Inventory valuation (2)

Question 1

What’s inventory valuation important for?

Answer 1

Financial reporting - Inventory is recorded at the lower of cost and net realisable value
Costing - Once inventory cost has been determined, a sales price can be determined using e.g. mark up

Question 2

Define FIFO

Answer 2

First in first out assumes that materials are issued out of inventory in the order in which they were delivered into inventory
FIFO is appropriate for many businesses (e.g. retailer selling fish)

Question 3

State some advantages and disadvantages of FIFO

Answer 3

Advantages:
Logical - reflects the most likely physical flow
Easily understood
Inventory values at up-to-date prices (i.e. replacement cost)
Acceptable to HMRC

Disadvantages:
Cumbersome
In time of rising prices (inflation), reported profits are high due to lagging issue prices and high closing inventory valuations
Cost comparisons between jobs are difficult

Question 4

Define LIFO

Answer 4

Last in first out assumes that materials are issued out of inventory in the reverse order in which they were delivered
LIFO is only appropriate for a few businesses (e.e. a coal merchant who stores coal inventories in a large ‘bin’)

Question 5

State some advantages and disadvantages of LIFO

Answer 5

Advantages:
Issue prices are up-to-date
In times of rising prices, reported profits are reduced as closing inventory is valued at a lower cost
Makes managers aware of recent costs

Disadvantages:
rarely reflects physical use of inventory
Cumbersome
Not usually acceptable to HMRC or per IAS2
Inventory values may become very out-of-date
Cost comparisons between jobs are difficult

Question 6

Define cumulative weighted average

Answer 6

Cumulative weighted average values all issues and inventory at an average price
The average price is recalculated after every receipt
Cumulative weighted average = running total costs/running total of units
The CWA method could be appropriate for businesses such as oil merchants

Question 7

State some advantages and disadvantages of CWA

Answer 7

Advantages:
Acceptable to HMRC
Logical because units have all the same value
Fluctuations in prices are smoothed out

Disadvantages:
Issue prices and inventory values may not be an actual purchase price
Inventory values and issue prices may both lag behind current values

Question 8

Define periodic weighted average

Answer 8

Periodic weighted average values each issue at the same average which is based on all purchases for the period
Periodic weighted average = total costs for the period/total units for the period
Only use PWA in exam if you’re asked to