FUNDAMENTALS OF ACCOUNTING - CHAPTER 4

CHAPTER - 4 INVENTORIES Copyright -The Institute of Chartered Accountants of India INVENTORIES Learning objectives After studying this chapter, you will be able to: (cid:2) Understand the meaning of term 'Inventory'. (cid:2) Learn the technique of Specific identification, FIFO, Average price, Weighted Average Price and Adjusted Selling Price methods of inventory valuation. (cid:2) Understand the methods of inventory record keeping and comprehend the intricacies relating to stock taking. 1. MEANING Inventory can be defined as tangible property held for sale in the ordinary course of business, or in the process of production for such sale, or for consumption in the production of goods or services for sale, including maintenance supplies and consumables other than machinery spares. Inventories are assets: (a) held for sale in the ordinary course of business; (b) in the process of production for such sale; (c) in the form of materials or supplies to be consumed in the production process or in the rendering of services. Inventories encompass goods purchased and held for resale, for example merchandise (goods) purchased by a retailer and held for resale, or land and other property held for resale. Inventories also include finished goods produced, or work in progress being produced, by the enterprise and include materials, maintenance supplies, consumables and loose tools awaiting use in the production process. However, inventories do not include machinery spares which can be used only in connection with an item of fixed asset and whose use is expected to be irregular; such machinery spares are generally accounted for as fixed assets. The types of inventories are related to the nature of business. The inventories of a trading concern consist primarily of products purchased for resale in their existing form. It may also have an inventory of supplies such as wrapping paper, cartons, and stationery. The inventories of manufacturing concern consist of several types of inventories: raw material (which will become part of the goods to be produced), parts and factory supplies, work-in-process (partially completed products in the factory) and, of course, finished products. At the year end every business entity needs to ascertain the closing balance of stock which comprise of stock of raw material, work-in-progress, finished goods and miscellaneous items. Value of closing stock is put at the credit side of the Trading Account and asset side of the Balance Sheet. So before preparation of final accounts, the accountant should know the value of stock of the business entity. However, we shall restrict our discussion on inventory valuation for raw materials of a manufacturing concern and goods of a trading concern. The valuation of other types of inventories will be covered in Advanced Accounting and Cost Accounting subject at Integrated Professional Competence Course. 4.2 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India Types of Inventories In case of manufacturing concerns In case of Trading concerns Raw Materials Work-in- Finished goods Finished goods progress Covered in CPT To be covered in Covered in CPT and PCC PCC and PCC * CPT – Common Proficiency Test * PCC – Professional Competence Course 2. INVENTORY VALUATION A primary issue in accounting for inventories is the determination of the value at which inventories are carried in the financial statements until the related revenues are recognized. Inventory is generally the most significant component of the current assets held by a trading or manufacturing enterprise. It is widely recognised that the major asset that affects efficiency of operations is inventory. Both excess of inventory and its shortage affects the production activity, and the profitability of the enterprise whether it is a manufacturing or a trading business. Proper valuation of inventory has a very significant bearing on the authenticity of the financial statements. The significance of inventory valuation arises due to various reasons as explained in the following points: (i) Determination of Income The valuation of inventory is necessary for determining the true income earned by a business entity during a particular period. To determine gross profit, cost of goods sold is matched with revenue of the accounting period. Cost of goods sold is calculated as follows: Cost of goods sold = Opening stock + Purchases + Direct expenses - Closing stock. Inventory valuation will have a major impact on the income determination if merchandise cost is large fraction of sales price. The effect of any over or understatement of inventory may be explained as: (a) When closing inventory is overstated, net income for the accounting period will be overstated. (b) When opening inventory is overstated, net income for the accounting period will be understated. (c) When closing inventory is understated, net income for the accounting period will be understated. FUNDAMENTALS OF ACCOUNTING 4.3 Copyright -The Institute of Chartered Accountants of India INVENTORIES (d) When opening inventory is understated, net income for the accounting period will be overstated. The effect of misstatement of inventory figure on the net income is always through cost of goods sold. Thus, proper calculation of cost of goods sold and for that matter, proper valuation of inventory is necessary for determination of correct income. (ii) Ascertainment of Financial Position Inventories are classified as current assets. The value of inventory on the date of balance sheet is needed to determine the financial position of the business. In case the inventory is not properly valued, the balance sheet will not disclose the truthful financial position of the business. 