VALUATION OF STOCK

The process of calculating the value of goods or materials owned by a company or available for sale in a store at a particular time, or the value that is calculated.

Scope of valuation of stock: a) Work in progress arising under construction contracts, including directly related service contracts. b) Work in progress arising in the ordinary course of business of service providers. c) Shares, debentures and other financial instruments held as stock-in-trade. d) Producers inventories of livestock, agricultural and forest products, and mineral oils, ores and gases to the extent that they are measured at net realisable value in accordance with well established practices in those industries.

Cost of Inventories: a) Costs of Purchase: The costs of purchase consist of the purchase price including: Duties and taxes Freight inwards Other expenditure directly attributable to the acquisition. Trade discounts, rebates, duty drawbacks and other similar items are deducted in determining the costs of purchase. b) Costs of Conversion: The costs of conversion of inventories include: costs directly related to the units of production, such as direct labour. Fixed production overheads : indirect costs of production that remain relatively constant regardless of the volume of production. Variable production overheads : indirect costs of production that vary directly, or nearly directly, with the volume of production.

C) Other Costs: 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. For example, it may be appropriate to include overheads other than production overheads or the costs of designing products for specific customers in the cost of inventories.

Methods of valuation of stock: a) First-in-first-out (FIFO): Defined: The oldest inventory asset is recorded as sold first regardless of the actual shelf-age of the given physical asset. Applied: While it is the most widely used accounting technique in periodic inventory management today, FIFO may fail to offer a full picture of inventory value if inflation and price increases are not closely analyzed. Thus, FIFO may inflate or deflate the actual value of future inventory. Advantages of FIFO: FIFO method is easy to understand and operate It is suitable for bulky materials with high unit prices Also helps to avoid detoriation & obsolescence This method is useful when prices are falling FIFO method is also useful when transactions are not too many and prices of materials are fairly steady.

Disadvantages of FIFO : FIFO method is improper if many lots are purchased during the period at different prices. It overstates profits especially during inflation. If the prices of the materials are increasing rapidly, the current production cost may be understated.

 This method increases the possibility of clerical errors. For pricing rise, the issue price does not reflect the market price as materials are issued from the earliest consignments. b) Last-in first-out (LIFO): Defined: The newest inventory asset is recorded as sold first. Applied: The LIFO method could reduce a companys tax responsibility in times of growing inflation but it has been heavily regulated under the International Financial Reporting Standards. Advantages of LIFO: LIFO method is appropriate for matching cost and revenue. LIFO is simple to operate and easy to understand. LIFO facilitates complete recovery of material cost. LIFO is most suitable when prices are rising. In times of rising prices, LIFO method of pricing issues is most suitable because materials are issued at the current market prices which are high.

Disadvantages of LIFO : Inventory valuation does not reflect the current prices and therefore are useless in the context of current conditions. Due to variation of prices, comparison of cost of similar job is not possible.

 Calculations become complicated when rates of receipts are highly fluctuating. LIFO involves considerable clerical work. For pricing a single requisition, more than one price has often to be adopted. c) Average cost Method: Defined: The AVCO (average cost) method will take the total cost of goods still available for sale and divide it by the total sum of product from the beginning inventory and purchases. Applied: With the AVCO method, cost flow is determined as a weighted average of all total unit costs. It is divided into Simple Average Method and Weighted Average Method. i) Simple Average Method: Under this method, simple average rate at cost is obtained by adding the rate of purchases represented by stock at the time of issue & then dividing the same by the number of such rates. The rate needs to be revised at the time of any new purchase or exhaustion of any existing stock. To dampen the severity of the effect of rises & falls in the purchase price, use of any kind of average rate is made. Thus, in case of fluctuating rates of purchase, average cost is used. However, obviously, cost does not get properly represented by the average cost.

ADVANTAGES OF SIMPLE AVERAGE METHOD : It is simple to work out & apply. Issue price cannot be affected considerably by the fluctuations in prices of purchase. Average cost method is suitable for the condition when different lots of purchases get mixed up so that the identification is not possible. Where the quantity of each purchase is stable but the prices fluctuate, average cost method suits the condition. DISADVANTAGES OF SIMPLE AVERAGE METHOD : Profit or loss in material arises as total cost incurred usually does not become equal to the total charges. Frequent calculations of rates will be necessary in case of frequent purchases, thereby involving much clerical work. Average rate may have to be revised due to exhaustion of an existing stock even if no new purchase comes. Too much profit or loss on materials may be resulted from the method, when lots of purchases vary much in quantities. Due to fact that the identity of the materials disappeared in the store, the verification of closing stock figures becomes difficult. Absurd figures may be shown by the closing stock. The closing stock account may even show credit balance, in times of inflationary spiraling.

ii) WEIGHTED AVERAGE METHOD : The weighted average cost under this method is obtained by dividing the total value (at cost) of materials in stock at the time of issue by the total quantity of materials in stock. Only the rates are taken into consideration in case of simple average, on the other hand, the rates & corresponding quantities are considered in case of weighted average because by multiplying the quantity by the rate, the value at cost is obtained. If q, q1, q2, & q3 are the quantities in stocks on a day with p, p1, p2 & p3 as the corresponding purchases, the weighted average rate will be worked out as below: Weighted average rate = pq + p1q1+p2q2+p3q3 q + q1 + q2 + q3

ADVANTAGES OF WEIGHTED AVERAGE METHOD : The effect of price fluctuations on issue rates are smoothened effectively by the method. The rate continues in its application unless a new purchase arrives. Only if, in the calculation of the rates, mathematical approximation is made then profit or loss on materials arises. Simple & not too much clerical work is involved unless purchases are made frequently.

Where both the price & quantity ordered fluctuate, this method suits the condition.

DISADVANTAGES OF WEIGHTED AVERAGE METHOD : The work of calculation of rates becomes considerable in case where a frequent purchase is made. The cost price (nor the market price) of the materials actually issued are not represented by the charges made to issues. Unless the rates are calculated correcting up to 4 or 5 places of decimal whenever necessary, profit or loss on materials may be created by the method.