Topic 1 Inventory

TOPIC 1: ACCOUNTING FOR INVENTORY

1.0 OBJECTIVES
At the end of the lesson, students should be able to:
1. Define inventory and understand the importance of accounting for inventory.
2. Describe the inventory system.
3. Explain the basis for inventory valuation.
4. Calculate the value of inventory by using three different method.
5. Identify the effects of using LIFO, FIFO and AVCO methods on profit or loss.
6. Prepare Statement of Inventory Valuation.

1.1 INTRODUCTION
➢ Inventory:
FRS 102 defines inventory as assets owned by the business for the purposes of
selling to the customer. Inventories are managed in order to determine
inventories on hand, inventories available for sale and cost of goods sold
(COGS). Mainly consists of raw materials, work in progress and finished goods.
In SOPOLCI → calculate COGS; while in SOFP → company’s current assets.

FRS 102 defined tangible properties as:
i) Held for sale in the ordinary course of business
ii) In the process of production for such sale, or
iii) In the form of materials or supplies to be consumed in the
production process or services to be available for sale

➢ Reasons for accurate accounting for inventory:
i) Ascertain the costs of goods sold for a particular accounting
period so the amount may be matched against sales.
ii) Determine value of unsold inventory at the end of accounting
period, as inventory often form a great proportion of the
current assets of business.

1

1.2 INVENTORY SYSTEM

PERIODIC PERPETUAL
Inventory account is updated on a Updates inventory accounts continuously
periodic basis; monthly, quarterly or at after each purchase or sale.
the end of accounting period.
No detail records on inventory on hand Detail records are kept for both inventory
throughout the period. purchase and sale. It continuously shows
the inventory on hand.
Physical stock count at the end of The COGS is determined and recorded
accounting period enable the when purchases and sales occur.
determination of COGS.
No records kept on both quantities and Keeps track of both quantities and cost.
cost.
Done manually by doing physical stock. A computerise accounting system.
Best suited for businesses selling high- Best suited for small business and
volume products with several outlets. businesses selling high-priced, low volume
products.
Example: Hypermarket, Stationery Shop Example: Motor Vehicle Company,
Watches and Jewelleries Shop.

1.3 BASIS OF INVENTORY VALUATION

The basis of valuation is at the lower of cost and Net Realisable Value (NRV), which
means an inventory should be valued at either the cost price or the NRV, whichever
is the lower.

COST NRV

Cost is defined as the expenditure, which has been incurred in the normal course of
business in bringing the product or services to its present location and condition. The
cost includes the invoice price of the inventory purchased, transportation cost,
insurance, storage, import duty etc.

Inventory cost = Inventory purchase cost + cost involved before the inventory can
be sold – purchase discounts.

2

NRV is the estimated selling price in the ordinary course of business less the estimated
costs of completion and the estimated costs necessary to make the sale.

NRV = SALES PRICE – INVENTORY COMPLETION COST

The concept of prudence is use when inventory is valued. Inventory should not be
over-valued; otherwise profits shown will be too high. Therefore, if the NRV of the
inventory is less than the cost of the inventory, then the figure to be taken for the final
account is that of NRV.

Example:

Ahmad bought 1,000 units of inventory at the cost of RM 10 per unit 2 months ago.
Now, the inventory can be sold at the price of RM 14 per unit. However, RM 5 is
needed as expense until the inventory can be sold.

NRV = 1,000 x (RM14 – RM5) = RM 9,000

Cost = 1,000 x RM10 = RM 10,000

Inventory value is determined based on the lowest value between cost and NRV.
Therefore, inventory value is RM 9,000.

Additional Information for Cost VS NRV:

Situation 1 2 3
Example Cost RM500 VS NRV Cost RM600 VS NRV i) Cost RM600 VS NRV
RM560, cost already RM480, cost already RM480 OR
included in the stock included in the stock ii) Cost RM500 VS
count. count. NRV RM620
excluded from the
Solution Lowest value is at Lowest value is at stock count.
cost, therefore no NRV, therefore must Take any lowest value
adjustment needed reduce to NRV by and add it to the
to the Statement of RM120 (RM600- Statement of
Inventory Valuation. RM480), must minus Inventory Valuation.
RM120 in the i) add RM480 OR
Statement of ii) add RM500
Inventory Valuation.