'Inventory' also affects analysis of financial statements as various ratios based on current assets, net working capital, total assets considering stock as one of the variables require inventory as its constituents. (iii) Liquidity Analysis Inventory is classified as a current asset, it is one of the components of net working capital which reveals the liquidity position of the business. Current ratio which studies the relationship between current assets and current liabilities is significantly affected by the value of inventory. (iv) Statutory Compliance Schedule VI of the Indian Companies Act, 1956 requires that the details of quantities of each class of goods along with method of valuation of raw material, work-in-progress and finished goods should be disclosed in the financial statements. As per the requirements of the Accounting Standards, the financial statements should disclose (a) the accounting policies adopted in measuring inventories, including the cost formula used, and (b) the total carrying amount of inventories and its classification appropriate to the enterprise. The common classification of inventories are raw materials; work-in-progress; finished goods; stores and spares and loose tools. 3. BASIS OF INVENTORY VALUATION Inventories should be generally valued at the lower of cost or net realizable value. Pricing of inventory assumes significance when different lots are purchased at varying prices at different timings. In case of no change in price level, determination of historical cost of inventory shall not pose any major problem. Cost The amount of expenditure incurred on acquisition of goods. This is the estimated selling price in the ordinary course of business Net realizable value : less the estimated costs of completion and the estimated costs necessary to make the sale. An assessment is made of net realisable value as at each balance sheet date. Inventories are usually written down to net realisable value on an item-by-item basis. In some circumstances, however, it may be approximate to group similar or related items. 4.4 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India Basis of Inventory Valuation Cost Net realizable value Whichever is less Value of Inventory 4. TECHNIQUES OF INVENTORY VALUATION Inventory Valuation Techniques Inventory, not ordinarily Inventory, ordinarily interchangeable interchangeable Specific identification method Historical cost Non-historical cost methods methods FIFO LIFO Average Weighted Base Stock Price Average to be Price discussed at IPCC level Standard Adjusted Latest cost to be Selling Purchase Price discussed at Price to be discussed IPCC level at IPCC level FUNDAMENTALS OF ACCOUNTING 4.5 Copyright -The Institute of Chartered Accountants of India INVENTORIES 4.1 HISTORICAL COST METHODS Under historical cost methods, cost of goods refers to the historical cost of acquisition of goods. It is the value of resources required to obtain the inventory in its present condition and includes "cost of purchase and other costs incurred in bringing the inventories up to their present location and condition". The purchase price including duties and taxes (other than those Costs of purchase which are subsequently recoverable by the enterprise from the taxing authorities), freight inwards and other expenditure directly attributable to the acquisition of goods. Trade discounts, rebates, duty drawbacks and other similar items are deducted in determining the costs of purchase. Other costs are included in the cost of inventories only to the extent that they are incurred in bringing the inventories to their present location and condition. Other Costs While determining cost of inventories, certain costs are excluded and recognised as expenses in the period in which they are incurred. Examples are: (i) costs arising due to abnormal amount of wasted materials, labour or other production costs, and (ii) storage costs are excluded in calculation of cost of inventories unless these costs are necessary in the production process prior to a further production stage, (iii) administrative overheads that do not contribute to bring the inventories to their present location and condition; and (iv) selling and distribution costs. Interest and other borrowing costs are usually considered as not relating to bringing the inventories to their present location and condition and are, therefore, usually not included in the cost of inventories. There is no unique formula for determination of historical cost of inventories. The different techniques for valuation of inventory have been discussed below: (i) Specific Identification Method Pricing under this method is based on actual physical flow of goods. It attributes specific costs to identified goods and requires keeping different lots purchased separately to identify the lot out of which units in stock are left. The historical costs of such specific purpose inventories may be determined on the basis of their specific purchase price or production cost. This method is generally used to ascertain the cost of inventories of items that are not ordinarily interchangeable, otherwise it requires the use of FIFO (First in first out) or weighted overage price/average price formula. (ii) FIFO (First in first out) Method The actual issue of goods is usually from the earliest lot on hand. The stock of goods on hand therefore, consists of the latest consignments. Thus, the closing inventory is valued at the price paid for such consignments. Now, let us take an example to understand the application of FIFO method. 4.6 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India Illustration 1 A manufacturer has the following record of purchases of a condenser, which he uses while manufacturing radio sets: Date Quantity (units) Price per unit Dec. 4 900 5.00 Dec. 10 400 5.50 Dec. 11 300 5.50 Dec. 19 200 6.00 Dec. 28 800 4.75 2,600 1,600 units were issued during the month of December. Solution The closing stock is 1,000 units and would consist of - 800 units received on 28th December; and 200 units received on 19th December as per FIFO Rs. The value of 800 units @ Rs. 4.75 3,800 The value of 200 units @ Rs. 6.00 1,200 Total 5,000 (iii) LIFO (Last in first out) Method Though actual issues are made out of the earliest lot on hand to prevent unnecessary deterioration in value, it is sometimes assumed that the issue to be valued is to be according to the price paid for the latest consignments on hand. The closing stock then is assumed to consist of earlier consignments and its value is then calculated according to such consignments. This method of valuing stock