior to performing the closing stock double entry for the next accounting period.
9.3 FRS102 Section 23 – Revenue recognition for service businesses
This covers all revenue arising to businesses (sale of goods, provision of services, interest, royalties etc). It states revenue should be recognised when it is received or receivable.
If a service is completed within one accounting period, then the revenue should be recognised within that accounting period. However, the situation is more complicated when the provision of services spans more than one accounting period.
FRS 102 states, sales income builds up over the life of the service contract, rather than when the work is completed, or the client is invoiced. It requires businesses to recognise the value of work done under the service contract as sales income in its profit and loss account based on the stage of completion of the contract.
Under FRS 102 provided the revenue, costs and stage of completion of the contract are reasonably measured and it is probable the revenue will be received the accounts will recognise the sales value of the work done to date and show the related cost as an expense in the same period. Where the outcome cannot be estimated reliability, revenue should be recognised only to the extent of the expenses recognised that are recoverable from the customer.
Revenue recognition – the amount of sales income that should be recognised on unfinished service contracts depends on the nature of the service. You can spread the project fee over the total number of hours the service was estimated to take, but there is no single rule. Businesses must develop an appropriate accounting policy to recognise unfinished contracts. The amount of revenue recognised on any contract for services should also reflect any uncertainties as to the amount the customer will accept and pay.
Tax implications of revenue recognition – the same revenue figures will be used for tax purposes as for accounting purposes provided that the accounts have been prepared in accordance to UK GAAP.