For further understanding about basis of inventory valuation, you can get the info in
the following link:

https://rise.articulate.com/share/l-xsH8KTRfg2Q-ZQ-Vbb__0CxcpVclr3

3

1.4 METHODS OF INVENTORY VALUATION

First in First Out (FIFO)

• Inventory is sold according to the sequence it is acquired, starting from the
first purchase to the last purchase. Thus, inventory kept at the end of an
accounting period is the inventory that is bought last.

Last in First Out (LIFO)

• The inventory that is bought last will be the first to be sold, followed by other
inventories according to the sequence of purchase, from the last purchase to
the first.

Average Cost (AVCO)

• Inventory will be valued at average cost and not based on inventory purchase
price.

Example:

Date Activities Details
1-May Beginning inventory 50 units @ RM15.00
4-May Purchases 140 units @ RM15.50
11-May Purchases 70 units @ RM16.00
26-May Sales
31-May Sales 190 units
30 units

FIFO Method

Date Purchases Sales Balance Total
1/5 50 @ RM15 = RM750
50 @ RM15 = RM750 50 @ RM15 = RM750 RM2,920
4/5 RM750 140 @ RM15.50 =
RM2,170 50 @ RM15 = RM750 RM4,040
140 @ RM15.50 = 140 @ RM15.50 = RM2,170
RM2,170 30 @ RM16 = RM480
COGS = RM3,400 50 @ RM15 = RM750
11/5 70 @ RM16 = 140 @ RM15.50 = RM2,170
RM1,120
70 @ RM16 = RM1,120

26/5 70 @ RM16 = RM1,120 RM1,120

31/5 40 @ RM16 = RM640 RM640
Purchase cost =
RM4,040

4

LIFO Method

Date Purchases Sales Balance Total
1/5 50 @ RM15 = 50 @ RM15 = RM750 RM750
RM2,920
RM750 50 @ RM15 = RM750 RM4,040
140 @ RM15.50 = RM2,170
4/5 140 @ RM15.50 = RM1,060
RM2,170 50 @ RM15 = RM750
140 @ RM15.50 = RM2,170
11/5 70 @ RM16 =
RM1,120 70 @ RM16 = RM1,120

26/5 70 @ RM16 = 50 @ RM15 = RM750
RM1,120
20 @ RM15.50 = RM310
120 @ RM15.50 =
31/5 RM1,860 40 @ RM15 = RM600 RM600

Purchase cost = 20 @ RM15.50 =
RM4,040 RM310

10 @ RM15 = RM150

COGS = RM3,440

AVCO Method

Date Purchases Sales Balance Total
1/5 50 @ RM15 = RM750
190 @ RM15.54 = 50 @ RM15 = RM750 RM2,920
4/5 RM750 RM2,953
50 @ RM15 = RM750 RM4,040
140 @ RM15.50 = 30 @ RM15.54 = 140 @ RM15.50 = RM2,170
RM2,170 RM466
50 @ RM15 = RM750
11/5 70 @ RM16 = COGS = RM3,419 140 @ RM15.50 = RM2,170
RM1,120
70 @ RM16 = RM1,120

26/5 70 @ RM15.54 = RM1,088 RM1,088

31/5 40 @ RM15.54 = RM621 RM621

Purchase cost =
RM4,040

Effects of using different method of costing on profit calculation:

Different method of costing will give different closing inventory figures. Therefore,
different method of costing will affect gross profit and gross loss calculation.

5

Example:

EXTRACT STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME
FOR THE YEAR ENDED …….

Sales FIFO (RM) LIFO (RM) AVCO (RM)
(-) COGS: 5,000 5,000 5,000

Purchases 4,040 4,040 4,040
(-) Closing inventory
GROSS PROFIT (640) (3,400) (600) (3,440) (621) (3,419)
1,581
1,600 1,560

CONCLUSION:

FIFO LIFO AVCO
Provides the lowest COGS Provides the highest COGS Has the effect of
during the period of rising during period of rising smoothing out
prices and the highest prices. distortions in profit
COGS during period of figure in period of
declining prices. Disadvantages: the fluctuating prices.
inventory stated in SOFP
Advantage: the inventory does not represent Suitable method for
stated in the SOFP is current market value. manufacturing business.
reasonably close to its
market value at the SOFP Not recommended by
date. accounting profession and
tax authority.