is known as LIFO basis. Under this basis, goods issued are valued at the price paid for the latest lot of goods on hand which means stock of goods in hand is valued at price paid for the earlier lot of goods. In the absence of details of issue, the price paid for the earliest consignments is used for valuing closing stock. LIFO method is based on an irrational assumption that inventories entering last in the stores are issued or consumed first. However, the flow of goods which is generally observed in business entities is contradictory to this assumption. Therefore, LIFO method is no longer adopted for valuing inventories. Generally, in practice, FIFO and Average Price Method are popular among the business entities. (iv) Average Price Method Average price for computing value of stock is a very simple approach. (All the different prices are added together and then divided by the number of prices). The closing stock is then valued according to the price ascertained. FUNDAMENTALS OF ACCOUNTING 4.7 Copyright -The Institute of Chartered Accountants of India INVENTORIES Illustration 2 In the same example of a manufacturer of radio sets given earlier, let us calculate the value of closing inventory using Average Price Method: Record of purchases Date Quantity (units) Price per unit Dec. 4 900 5.00 Dec. 10 400 5.50 Dec. 11 300 5.50 Dec. 19 200 6.00 Dec. 28 800 4.75 2,600 Record of issues Date Quantity (units) Dec. 5 600 Dec. 12 400 Dec. 29 600 Total 1,600 Solution The simple average in this question is: [(5.00 + 5.50 + 5.50 + 6.00 + 4.75)/5] = 26.75/5 = Rs. 5.35 1,000 units valued at Rs. 5.35 would be Rs. 5,350. Let us try to analyse the impact of FIFO and Average price method with the help of the following chart: Units Received Units issued 10.1.2009 500 units at Rs. 5 20.1.2009 500 units 15.1.2009 500 units at Rs. 6 FIFO Average Cost Method 500 units at 500 units at Rs. 6 = Rs. 3,000 Rs. 5.50 = Rs. 2,750 4.8 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India (v) Weighted Average Price Method However, it is more logical to compute weighted average price using the quantities purchased in a lot as weights. Under weighted average price method, cost of goods available for sale during the period is aggregated and then divided by number of units available for sale during the period to calculate weighted average price per unit. Thus Total cost of goods available for sale during the period Weighted average price per unit = Total number of units available for sale during the period Closing stock = No. of units in stock X Weighted average price per unit Cost of goods sold = No. of units sold X Weighted average price per unit. Illustration 3 On the basis of the datas given in illustration 1, calculate the weighted average price and also the value of closing inventory by weighted average price method. Solution The computation of weighted average price in the referred example is shown below: Quantity Rate Price paid units Rs. Rs. 900 5.00 4,500 400 5.50 2,200 300 5.50 1,650 200 6.00 1,200 800 4.75 3,800 2,600 Total 13,350 Rs. 13,350 Weighted average price = 2,600 = Rs. 5.135 per unit Value of closing inventory of 1,000 units = 1,000 x Rs. 5.135 = Rs. 5,135 It should be noted that if a stock ledger is maintained, recording receipts/issues daily, the average would be different. A new average rate would be calculated on receiving a fresh consignment. Answer on that basis would be as under: FUNDAMENTALS OF ACCOUNTING 4.9 Copyright -The Institute of Chartered Accountants of India INVENTORIES Date Receipts Issues Balance Qty. Rate Amount Qty. Rate Amount Qty. Rate Amount Dec. Units Rs. Rs. Units Rs. Rs. Units Rs. Rs. 4 900 5.00 4,500 900 5.00 4,500 5 600 5.00 3,000 300 5.00 1,500 10 400 5.50 2,200 700 5.28 3,700 11 300 5.50 1,650 1,000 5.35 5,350 12 400 5.35 2,140 600 5.35 3,210 19 200 6.00 1,200 800 5.51 4,410 28 800 4.75 3,800 1,600 5.13 8,210 29 600 5.13 3,078 1,000 5.13 5,132 4.2 NON-HISTORICAL COST METHODS Non-historical cost methods do not consider the historical cost incurred to acquire the goods. Non- historical cost methods include Adjusted Selling Price method, Standard Cost and Latest Purchase Price method. Adjusted Selling Price method can be explained as follows: (i) Adjusted selling price method This method is also called retail inventory method. It is used widely in retail business or in business where the inventory comprises of items, the individual costs of which are not readily ascertainable. The use of this method is appropriate for measuring inventories of large numbers of rapidly changing items that have similar margins and for which it is impracticable to use other costing methods. The cost of the inventory is determined by reducing from the sales value of the inventory the appropriate percentage of gross margin. The percentage used takes into consideration inventory which has been marked below its original selling price. An average percentage for each retail department is often used. The calculation of the estimated gross margin of profit may be made for individual items or groups of items or by departments, as may be appropriate to the circumstances. Illustration 4 M/s X, Y and Z are in retail business, following information are obtained from their records for the year ended 31st March, 2009: Goods received from suppliers (subject to trade discount and taxes) Rs. 15,75,500 Trade discount 3% and sales tax 11% Packaging and transportation charges Rs. 87,500 Sales during the year Rs. 22,45,400 Sales price of closing inventories Rs. 2,35,000 4.10 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India Find out the historical cost of inventories using adjusted selling price method. Solution Determination of cost of purchases: Goods received from suppliers Rs. 15,75,500 Less : Trade discount 3% Rs. 47,265 Rs. 15,28,235 Add : Sales Tax 11% Rs. 1,68,106 Rs. 16,96,341 Add : Packaging and transportation charges Rs. 87,500 Rs. 17,83,841 Determination of estimated gross profit margin: Sales during the year Rs. 22,45,500 Closing inventory at the selling price Rs. 2,35,000 Rs. 24,80,500 Less : Purchases Rs. 17,83,841 Gross profit Rs. 6,96,659 Gross profit margin 28.09% Inventory valuation: