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Asset Valuation

Inventories (HKSSAP 22)

Valuation of Stock

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Introduction

Hong Kong statement of Standard accounting Practice (2.122) – Inventories (i.e. Stock) is to prescribe the accounting treatment for inventories

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Inventories

Inventories are assets: Held for sale in the ordinary course of business In the process of production for such sale In the form of materials or supplies to be

consumed in the production process or in the rendering of services

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Classifications of Inventories

Merchandise Production supplies Materials Work in progress Finished goods

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Measurement of inventories

HKSSAP 22 stated that inventories should be measured at the lower of cost and net realisable value

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Cost of Inventories

The cost of inventories should comprise: Cost of purchase Cost of conversion Other costs incurred in bringing the inventories to

their present location and condition

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Cost of Purchase

The costs of purchase of inventories comprise: The purchase price Trade discount, rebates and other similar items

are deducted in determining the costs or purchase

Import duties Other taxes Transport, handling and other costs directly

attributable to the acquisition of finished goods, materials and services

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Cost of Conversion

The costs of conversion of inventories include: Costs directly related to the units of production

(e.g. direct labour) Fixed/variable production overheads (e.g.

depreciation and maintenance of factory building and equipment, indirect material

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Other Costs

Other cost are included: Cost of inventories that they are incurred in bring

the inventories to their present location and condition

For instance, include non-production overheads or the costs of designing products for specific customers in the cost of inventories

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Costs excluded from the cost of inventories Examples costs excluded from the cost of inv

entories and recognised as expenses in the period in which they are incurred are: Abnormal amounts of wasted materials, labour or

other production cost Storage costs, unless those costs are necessary i

n the production process prior to a further production stage

Administrative overheads that do not contribute to bringing inventories to their present location and condition

Selling costs

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Cost of Inventories of a Service Provider

The cost of inventories of a service provider consists of the labour and other costs of personnel directly engaged in providing the service, including supervisory personnel, and attributable overheads

Labour and other costs relating to sales and general administrative personnel are not included but are recognised as expenses in the period in which they are incurred

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Net Realisable Value (NPV)

Net realisable value is the estimating selling price in the ordinary course of business less the estimated (further) costs of completion and estimated costs necessary to make the sale (marketing, selling and distribution cost)

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Example Stock at 31 Dec 20XXArticles Categories Cost NRV 1 Hats $80 $85 2 Hats $110 $90 3 Cloths $245 $320 4 Cloths $360 $400 5 Shoes $140 $105 6 Shoes $190 $170

$1125 $1170

Use the following method to value the above stock:1. Aggregate method2. Category method3. Article method

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Aggregate method Total value of stock at cost = $1125 Total value of stock at NPV = $1170 Low figure $1125 will be chosen

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Categories methodCategories Cost NRVHats $80+110= $190 $85+90=$175

Cloths $245+360=$605 $320+400=$720

Shoes $140+190=$330 $105+170=$275The lower of cost and NRV:

Hats $175Cloths $605Shoes $275Total $1055

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Articles method

Article Lower of cost and NRV

1 $80

2 $90

3 $245

4 $360

5 $105

6 $170

$1050

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Situations where NRV is lower than cost An increase in costs or a fall in selling price Physical deterioration of stock Obsolescence of stock A deliberate pricing strategy to sell goods at a low

price Errors in production or purchasing

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Recognition as an expense

When inventories are sold, the carrying amount of those inventories should be recognized as an expense in the period in which the related revenue is recognized.

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Stock Taking Methods

Periodic Inventory Perpetual Inventory

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Periodic Inventory

The totals of purchases and issues (sales) are recorded at the end of each financial period and the balance of the inventories will only be calculated at the end of each period

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Perpetual Inventory

A running balance is maintained to record the movements of the inventories after every purchase and issue (sale) of the inventories

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Methods of inventories valuation

First-in, first-out (FIFO) Last-in, First-out (LIFO) Weighted Average Cost (AVCO) Specific Identification/Unit Cost

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First-in, First-out (FIFO)

Items of inventory which were purchased first are sold first

The cost of goods sold is based on the oldest price

The closing stock is valued at the most recent price

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Last-in, First-out (LIFO)

The items of inventory which were purchased recently are sold first

The cost of goods sold is based upon the most recent prices

The closing stock is valued at the oldest prices

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Weighted Average Cost (AVCO)

The cost of good sold and the closing stock are valued at the weighted average cost

After each purchase of stock, the average cost for each item of stock is computed

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Specific identification

Each item of stock has its own identity and it is distinguishable from any other unit

The cost of goods sold and closing stock are determined by associating the units of stock with their specific unit costs

This method is appropriate for companies that handle a relatively low volume of high-value goods such as jewellery and automobilies

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Example

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During the year of 20XX, the following were the purchases and Sales of Product A:

Receipts SalesQuantity (kilos) Price per kilo Quantity (kilos) Price per kilo

20XXJanuary 100 2February 60 5March 80 2.5May 40 3June 80 5July 50 3.5August 100 6October 100 4November 100 6

Required:Prepare trading accounts for the year of 20XX showing the gross profit if Closing stock is valued on each of the following bases:(a) FIFO (b) LIFO (c) AVCO

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FIFO

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Date

20XX

Received

Qty Price Amt.

