08/08/2023

CHAPTER 2
Inventory valuation

Calculating unit costs

Indirect costs Direct costs

Cannot be traced in full to cost Can be traced in full to cost
object being costed unit being costed

Direct material cost Direct labour cost Direct expenses

FIFO LIFO Weighted Average

Cumulative weighted
Periodic weighted average
average

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Direct and Indirect costs

Look back chapter 1 to understand Direct and Indirect costs.
Note: There are a few possible misconceptions about direct and
indirect costs that should be clarified at this stage.
(a) Direct costs are not necessarily bigger in size than indirect costs.
(b) Indirect costs are not less important than direct costs.
(c) It is easy to confuse fixed and variable costs with indirect and
direct costs.

Test your understanding 1

Indicate whether each of the following costs would be classified as a direct
cost or an indirect cost of a particular car repair in a garage. The repair was
worked on in overtime hours due to an unusually large number of repairs
being booked into the garage that day.

Expenses Direct/Indirect
(1) The salary of the garage’s accountant
(2) An overtime premium paid to the mechanic
carrying out the repair
(3) The wages of the supervisor overseeing the
mechanic carrying out the repair

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Test your understanding 1

Expenses Direct/Indirect

(4) The cost of heating the garage

(5) An idle time payment made to the mechanic
while waiting for a delivery of parts for a number
of jobs
(6) A can of engine oil used in the repair
(7) A smear of grease used in the repair

Inventory valuation
• Need Inventory Valuation for :
• Preparation of accounts
• Pricing of material issues to production
Note: Financial Accounts Preparation.
Inventories are valued at ‘lower of cost or net realisable value’.
This is undertaken at period end, and inventory records are
adjusted where necessary.

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Charging inventory to production

• Goods may move physically from stores by:
• Oldest goods first
• Latest goods first
• Random choice
• Easiest to reach etc.
However the valuation of these issues must be on a consistent
basis. This means goods may be issued not necessarily at the
price paid for them.

Assumption for pricing inventories

Three popular methods of pricing inventories for issue to production are
based on the following assumptions:

First in First out

Assumptions

(FIFO)

Last in First out

(LIFO)

Weighted average
costs

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FIFO_First in First out

Assumes materials issued in order in which they were
delivered into inventory. Priced at cost of earliest delivery
remaining in stock

Advantages Disadvantages

Logical, represents what is FIFO can be cumbersome to

physically happening operate
Easy to explain and easier Difficult to compare material
accepted cost between jobs
Closing inventory valuation In period of inflation, issue
nearer to replacement cost prices are below market value

Test your understanding 2

M Ltd had the following material transactions during the first quarter in this
year. Assume that opening inventory is zero.
Using the FIFO basis, what is:
(a) Value of closing inventory?
(b) Value of issues?
Purchases Price/Unit Issues
(Units) (£) (Units)
15-Jan 400 3
19-Jan 150 2
23-Jan 200
07-Feb 300 2.5
14-Feb 340

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LIFO_Last in First out

Assumes materials issued in reverse order to delivery. Most
recent issued first
Advantages Disadvantages

Inventory issued at a price close LIFO can be cumbersome to

to market value operate. Tendency to jump from
batch to batch.
Managers made aware of recent LIFO usually opposite to what is
costs for making decisions physically happening- confusing

Decision making affected by

constantly changing prices

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Test your understanding 3

M Ltd had the following material transactions during the first quarter in this
year. Assume that opening inventory is zero.
Using the LIFO basis, what is:
(a) Value of closing inventory?
(b) Value of issues?
Purchases Unit price Issues
(units) £ (units)
15 Jan 400 3
19 Jan 150 2
23 Jan 200
07 Feb 300 2.5
14 Feb 340

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Test your understanding 3b

M Ltd had the following material transactions during the first quarter in this
year. Assume that opening inventory is zero.
Using the LIFO basis, what is:
(a) Value of closing inventory?
(b) Value of issues?
Purchases Unit price Issues
(units) £ (units)
15 Jan 400 3
19 Jan 150 2
23 Jan 550
07 Feb 300 2.5
14 Feb 240

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Cumulative weighted average

Calculates weighted average price for all units in inventory.
Issues are priced at this average cost.
The cumulative weighted average method could be
appropriate for businesses such as oil merchant, where deliveries
are fully mixed in with existing inventory.

Calculates weighted Running total of costs

=
average price Running total of units

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Cumulative weighted average

Advantages Disadvantages

Price fluctuations are evened out. Issue price can bear no relation
Easier data for decision making to an actual price paid.

Easier to administer than FIFO Prices tend to lag behind current

and LIFO. No need to identify market values in time of
batches separately inflation

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Test your understanding 4

M Ltd had the following material transactions during the first quarter in
this year. Assume that opening inventory is zero.
Using the Cumulative weighted average basis, what is:
(a) Value of closing inventory?
(b) Value of issues?

Purchases Unit price Issues

(units) £ (units)
15 Jan 400 3
19 Jan 150 2
23 Jan 200
07 Feb 300 2.5
14 Feb 340

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Periodic weighted average

Periodic weighted average values each issue at the same
average price which is based on all purchases for the period.

Periodic weighted Cost of opening Inv + Total cost of receipts in period

=
average price Units in opening Inv + Total units received in period

In the exam, only use the periodic weighted average method

if you are specifically told to.

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Test your understanding 5

M Ltd had the following material transactions during the first quarter in this
year. Assume that opening inventory is zero.
Using the Periodic weighted average basis, what is:
(a) Value of closing inventory?
(b) Value of issues?
Purchases Unit price Issues
(units) £ (units)
15 Jan 400 3
19 Jan 150 2
23 Jan 200
07 Feb 300 2.5
14 Feb 340

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Test your understanding 6

Sunnies had an opening inventory of 200 glasses valued at £120 per pair
on 1 July. The following receipts and issues were recorded in July:
5 July Issue 150 glasses
9 July Receipt 250 glasses @ 110 per pair

11 July Issue 90 glasses

20 July Issue 180 glasses

What is the value of issues during July using the FIFO method?

What is the value of issues during July using the LIFO method?

What is the value of issues with the CWA method?

What is the value of issues with the periodic weighted average method?

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Test your understanding 7

Given this is a time of decreasing prices, which inventory valuation

technique led to the highest and lowest:
(a) Closing inventory value
(b) Value of issues
(c) Profit

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Test your understanding 8

The following information relates to TYUs 8 to 9

A business had opening inventory of 300 units valued at £4.50 per unit on 1 May.
The following receipts and issues were recorded in May:
2 May Issue 200 units
7 May Receipt 500 units @ 4.8 per pair
13 May Issue 400 glasses
20 May Receipt 500 glasses @ 5.0 per pair
28 May Issue 450 glasses

What is the value of issues during the month using the FIFO method?
A £4,750 B £5,000 C £5,030 D £5,080

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Test your understanding 9

What is the value of issues during the month using the LIFO method?
A £4,750 B £5,000 C £5,030 D £5,070

What is the value ofclosing inventory?

FIFO method LIFO method
A £1,180 £1,250
B £1,250 £1,180
C £1,250 £730
D £1,180 £730

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