Selling price of closing inventories Rs. 2,35,000 Less : Gross profit margin 28.09% Rs. 66,012 Rs. 1,68,988 Illustration 5 From the following information, calculate the historical cost of inventories using adjusted selling price method: Rs. Sales during the year 2,00,000 Cost of purchases 2,00,000 Opening stock Nil Closing stock at selling price 50,000 FUNDAMENTALS OF ACCOUNTING 4.11 Copyright -The Institute of Chartered Accountants of India INVENTORIES Solution Calculation of gross margin of profit: Rs. Sales 2,00,000 Add: Closing inventory (at selling price) 50,000 Selling price of goods available for sale : 2,50,000 Less : Cost of goods available for sale 2,00,000 Gross margin 50,000 50,000 Rate of gross margin = ×100=20% 2,50,000 Cost of closing stock = 50,000 less 20% of Rs. 50,000 = Rs. 40,000 5. INVENTORY RECORD SYSTEMS There are two principal systems of determining the physical quantities and monetary value of inventories sold and in hand. One system is known as 'Periodic Inventory System' and the other as the 'Perpetual Inventory System'. The periodic system is less expensive to use than the perpetual method. But the useful information obtained from perpetual system eclipses the cost consideration. These systems are distinguished on the basis of the actual records kept to ascertain the cost of goods sold and the closing inventory valuations. 5.1 PERIODIC INVENTORY SYSTEM Periodic inventory system is a method of ascertaining inventory by taking an actual physical count (or measure or weight) of all the inventory items on hand at a particular date on which inventory is required. It is because of actual physical count that the system is also called physical inventory system. The cost of goods sold is determined as shown below: Opening inventory (known) + Purchases (known) - closing inventory (physically counted) = Cost of goods sold. Periodic inventory system is simple and less expensive than the perpetual system. In this system, stock account is adjusted at the end of the accounting period to determine cost of goods sold. This system suffers from various limitations: (i) Physical stock taking is required more than once a year for preparation of quarterly or half yearly financial statements thereby making this system more expensive. (ii) Physical count of goods requires closure of normal operations of business. (iii) As cost of goods sold is taken as residual figure, it includes loss of goods during the year. (iv) Inventory control is not possible under this system. 5.2 PERPETUAL INVENTORY SYSTEM Perpetual inventory system is a system of recoding inventory balances after each receipt and issue. In order to ensure accuracy of perpetual inventory records, physical stocks should be checked and compared with recorded balances. Under this system, cost of goods issued is 4.12 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India directly determined and stock of goods is taken as residual figure with the help of stock ledger in which flow of goods is recorded on continuous basis. The basic feature of this system is the maintenance of stock ledger to have records of goods on continuous basis. Perpetual inventory system helps to overcome the limitations of periodic system. As stock is taken as residual figure, it includes loss of goods. However, the main limiting factor is the cost of using this system. 5.3 DISTINCTION BETWEEN PERIODIC INVENTORY SYSTEMAND PERPETUAL INVENTORY SYSTEM Both the systems - Periodic Inventory System and Perpetual Inventory System are not mutually exclusive and complementary in nature. Distinction between both the systems can be explained as follows: S. Periodic Inventory System Perpetual Inventory System No. 1. This system is based on physical verification. It is based on book records. 2. This system provides information about stock It provides continuous information about and cost of goods sold at a particular date stock and cost of sales. 3. This system determines inventory and takes It directly determines cost of goods sold cost of goods sold as residual figure. and computes stock as balancing figure. 4. Cost of goods sold includes loss of goods Closing inventory includes loss of goods as goods not in stock are assumed to be sold. as all unsold goods are assumed to be in inventory. 5. Under this method, inventory control is not Inventory control can be exercised under possible. this system. 6. This system is simple and less expensive. It is costlier method. 7. Periodic system requires closure of business Inventory can be determined without for counting of stock. affecting the operations of the business. 6. STOCK TAKING Normally all operations are suspended for one or two days during the financial year and physical inventory is taken for everything in the godown or the store periodically. For the year- end inventory valuation, physical stock taking is done during the last week of the financial year. If stock taking is finished on 26th March, whereas accounting year ends on 31st March purchases and sales subsequent to 26th March are then separately adjusted. Later, a value is put on each item. The principle of cost or market price, whichever is lower, is applied either for the inventory as a whole or item by item. Often, stock taking cannot be carried out on the closing day. It is carried out a few days later or some times even a few days earlier. In such a case, the actual value of the stock must be so adjusted as to relate it to the end of the year concerned. For doing so, it will be necessary to FUNDAMENTALS OF ACCOUNTING 4.13 Copyright -The Institute of Chartered Accountants of India INVENTORIES take into account the goods that have come in (purchases and sales returns) and those that have gone out (sales and purchase returns) during the interval between the close of the year and the date of actual stock taking. Further, the adjustment of all goods must be on the basis of cost. Suppose, a firm that closes its books on 31st December, carried out the stock taking on the 7th January next year and actual stock was of the cost of Rs. 78,500, during the period January 1 to 7 purchases were Rs. 15,300 and sales Rs. 25,000, the mark up being 25% on cost. The stock on 31st December would be Rs. 83,200 as shown below: Rs. Stock ascertained on January 7 78,500 Less : Purchases during the period Jan. 1 to 7 15,300 63,200 Add : Cost of goods sold during the period : 25,000 × (100/125) 20,000 83,200 Illustration 6 From the following particulars ascertain the value of stock as on 31st March, 2009: Rs. Stock as on 1.4.2008 14,250 Purchases 76,250 Manufacturing Expenses 15,000 Selling Expenses 6,050 Administrative Expenses 3,000 Financial Charges 2,150 Sales 1,24,500 At the time of valuing stock as on 31st March, 2008, a sum of Rs. 1,750 was written off on a particular item, which was originally purchased for Rs. 5,000 and was sold during the year for Rs. 4,500. Barring the transaction relating to this item, the gross profit earned during the year was 20 percent on sales. 