Sold

Qty Price Amt.

Balance

Qty Price Amt.

January 100 2 200 100 2 200

February 60 2 120 40 2 80

March 80 2.5 200 40 2 80

80 2.5 200

May 40 3 120 40 2 80

80 2.5 200

40 3 120

June 40 2 80

40 2.5 100

40 2.5 100

40 3 120

July 50 3.5 175 40 2.5 100

40 3 120

50 3.5 175

August 40 2.5 100

40 3 120

20 3.5 70

30 3.5 105

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Date

20XX

Received

Qty Price Amt.

Sold

Qty Price Amt.

Balance

Qty Price Amt.

October 100 4 400 30 3.5 105

100 4 400

November 30 3.5 105

70 4 250

30 4 120

Therefore, closing stock: 30 kilos X $4 = $120

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LIFO

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Date

20XX

Received

Qty Price Amt.

Sold

Qty Price Amt.

Balance

Qty Price Amt.

January 100 2 200 100 2 200

February 60 2 120 40 2 80

March 80 2.5 200 40 2 80

80 2.5 200

May 40 3 120 40 2 80

80 2.5 200

40 3 120

June 40 3 120

40 2.5 100

40 2 80

40 2.5 100

July 50 3.5 175 40 2 80

40 2.5 100

50 3.5 175

August 50 3.5 175

40 2.5 100

10 2 20

30 2 60

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Date

20XX

Received

Qty Price Amt.

Sold

Qty Price Amt.

Balance

Qty Price Amt.

October 100 4 400 30 2 60

100 4 400

November 100 4 400 30 2 60

Therefore, closing stock: 30 kilos X $2 = $60

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AVCO

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Date

20XX

Received

Qty Price Amt.

Sold

Qty Price Amt.

Balance

Qty Price Amt.

January 100 2 200 100 2 200

February 60 2 120 40 2 80

March 80 2.5 200 40 2 80

80 2.5 200

120 2.33 280

May 40 3 120 120 2.33 280

40 3 120

160 2.5 400

June 80 2.5 200 80 2.5 200

July 50 3.5 175 80 2.5 200

50 3.5 175

130 3.75 487

August 100 2.88 288 30 2.88 87

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Date

20XX

Received

Qty Price Amt.

Sold

Qty Price Amt.

Balance

Qty Price Amt.

October 100 4 400 30 2.88 87

100 4 400

130 3.75 487

November 100 3.75 374 30 3.75 113

Therefore, closing stock: 30 kilos X $3.75 = $113

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Trading account for the year of 20XXFIFO LIFO AVCO$ $ $ $ $ $

Sales (140*$5+200*$6) 1900 1900 1900Less:COCS

Purchases 1095 1095 1095Less: Closing

Stock 120 975 60 1035 113 982925 865 918

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Comparison of three methods

There is a need for an organization to be consistent in its issue pricing methods

Because of SSAP recommendations and the Inland Revenue, the use of the FIFO or the average price system appear to be most common.

The LIFO system is generally not acceptable to the Inland and is not recommended by SSAP

Because of rising prices LIFO, by keeping down disclosed profits, paying less taxation, provides a hedge against inflation

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Goods on sales or return

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Goods received on sale or return

Our firm do not have to pay for the goods until we sell them

If our firm do sell them, we return them to our supplier

The goods do not belong to us, so the goods on sale or return at the stocktaking date, they should not be included in our stock valuation

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Goods sent on sale or return

The customer do not pay for the goods until they confirm to buy. If they do not buy, those goods will return to us

Goods on the ‘sale or return’ basis will not be treated as normal sales and should be included in the closing stock unless the sales have been confirmed by customer

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Stock &

the Balance Sheet Date

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Why occurs?

All the counting and valuation of stock is done on the last day of the accounting period

But it is difficult for large business to count it since there may be too many items of stock

The stocktaking may take place over a period of days

To get the figure of the stock valuation as on the last day of the accounting period, adjustment should be made

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Example

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ABC Ltd. has a financial year which ends on 31 December 20XX. The stocktaking is not in fact done until 8 January 20XX.

It is found that the stock value amounted to $28850 on 8 January 20XX.

The following information is available about transactions between 31 December 20XX and 8 January 20XX: Purchases since 31 December 20XX amounted to $2370 at cost Returns inwards since 31 December 20XX were $350 at selling

price Sales since 31 December 20XX amounted to $3800 at selling

price The selling price is always cost price + 25%

What is the stock value 31 December 20XX?

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ABC Ltd. Computation of stock as at 31 Dec 20XX $ $Stock at 1 Jan 20XX (at cost) 28850Add:

Less:

Stock in hand as at 31 Dec 20XX

Sales (3800-3800*25/125) 3040

Returns inwards (350-350*25/125) 280Purchases (at cost) 2370 2650

31890

29240