Written by Inventory valuation involves determining the value of goods and services held by a company for sale.
There are three methods of inventory valuation, namely; First-In-First-Out(FIFO), Last-In-First-Out(LIFO), and Weighted Average Pricing (WAP).
First-In-First-Out(FIFO) Method
FIFO is a method of valuing stock which assumes that materials are used up in the same sequence as they are purchased.
That is, it assumes that older materials are used up first while recent materials are used up last.
The First-In, First-Out (FIFO) method assumes that the first items purchased or produced are the first ones sold or used.
Imagine a scenario where a company purchases a specific material on different occasions at varying prices.
According to the FIFO method, when the company sells or utilizes the material, it would assume that the oldest inventory (i.e., the earliest purchases) is consumed or sold first.
It is only after exhausting the older inventory that the more recent purchases would be consumed.
So, in essence, FIFO follows a logical flow of inventory, where the first items in are the first items out.
First-in-First-Out stock valuation is most suitable where the material is of comparatively high value and not in frequent demand.
It is also appropriate where there are relatively few changes in the purchase prices of inventory.
Last-in-Last-Out(LIFO) method
Unlike the First-In-First-Out (FIFO) method, LIFO operates under the assumption that the most recently acquired or produced goods are the first ones to be sold or used.
In other words, it follows the principle of using up or selling the latest inventory before considering older inventory.
To understand LIFO in practice, let’s consider an example.
Suppose a company regularly purchases a specific material at varying prices.
Using the LIFO method, when the company sells or uses the material, it assumes that the most recent purchases are the first to be consumed or sold.
It is only after depleting the most recent inventory that the older purchases would be considered.
Because LIFO assumes that the last set of inventory received is the first to leave the stores, the resulting closing inventory will be valued at older prices.
Weighted Average Costing(WAC) Method
Just as its name implies, weighted average costing is a method of valuing stock where the value of stocks is valued using a weighted average price.
It is a method of determining the cost of goods sold and ending inventory by taking the average cost of all units available for sale during a period.
Weighted average costing is often used when inventory items are not identical or it is difficult to determine the specific cost of each unit.
To calculate the weighted average cost, we divided the cost of goods available for sale by the number of units available for sale.
That is, weighted average costs=\(\frac{\text{cost of goods available for sale}}{\text{Number of units available for sales}}\)
The cost of goods available for sale is calculated by adding the beginning inventory cost to the cost of goods purchased during the period. The number of units available for sale is calculated by adding the beginning inventory quantity to the quantity of goods purchased during the period.
Once the weighted average cost has been calculated, it is then used to calculate the cost of goods sold and ending inventory.
The cost of goods sold is calculated by multiplying the weighted average cost by the number of units sold. The ending inventory is calculated by subtracting the cost of goods sold from the cost of goods available for sale.
Example
Bike Limited Purchased 100 bikes during March 2018 and sold 60 bikes, details of which are as follows:
| Date | Details |
|---|---|
| March 1 | Purchased 50 bikes at N500 each |
| March 5 | Sold 20 bikes |
| March 15 | Sold 10 bikes |
| March 18 | Purchased 50 bikes at N700 each |
| March 25 | Sold 30 bikes |
Calculate the cost of goods sold and closing stock under the following stock valuation method:
- FIFO method
- LIFO method
- Weighted average Method
Solution:
1. Under FIFO, goods that are bought first are sold first while goods that are bought last are sold last.
Since we sold 60 units, 50 of the units sold will come from the stock of goods purchased on March 1, while the remaining 10 will come from the goods purchased on March 18.
As a result, the cost of goods sold will be 50 x 500 + 10 x 700=N32,000.
Since we sold all 50 units of goods purchased on March 1 and sold 10 out of the goods purchased on March 18, the closing stock will be the remaining 40 units of goods of March 18 stock, which were purchased at N700 each.
Therefore, the closing stock will be 40 x 700 = N28,000
2. Under LIFO, goods that are bought first are sold last while goods that are bought last are sold first.
Since we sold 60 units of the goods, 50 of the goods will come from the goods purchased on March 18, while the 10 units will come from the goods purchased on March 1.
As a result, the cost of goods sold will be 50 x 700 + 10 x 500=N40,000.
Since we sold all 50 units of goods purchased on March 18 and sold 10 out of the goods purchased on March 1, the closing stock will be the remaining 40 units of goods of March 1 stock, which were purchased at N500 each.
Therefore, the closing stock will be 40 x 500=N20,000.
3. Before we can calculate the weighted average costs using the following formula:
WAC=\(\frac{\text{cost of goods available for sale}}{\text{Number of units available for sale}}\)
WAC=\(\frac{500 \times 50 + 700 \times 50}{100}\)
WAC =N600.
Since we sold 600 units, the costs of goods sold will be 600 x 60=36,000.
After selling 60 units, we have 40 units left. Hence, the closing stock will be 600 x 40= 24,000.