4.14 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India Solution Statement of stock in trade as on 31st March, 2009 Rs. Rs. Stock as on 31st March, 2008 14,250 Less : Book value of abnormal stock (Rs. 5,000 - Rs. 1,750) 3,250 11,000 Add : Purchases 76,250 Manufacturing Expenses 15,000 1,02,250 Less : Cost of goods sold : Sales as per books 1,24,500 Less : Sales of abnormal item 4,500 1,20,000 Less : Gross Profit @ 20% 24,000 96,000 Stock in trade as on 31st March, 2009 6,250 Illustration 7 A trader prepared his accounts on 31st March, each year. Due to some unavoidable reasons, no stock taking could be possible till 15th April, 2009 on which date the total cost of goods in his godown came to Rs. 50,000. The following facts were established between 31st March and 15th April, 2009. (i) Sales Rs. 41,000 (including cash sales Rs. 10,000) (ii) Purchases Rs. 5,034 (including cash purchases Rs. 1,990) (iii) Sales Return Rs. 1,000. Goods are sold by the trader at a profit of 20% on sales. You are required to ascertain the value of inventory as on 31st March, 2009. Solution Statement of valuation of stock on 31st March, 2009 Rs. Rs. Value of stock as on 15th April, 2009 50,000 Add : Cost of goods sold during the period from 31st March, 2009 to 15th April, 2009 Sales (Rs. 41,000 - Rs. 1,000) 40,000 Less : Gross Profit (20% of Rs. 40,000) 8,000 32,000 82,000 Less : Purchases during the period from 31st March, 2009 to 15th April, 2009 5,034 76,966 FUNDAMENTALS OF ACCOUNTING 4.15 Copyright -The Institute of Chartered Accountants of India INVENTORIES Illustration 8 Stock taking for the year ended 30th September, 2009 was completed by 10th October 2009, the valuation of which showed a stock figure of Rs. 1,67,500 at cost as on the completion date. After the end of the accounting year and till the date of completion of stock taking, sales for the next year were made for Rs. 6,875, profit margin being 33.33 percent on cost. Purchases for the next year included in the stock amounted to Rs. 9,000 at cost less trade discount 10 percent. During this period, goods were added to stock at the mark up price of Rs. 300 in respect of sales returns. After stock taking it was found that there were certain very old slow moving items costing Rs. 1,125, which should be taken at Rs. 525 to ensure disposal to an interested customer. Due to heavy flood, certain goods costing Rs. 1,550 were received from the supplier beyond the delivery date of customer. As a result, the customer refused to take delivery and net realisable value of the goods was estimated to be Rs. 1,250 on 30th September. Compute the value of stock for inclusion in the final accounts for the year ended 30th September, 2009. Solution Statement showing the valuation of stock as on 30th September, 2009 Rs. Value of Stock as on 10th October 1,67,500 Add: Cost of goods sold after 30th September till stock taking (Rs. 6,875 - Rs. 1,719) 5,156 Less: Purchases for the next period (net) 8,100 Less: Cost of Sales Returns 225 Less: Loss on revaluation of slow moving inventories 600 Less: Reduction in value on account of default 300 Value of Stock on September 30 1,63,431 Note: Profit margin of 33.33 percent on cost means 25 percent on sales price. Illustration 9 The following are the details of a spare part of Sriram mills: 1-1-2009 Opening stock Nil 1-1-2009 Purchases 100 units @ Rs. 30 per unit 15-1-2009 Issued for consumption 50 units 1-2-2009 Purchases 200 units @ Rs. 40 per unit 15-2-2009 Issued for consumption 100 units 20-2-2009 Issued for consumption 100 units Find out the value of stock as on 31-3-2009 if the company follows First in first out basis. 4.16 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India Solution First-in-First out basis Sriram Mills Calculation of the value of stock as on 31-3-2009 Receipts Issues Balance Date Units Rate Amount Units Rate Amount Units Rate Amount Rs. Rs. Rs. Rs. Rs. Rs. 1-1-2009 Balance Nil 1-1-2009 100 30 3,000 100 30 3,000 15-1-2009 50 30 1,500 50 30 1,500 1-2-2009 200 40 8,000 50 30 1,500 200 40 8,000 15-2-2009 50 30 1,500 150 40 6,000 50 40 2,000 20-2-2009 100 40 4,000 50 40 2,000 Therefore, the value of stock as on 31-3-2009: 50 units @ Rs. 40 = Rs. 2,000 Illustration 10 The following are the details of a spare part of Sriram mills: 1-1-2009 Opening stock Nil 1-1-2009 Purchases 100 units @ Rs. 30 per unit 15-1-2009 Issued for consumption 50 units 1-2-2009 Purchases 200 units @ Rs. 40 per unit 15-2-2009 Issued for consumption 100 units 20-2-2009 Issued for consumption 100 units Find out the value of stock as on 31-3-2009 if the company follows Weighted Average basis. FUNDAMENTALS OF ACCOUNTING 4.17 Copyright -The Institute of Chartered Accountants of India INVENTORIES Solution Weighted Average basis Sriram Mills Calculation of the value of stock as on 31-3-2009 Receipts Issues Balance Date Units Rate Amount Units Rate Amount Units Rate Amount Rs. Rs. Rs. Rs. Rs. Rs. 1-1-2009 Balance Nil 1-1-2009 100 30 3,000 100 30 3,000 15-1-2009 50 30 1,500 50 30 1,500 1-2-2009 200 40 8,000 250 38 9,500 15-2-2009 100 38 3,800 150 38 5,700 20-2-2009 100 38 3,800 50 38 1,900 Therefore, the value of stock as on 31-3-2009 = 50 units @ Rs. 38 = Rs. 1,900 SELF EXAMINATION QUESTIONS Pick up the correct answer from the given choices: 1. The amount of purchase if Cost of goods sold is Rs.80,700 Opening stock Rs.5,800 Closing stock Rs.6,000 (a) Rs. 80,500 (b) Rs. 74,900 (c) Rs. 74,700 (d) Rs. 80,900. 