Methods of valuation of inventories:

First in first Out (FIFO) method

Last In First Out (LIFO) method

Weighted Average Price method

Highest In first Out (HIFO) Method

Specific Identification Method

Next In First Out Method ( NIFO) Method

Base stock method

a) FIFO

FIFO method is based on the assumption that the goods which are received first are

issued first. The goods sold, therefore, consists of the earliest lots and the ending

inventory consists of the latest lots. The ending inventory is stated in the Balance Sheet at

a value nearer the current market price.

Advantages

Values the stock closer to the current market price - most recent purchases Based on cost

- no unrealised profit Realistic - normal procedure of

selling those materials/goods which have been longest in stock.

Disadvantages

Involves complicated calculations and hence increases the possibility of clerical errors.

Comparison between different jobs using the same type of material becomes difficult.

FIFO method is suitable for

Perishable goods

No frequent purchases

Moderate fluctuations in the price of materials

Material easily identifiable as belonging to a particular lot

b) LIFO

It is based on the assumption that the goods which are received last are issued first.

Therefore the goods sold consists of the latest lots and the ending inventory consists of

the earliest lots. The ending inventory is understated in the Balance Sheet at old cost

Last In First Out Method (LIFO)

Advantages

Takes into account the current market conditions

Based on cost –no unrealised profit

Disadvantages

Involves complicated calculations

Not suitable for perishable goods

LIFO method is suitable for goods which are of a bulky and non-perishable nature

Difference between LIFO and FIFO

Basis of Distinction FIFO LIFO

1.Basic Assumption Goods received first are

issued first

Goods received last are

issued first

2.Cost of Goods sold Cost of goods sold represents

cost of earlier purchases

Cost of goods sold represents

cost of recent purchases

3.Distortion in Balance

sheet

B/S shows the ending

inventory at a value nearer

the current market price

B/S is distorted because

ending inventory is

understated at old cost

4.Ending Inventory Ending Inventory represents

cost of recent purchases

Ending Inventory represents

cost of earlier purchases

5. In case of Rising

Prices

Higher income is reported Lower income is reported

c) Weighted Average Price method- The weighted-average method relies on average

unit cost to calculate cost of units sold and ending inventory. Average cost is determined

by dividing total cost of goods available for sale by total units available for sale.

d) HIFO- HIFO is

an inventory distribution method in which the inventory with the highest cost of purchase

is the first to be used or taken out of stock.

e) Specific Identification Method Specific identification of cost means that specific

costs are attributed to identified items of inventory. This is an appropriate treatment for

items that are segregated for a specific project, regardless of whether

they have been purchased or produced. However, when there are large

numbers of items of inventory which are ordinarily interchangeable, specific

identification of costs is inappropriate.

Stock Valuation-Stock is valued at lower of the cost or market price.

7) Stock Audit-Physical verification of stock may be periodic or continuous. The second

system is better than the first one.

Techniques of Inventory control

ABC Analysis

This technique of inventory control is also known as Always Better Control technique.

ABC analysis is an analytical method of control which aims at concentrating efforts on

those areas where attention is needed most.

This is a principle of selective control. The emphasis of ABC analysis technique is that

the management should concentrate its energy in controlling those items that mostly

affect the organisational objects. Manufacturing concerns find it useful to group the

materials into three classes on the basis of investment involved.

Materials having higher values but constitute small percentage of total items, are grouped

in 'A' category. On the other hand, a large percentage of items of materials which

represent a smaller percentage of the values, are grouped in 'C' category. Items of

materials having moderate value 'and moderate size are grouped in 'B' category.

After the items of materials are classified into A, B and C category, control can be

exercised in a selective manner as follows:

(i) Greater care and strict control should be exercised on the items of category 'A' as any

loss or breakage or wastage of any item of this category may prove to be very costly.

Economic order quantity and re-order level should be carefully fixed for such category of

items.

(ii) Moderate and relaxed control is required for the items of category 'B'.

(iii) There is not much need for exercising control over the items of category 'C' Periodic

or annual verification is required for this category of materials.

Advantages of ABC Analysis:

The advantages of ABC analysis are given below:'

Close and strict control of costly items is ensured.

Investment in inventory can be regulated and funds can be utilised in the best possible

way.

Economy is achieved in respect of stock carrying cost.

It helps to keep enough safely stock for 'C' category items.

Clerical cost can be reduced and inventory is maintained at optimum level.

Scientific and selective control helps in maintenance of high stock turnover rate.

Inventory Turnover Ratio

Every firm has to maintain a certain level of inventory of finished goods so as to be able

to meet the requirements of the business. But the level of inventory should neither be too

high nor too low.

A too high inventory means higher carrying costs and higher risk of stocks becoming

obsolete whereas too low inventory may mean the loss of business opportunities. It is

very essential to keep sufficient stock in business.

Stock turn over ratio and inventory turn over ratio are the same. This ratio is a

relationship between the cost of goods sold during a particular period of time and the cost

of average inventory during a particular period. It is expressed in number of times. Stock

turn over ratio/Inventory turn over ratio indicates the number of time the stock has been

turned over during the period and evaluates the efficiency with which a firm is able to

manage its inventory. This ratio indicates whether investment in stock is within proper

limit or not.

The ratio is calculated by dividing the cost of goods sold by the amount of average stock

at cost.

Inventory Turnover Ratio = Cost of goods sold / Average inventory at cost

For example cost of goods sold is $500,000. The opening stock is $40,000 and the

closing stock is $60,000 (at cost). Calculate inventory turnover ratio

Inventory Turnover Ratio (ITR) = 500,000 / 50,000*

= 10 times

This means that an average one dollar invested in stock will turn into ten times in sales

Just In Time (JIT) inventory system

Just In Time (JIT) is a production and inventory control system in which materials are

purchased and units are produced only as needed to meet actual customer demand.

When Companies use Just in Time (JIT) manufacturing and inventory control system,

they purchase materials and produce units only as needed to meet actual customers

demand. In just in time manufacturing system inventories are reduced to the minimum

and in some cases are zero. JIT approach can be used in both manufacturing and

merchandising companies. It has the most profound effects, however, on the operations

of manufacturing companies which maintain three class of inventories-raw material,

Work in process, and finished goods. Traditionally, manufacturing companies have

maintained large amounts of all three types of inventories to act as buffers so that

operations can proceed smoothly even if there are unanticipated disruptions. Raw

materials inventories provide insurance in case suppliers are late with deliveries. Work in

process inventories are maintained in case a work station is unable to operate due to a

breakdown or other reason. Finished goods inventories are maintained to accommodate

unanticipated fluctuations in demand. While these inventories provide buffers against

unforeseen events, they have a cost. In addition to the money tied up in the inventories,

expert argue that the presence of inventories encourages inefficient and sloppy work,

results in too many defects, and dramatically increase the amount of time required to

complete a product.

Under ideal conditions a company operating at JIT manufacturing system would purchase

only enough materials each day to meet that days needs. Moreover, the company would

have no goods still in process at the end of the day, and all goods completed during the

day would have been shipped immediately to customers. As this sequence suggests, "just-

in-time" means that raw materials are received just in time to go into production,

manufacturing parts are completed just in time to be assembled into products, and

products are completed just in time to be shipped to customers.