1.5 INVENTORY COUNT AND STATEMENT OF FINANCIAL POSITION DATE

A physical count of inventories at the SOFP date is often done even though a business
may keep their inventory records. Any discrepancies between the records and physical
inventory count must be investigated and reconciled. Physical inventory count may
not be possible on the accounting date, therefore the inventory count normally
carried out a few days before or after accounting date. In that case, all transactions
that took place between the count date and the SOFP date must be adjusted to arrive
at the actual figure at the SOFP date. The value of the actual figure can be determined
by preparing the Statement of Inventory Valuation.

INVENTORY

Count BEFORE accounting period ends Count AFTER accounting period ends

(+) Inventory IN: (-) Inventory IN:

Purchase Purchase

Return inwards Return inwards

(-) Inventory OUT: (+) Inventory OUT:

Sales Sales

Return outwards Return outwards

6

1.6 OTHER CONSIDERATIONS

1 IN THE VALUATION OF INVENTORY

Goods MUST NOT INCLUDED in the Goods MUST INCLUDED in the inventory

inventory stock count: stock count:

Goods sold awaiting delivery to Goods bought and entered into the

the customers. books but not yet received (goods in

Free samples received from transit).

suppliers (inventory should be Goods bought and entered into the

valued at the lower of cost or books but are held by the

NRV). The cost of the samples to agent/consignee.

the business is nil therefore when Goods sent to customer on a “SALE

valuing inventory the sample OR RETURN BASIS”.

must be excluded.

Goods held by the business as

agent/consignee.

Goods received from supplier on

a “SALE OR RETURN BASIS”.

2 GOODS ON SALE OR RETURN BASIS

Received goods from a supplier: Sent goods to customer:

Goods do not have to be paid if Customer doesn’t have to pay us if

they are not sold. (We don’t paid the goods are not sold.

to supplier). Customer can returned back the

If cannot be sold, we can goods to us.

returned the goods to supplier. The goods belongs to us not the

(We have option to return the customer. It belongs to the company

goods if it is not able to sell). unless and until it is sold.

Until the goods are sold, the

goods belongs to the seller, not

belongs to us.

3 LOST OR DAMAGED INVENTORY

When this situation occur, evaluation for lost or damaged inventory must be

done to determine the total loss borne by the business; in addition to insurance

claim purposes.

4 MARK-UP

ON COST ON SELLING PRICE

Cost = Selling Price . Cost = Selling Price x (100% - % mark-up)
(100% + % mark-up)

7

1.7 FORMAT FOR PREPARING STATEMENT OF INVENTORY VALUATION

VXY (Company Name)

STATEMENT OF INVENTORY VALUATION AS AT …………... (accounting period end)

RM RM

Inventory as at ………………………….. (date of stock count) XX

ADD: XX

XX

XX

XX XX

XXX

LESS: XX

XX

XX

XX (XXX)

Inventory as at ………………………..(accounting period end) XXXX

TIPS FOR ANSWERING THE QUESTIONS FOR THIS TOPIC:

• Find when they do their stock count (before / after accounting period).

1

• List out the inventory in and out (with plus / minus).

2

• Check their mark-up (on cost / on selling price).

3

# More tips will be given in online class. So don’t skip your class ☺ ☺ ☺

8

EXERCISES: ACCOUNTING FOR INVENTORY

QUESTION 1 Inventory received 20 units @ RM60 each
Inventory issued 5 units
January Inventory received 15 units @ RM65 each
February Inventory issued 25 units
March Inventory received 5 units @ RM70 each
Inventory issued 8 units
April
June
July

Assume there was no previous balance of inventory brought forward into January. Using the
following information, you are to draw up a simple statement in tabular form showing the
value of closing inventory at each stage of inventory movement:

a) FIFO

b) LIFO

c) If a business changed from LIFO to FIFO methods of valuation for its closing
inventory, what would be the effect on its gross profit in that year?