2. Average Stock = Rs. 12,000. Closing stock is Rs. 3,000 more than opening stock. The value of closing stock = ______. (a) Rs. 12,000 (b) Rs. 24,000 (c) Rs. 10,500 (d) Rs. 13,500. 3. If the profit is 25% of the cost price then it is (a) 25% of the sales price (b) 33% of the sales price (c) 20% of the sales price (d) 15% of the sales price. 4. Goods purchased Rs. 1,00,000. Sales Rs 90,000. Margin 20% on cost. Closing Stock = ? (a) Rs. 20,000 (b) Rs. 10,000 (c) Rs. 25,000 (d) Rs. 28,000 4.18 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India 5. A company is following weighted average cost method for valuing its inventory. The details of its purchase and issue of raw-materials during the week are as follows: 1.12.2005 opening stock 50 units value Rs.2,200. 2.12.2005 purchased 100 units @Rs.47. 4.12.2005 issued 50 units. 5.12.2005 purchased 200 units @Rs.48. The value of inventory at the end of the week and the unit weighted average costs is (a) Rs. 14,200 – Rs. 47.33 (b) Rs. 14,300 – Rs. 47.67 (c) Rs. 14,000 – Rs. 46.66 (d) Rs. 14,400 – Rs. 48.00 6. The books of T Ltd. revealed the following information: Particulars Rs. Opening inventory 6,00,000 Purchases during the year 2008-2009 34,00,000 Sales during the year 2008-2009 48,00,000 On March 31, 2009, the value of inventory as per physical stock-taking was Rs. 3,25,000. The company’s gross profit on sales has remained constant at 25%. The management of the company suspects that some inventory might have been pilfered by a new employee. What is the estimated cost of missing inventory? (a) Rs. 75,000 (b) Rs. 25,000 (c) Rs. 1,00,000 (d) Rs. 1,50,000. 7. C Ltd. recorded the following information as on March 31, 2009: Rs. Stock as on April 01, 2008 80,000 Purchases 1,60,000 Sales 2,00,000 It is noticed that goods worth Rs.30,000 were destroyed due to fire. Against this, the insurance company accepted a claim of Rs.20,000. The company sells goods at cost plus 33 1/3 %. The value of closing inventory, after taking into account the above transactions is, (a) Rs.10,000 (b) Rs.30,000 (c) Rs.1,00,000 (d) Rs.60,000. 8. D Company, a dealer in cosmetics, records its inventory under first-in-first-out method, so as to minimize accumulation of outdated stock. The opening stock as on September 01, 2009 is 150 units at the rate of Rs.20 per unit. The purchases and sales made during the month are: FUNDAMENTALS OF ACCOUNTING 4.19 Copyright -The Institute of Chartered Accountants of India INVENTORIES Purchases: Date No. of units Cost price per unit 04-09-2009 200 Rs.25 14-09-2009 100 Rs.22 Sales: Date No. of units 03-09-2009 100 10-09-2009 150 With effect from September 01, 2009, the company decided to change the method of inventory valuation from the FIFO method to LIFO method. The change in the value of inventory as on September 30, 2009 consequent upon the change in the method of valuation is (a) Increase in the value of closing stock by Rs.250. (b) Decrease in the value of closing stock by Rs.250. (c) Increase in the value of closing stock by Rs.500. (d) Decrease in the value of closing stock by Rs.500. 9. E Ltd., a dealer in second-hand cars has the following five vehicles of different models and makes in their stock at the end of the financial year 2008-2009: Car Fiat Ambassador Maruti Esteem Maruti 800 Zen Cost (Rs.) 90,000 1,15,000 2,75,000 1,00,000 2,10,000 Net realizablevalue (Rs.) 95,000 1,55,000 2,65,000 1,25,000 2,00,000 The value of stock included in the balance sheet of the company as on March 31, 2009 was (a) Rs.7,62,500 (b) Rs.7,70,000 (c) Rs.7,90,000 (d) Rs.8,70,000. 10. On April 07, 2009, i.e, a week after the end of the accounting year 2008-09, a company undertook physical stock verification. The value of stock as per physical stock verification was found to be Rs.35,000. The following details pertaining to the period April 01, 2009 to April 07, 2009 are given: I. Goods costing Rs.5,000 were sold during the week. II. Goods received from consignor amounting to Rs.4,000 included in the value of stock. III. Goods earlier purchased but returned during the period amounted to Rs.1,000. IV. Goods earlier purchased and accounted but not received Rs.6,000. 4.20 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India After considering the above, the value of stock held as on March 31, 2009 was (a) Rs.27,000 (b) Rs.19,000 (c) Rs.43,000 (d) Rs.51,000. 11. While finalizing the current year’s profit, the company realized that there was an error in the valuation of closing stock of the previous year. In the previous year, closing stock was valued more by Rs.50,000. As a result (a) Previous year’s profit is overstated and current year’s profit is also overstated (b) Previous year’s profit is understated and current year’s profit is overstated (c) Previous year’s profit is understated and current year’s profit is also understated (d) Previous year’s profit is overstated and current year’s profit is understated 12. The total cost of goods available for sale with a company during the current year is Rs.12,00,000 and the total sales during the period are Rs.13,00,000. If the gross profit margin of the company is 33 1/3% on cost, the closing inventory during the current year is (a) Rs.4,00,000 (b) Rs.3,00,000 (c) Rs.2,25,000 (d) Rs.2,60,000. 13. A company follows weighted average cost method for the valuation of its inventory. The details of purchase and issue of raw-materials pertaining to the company during the week April 01, 2009 to April 07, 2009 are as follows: Date Particulars Purchases (Units) Issues (Units) Rate per Unit (Rs.) April 01 Opening stock 50 44 April 02 100 47 April 04 50 - The value of inventory at the end of the week under weighted average method is (a) Rs.4,600 (b) Rs.4,550 (c) Rs.4,700 (d) Rs.4,400. 14. Consider the following information pertaining to G & Sons as on March 31, 2009: Particulars Rs. Opening inventory 15,00,000 Purchases during the year 2008-09 45,00,000 Sales during the year 2008-09 50,00,000 As per physical inventory taken on March 31, 2009 the closing inventory was Rs.20,90,000. Gross profit on sales has remained constant at 25%. The management of the firm suspects that some inventory might have been taken away by a new employee. The estimated cost of missing inventory on the close of the financial year and the cost of goods sold during the year, respectively are (a) Rs.2,65,000; Rs.37,50,000 (b) Rs.2,10,000; Rs.39,10,000 (c) Rs.1,75,000; Rs.50,00,000 (d) Rs.1,60,000; Rs.37,50,000. FUNDAMENTALS OF ACCOUNTING 4.21 Copyright -The Institute of Chartered Accountants of India INVENTORIES 15. S Ltd. follows perpetual inventory system. On March 31 of every year, the company undertakes physical stock verification. On March 31, 2009, the value of stock as per the records differed from the value as per the physical stock. On scrutiny, the following differences were noticed: Goods purchased for Rs.10,000 were received and included in the physical stock but no entry was made in the books. Goods costing Rs.30,000 were sold and entered in the books but the stock is yet to be delivered. Goods worth Rs.5,000 are returned to the suppliers but is omitted to be recorded. If the inventory is valued in the books at Rs.1,50,000, the value of the physical inventory is (a) Rs.1,11,000 (b) Rs.1,89,000 (c) Rs.1,85,000 (d) Rs.1,59,000. 16. Consider the following data pertaining to H Ltd. for the month of March 2009: Particulars As on March 01, 2009 (Rs.) As on March 31, 2009 (Rs.) Stock 1,80,000 90,000 The company made purchases amounting Rs. 3,30,000 on credit. During the month of March 2009, the company paid a sum of Rs.3,50,000 to the suppliers. The goods are sold at 25% above the cost. The sales for the month of March 2009 were (a) Rs.4,12,500 (b) Rs.5,25,000 (c) Rs.90,000 (d) Rs.3,15,000. 17. Consider the following data pertaining to a company for the month of March 2009: Particulars Rs. Opening stock 22,000 Closing stock 25,000 Purchases less returns 1,10,000 Gross profit margin (on sales) 20% The sales of the company during the month are (a) Rs.1,41,250 (b) Rs.1,35,600 (c) Rs.1,33,750 (d) Rs.1,28,400. 18. O Ltd. maintains the inventory records under perpetual system of inventory. Consider the following data pertaining to inventory of O Ltd. held for the month of March 2009: Date Particulars Quantity Cost Per unit(Rs.) Mar. 1 Opening Inventory 15 400 Mar. 4 Purchases 20 450 Mar. 6 Purchases 10 460 If the company sold 32 units on March 24, 2009, closing inventory under FIFO method is (a) Rs.5,200 (b) Rs.5,681 (c) Rs.5,800 (d) Rs.5,950. 4.22 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India 19. Consider the following data pertaining to R Ltd. for the month of June 2009: Particulars Rs. Opening stock 30,000 Closing stock 40,000 Purchases 5,60,000 Returns outward 15,000 Returns inward 20,000 Carrige inward 5,000 If the gross profit is 20% of net sales, the gross sales for the month of June 2009 is (a) Rs.6,95,000 (b) Rs.6,75,000 (c) Rs.5,40,000 (d) Rs.6,68,750. 20. Consider the following for Q Co. for the year 2008-09: Cost of goods available for sale Rs.1,00,000 Total sales Rs. 80,000 Opening stock of goods Rs. 20,000 Gross profit margin 25% Closing stock of goods for the year 2008-09 was (a) Rs.80,000 (b) Rs.60,000 (c) Rs.40,000 (d) Rs.36,000. 21. Consider the following data pertaining to credit purchases made by K Ltd., a dealer in electronic goods, for the month of March 2009: Date Particulars No. of units Rate per unit Rs. Trade Discount March 01 Black & White TVs 50 3,000 10% Colour TVs 10 6,000 10% March 09 Tape Recorders 10 1,000 10% Two-in-one 10 1,500 10% March 19 Audio Cassettes 100 30 5% On March 22, 2009, the company purchased from LM Stationers on credit for office use 10 dozens of carbon papers at the rate of Rs.35 per dozen and 10 dozens of ball pens at the rate of Rs.25 per dozen. At the time of making payment on March 31, 2009, the suppliers have allowed a cash discount of 10% on the above purchases. The total of purchases for the month of March 2009, was (a) Rs.2,14,350 (b) Rs.2,38,000 (c) Rs.1,92,915 (d) Rs.2,38,600 FUNDAMENTALS OF ACCOUNTING 4.23 Copyright -The Institute of Chartered Accountants of India INVENTORIES From the given information, choose the most appropriate answer for questions 22 to 27. Hindustan Ltd. has furnished the following details : Date Particulars Units Rate (Rs.) 01.03.2009 Opening stock 100 1.75 05.03.2009 Purchased 150 1.50 12.03.2009 Purchased 300 1.60 08.03.2009 Issued 200 - 18.03.2009 Issued 250 - 22. What is the value of closing stock using FIFO method : (a) Rs. 170 (b) Rs. 160 (c) Rs. 150 (d) Rs. 180 23. Using the information given in the problem, the value of issues using FIFO method : (a) Rs. 700 (b) Rs. 580 (c) Rs. 605 (d) Rs. 720 24. Using the information given in problem, the value of closing stock as per LIFO method : (a) Rs. 172.50 (b) Rs. 225 (c) Rs. 160 (d) Rs. 167.50 25. Using the information given in problem, the value of issues using LIFO method : (a) Rs. 712.50 (b) Rs. 515.50 (c) Rs. 620 (d) Rs. 575.50 26. Using the information given in problem, the value of closing stock as per weighted average method : (a) Rs. 160 (b) Rs. 175.50 (c) Rs. 150 (d) Rs. 225.50 27. Using the information given in problem, the value of issues using weighted average method : (a) Rs. 600.50 (b) Rs. 580 (c) Rs. 620 (d) Rs. 720 From the given information, answer questions 28 to 36. Bharat Indian Oil is a bulk distributor of petrol. A periodic inventory of petrol on hand is taken when the books are closed at the end of each month. The following summary of information is available for the month : Sales Rs.9,45,000 General administration cost Rs.25,000 Opening Stock: 1,00,000 litres @ Rs.3 per litre Rs.3,00,000 Purchases (including freight inward): June 1 2,00,000 litres @ Rs.2.85 per litre June 30 1,00,000 litres @ Rs.3.03 per litre June 30 Closing stock 1,30,000 litres 4.24 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India 28. Compute the value of inventory on June 30 using FIFO method of inventory costing. (a) Rs. 3,88,500 (b) Rs. 4,18,500 (c) Rs. 2,58,000 (d) Rs. 3,60,500 29. Using the information given in problem, compute the amount of cost of goods sold for the month of June using FIFO basis. (a) Rs. 7,84,500 (b) Rs. 6,85,000 (c) Rs. 3,88,500 (d) Rs. 7,58,000 30. Compute net profit or loss for the month of June using FIFO method of inventory costing. (a) Rs. 1,60,000 (b) Rs. 1,15,500 (c) Rs. 1,25,000 (d) Rs. 1,35,500 31. Compute the value of inventory on June 30 using weighted average method of inventory costing. (a) Rs. 3,75,000 (b) Rs. 3,81,225 (c) Rs. 2,80,000 (d) Rs. 4,10,000 32. Using the information given in problem, compute the amount of cost of goods sold for the month of June using weighted average method. (a) Rs. 8,15,000 (b) Rs. 7,52,000 (c) Rs. 7,91,775 (d) Rs. 6,79,000 33. Compute gross profit or loss for the month of June using weighted average method of inventory costing. (a) Rs. 1,20,000 (b) Rs. 2,15,000 (c) Rs. 1,53,225 (d) Rs. 129,000 34. Compute the value of inventory on June 30 using LIFO method of inventory costing. (a) Rs. 3,85,500 (b) Rs. 3,69,000 (c) Rs. 2,97,000 (d) Rs. 4,18,000 35. Using the information given in the problem, compute the amount of cost of goods sold for the month of June using LIFO principle. (a) Rs. 7,87,500 (b) Rs. 6,75,000 (c) Rs. 8,15,000 (d) Rs. 7,95,000 36. Compute gross profit or loss for the month of June using LIFO method of inventory costing. (a) Rs. 1,95,500 (b) Rs. 165,000 (c) Rs. 1,57,500 (d) Rs. 1,95,000 From the following information, answer questions 37 to 42 The following are the details supplied by Agni Ltd. in respect of its raw materials for the Month of December, 2009 : Date Receipts Issues (Units) Price per unit (Rs.) (Units) 01.12.2009 2,000 (Opening) 5.00 07.12.2009 1,000 6.00 10.12.2009 - - 2,500 15.12.2009 2,000 6.50 31.12.2009 - - 2,200 On 31.12.2009, a shortage of 100 units was found. FUNDAMENTALS OF ACCOUNTING 4.25 Copyright -The Institute of Chartered Accountants of India INVENTORIES 37. Find the value of closing stock using LIFO principle. (a) Rs. 1,900 (b) Rs. 2,400 (c) Rs. 2,000 (d) Rs. 1,500 38. Using the data given in problem, the value of issues in the month of December 2009 using LIFO principle. (a) Rs. 35,000 (b) Rs. 27,500 (c) Rs. 20,000 (d) Rs. 65,000 39. Using the data given in problem, the value of closing stock using FIFO principle. (a) Rs. 1,600 (b) Rs. 1,500 (c) Rs. 1,950 (d) Rs. 2,000 40. Using the data given in problem, the value of issues in the month of December 2009 using FIFO method. (a) Rs. 27,050 (b) Rs. 35,500 (c) Rs. 19,500 (d) Rs. 21,300 41. Using the data given in problem , the value of closing stock using simple average principle. (a) Rs. 950 (b) Rs. 1,750 (c) Rs. 1,000 (d) Rs. 1,300 (e) Rs. 750 42. Using the data given in problem, the value of issues in the month of December 2009 using simple average method. (a) Rs. 15,385 (b) Rs. 21,675 (c) Rs. 19,750 (d) Rs. 27,417 From the following information, answer questions 43 to 47 X who was closing his books on 31.03.2009 failed to take the actual stock which he did on 9th April, when it was ascertained by him to be worth Rs 25,000. It was found that sales are entered in the Sales Day Book on the same day of despatch and the returns inward in the returns book as and when the goods are received back. Purchases are entered in the Purchase Day Book once the invoices are received. Observations - i. Sales between 31st March and 9th April as per Sales Book are Rs 1,720. Rate of gross profit is 33 1/3 % on cost. ii. Purchases during the same period as per Purchases Book are Rs 120. iii. Out of above purchases, goods amounting to Rs 50 were not received until after the stock was taken. iv. Goods invoiced during the month of March, but goods received only on 4th April, amounted to Rs 100. You want to find the value of physical stock on 31st March. You start with the value of stock on 9th April. 43. How would you adjust the observation # 1? (a) 1,720 (Less) (b) 1,290 (Less) (c) 430 (d) 1,290 (Add) 44. How would you adjust the observation # 2? (a) 120 (Less) (b) 170 (Less) (c) 50 (d) 120 (Add) 4.26 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India 45. How would you adjust the observation # 3? (a) 70 (Less) (b) 50 (Less) (c) 120 (d) 50 (Add) 46. How would you adjust the observation # 4? (a) 100 (Add) (b) 150 (Less) (c) 100 (Less) (d) 150 (Add) 47. Value of physical stock on 31st March = _______. (a) 26,320 (b) 26,120 (c) 6,190 (d) 23,530 From the following information, answer questions 48 to 53 Physical verification of stock was done on 23rd Iune. The value of stock was Rs. 4,80,000. Following transactions took place between 23rd June and 30th June: 1. Out of goods sent on consignment, goods costing Rs. 24,000 were unsold. 2. Purchases of Rs. 40,000 were made, out of which goods worth Rs. 16,000 were delivered on 5th July. 3. Sales were Rs. 1,36,000, which include goods worth Rs. 32,000 sent on approval. Half of these goods were returned before 30th June, but no intimation is available regarding the remaining goods. Goods are sold at cost plus 25%. However, goods costing Rs. 24,000 had been sold for Rs. 12,000. You want to determine the value of stock on 30th June. You start with physical stock on 23rd June. 48. What will you do regarding adjustment # 1? (a) 24,000 (Add) (b) 24,000 (less) (c) 48,000 (Add) (d) 48,000 (Less) 49. What will you do regarding adjustment # 2? (a) 24,000 (Add) (b) 16,000 (Add) (c) 40,000 (Add) (d) 40,000 (Less) 50. Normal Sales = ______. (a) 1,36,000 (b) 1,24,000 (c) 1,48,000 (d) 92,000 51. Cost of Normal Sales = _______. (a) 73,600 (b) 80,000 (c) 1,08,800 (d) 99,200 52. What will you do regarding adjustment # 3? (a) 73,600 (Add) (b) 24,000 (lAdd) (c) 97,600 (Less) (d) Both (a) and (b) 53. Value of stock on 30th June = ________. (a) 4,80,000 (b) 5,44,000 (c) 4,36,000 (d) 4,46,400 FUNDAMENTALS OF ACCOUNTING 4.27 Copyright -The Institute of Chartered Accountants of India INVENTORIES ANSWERS 1. (d) 2. (d) 3. (c) 4. (c) 5. (a) 6. (a) 7. (d) 8. (b) 9. (b) 10. (c) 11. (d) 12. (c) 13. (a) 14. (d) 15. (c) 16. (b) 17. (c) 18. (d) 19. (a) 20. (c) 21. (a) 22. (b) 23. (d) 24. (d) 25. (a) 26. (a) 27. (d) 28. (a) 29. (a) 30. (d) 31. (b) 32. (c) 33. (c) 34. (a) 35. (a) 36. (c) 37. (d) 38. (b) 39. (c) 40. (a) 41. (b) 42. (d) 43. (d) 44. (a) 45. (d) 46. (c) 47. (b) 48. (a) 49. (c) 50. (d) 51. (a) 52. (c) 53. (d) 4.28 COMMON PROFICIENCY TEST Copyright -The Institute of Chartered Accountants of India