QUESTION 2

Lime Enterprise physical inventory taking for the year ended 31 December 2020 was done on
15th January 2021. The value of inventory at the date of inventory taking was RM 60,650. The
mark up ratio was 25% on cost. The following facts were ascertained during audit:

1. Some goods damaged had been excluded in inventories count at their normal cost
of RM 5,577. These inventories could however be sold for RM 6,100 after repairs
estimated of RM 510 had been carried out.

2. One stock sheet have been over added by RM 300 and another under added by
RM130.

3. For the period 1 Jan - 15 Jan 2021, sales and purchase return were RM 1,700 and
RM 500 respectively.

4. One of the inventory sheet was valued at RM 1,150 on selling price.

5. Goods, selling price RM 600 had been sent to Permata for approval. Not taken into
inventory nor any entries in the books.

6. Free samples amounting to RM 4,300 received from Berlian Bhd had been excluded
from the inventory count.

7. Goods received on Sale or Return basis from a supplier amounting to RM 3,510 was
included in the inventory count.

You are required to prepare Statement of Inventory Valuation on 31 December 2020.

9

QUESTION 3
Sri Andaman is a shop that sells home decorations and artificial flowers. The accounts of Sri
Andaman close at 31 March each year. Owing to shortage of staff, the usual stocktaking was
only done on 8 April 2021 and the value of the inventory at cost was RM 88,110. All sales
made by Sri Andaman include a gross profit mark-up of 30%. During the eight days gap from
1 April until 8 April 2021, the following information was discovered:

1. Sales of curtains amounted to RM 37,752.
2. Artificial Roses purchased and received cost RM 9,000.
3. A quantity of 250 units of flowerpots costing RM 10 each were recorded as RM 12

each.
4. Some old inventory of cushions costing RM 3,900 could now be sold for half of the

cost price.
5. Some decorative mirrors sent on Sale or Return Basis to a retailer in Senawang at

RM 9,900 was excluded from the inventory count. The retailer has not indicated
any sale made on the mirrors.
6. Total returns made by customers during those eight days totalled RM 999 at selling
price.
7. A special sale of RM 6,366 was given to an order of artificial silk flowers by a regular
customer for her daughter’s wedding. This sale was made at a mark-up of 25%.

Required:
a) Prepare a Statement of Inventory Valuation as at 31 March 2021 for Sri Andaman.
b) Describe the adjustment needed for unsold inventory for goods sold on Sale or
Return Basis.

10

QUESTION 4

Yusof Brothers is a wholesale business that prepares its annual accounts on 31 May each year.
The business has suffered serious employee problems which caused the annual stocktaking
to be delayed by three weeks (21 June 2021). The stocktaking was not performed with its
usual efficiency. The closing inventory figure taken on 21 June 2021 was RM 36,475. The
management of Yusof Brothers hired a group of expert stock takers to do a thorough
investigation on the inventory and related records. The following information was discovered:

1. All goods were sold at a mark-up on cost of 25%.

2. Unused advertising material worth RM 2,130 had been incorrectly included in the
closing inventory.

3. The following transactions took place between 31 May and 21 June 2021:

Sales RM
Sales returns 2,650
Purchases 430
Purchases returns 4,500
250

4. On 15 May 2021, goods invoiced at RM 700 had been sent to a customer on a Sale
or Return Basis. The customer had bought some of the goods immediately at a price
of RM 280. The remaining unsold goods had not been included in the closing
inventory.

5. Some old inventories at a selling price of RM 400 are nearly expired. It was decided
to reduce the selling price of the inventories by 25%.

Required:

a) Prepare a Statement of Inventory Valuation as at 31 May 2021.

b) When the net realisable value of the inventory is lower than cost, the cost of the
inventory must be written down to net realisable value. Explain the accounting
concept related to the statement above.

11

QUESTION 5
The annual inventory taking of Cure Trading did not take place on the company’s year-end 30
June 2021 due to staff shortage. Therefore, the physical inventory taking of Cure Trading was
done on 4 July 2021 and the total inventories shown by the inventory sheets were RM 16,450.
The rate of gross profit was 20% on selling price. The following information was discovered:

1. Between 1 July and 4 July, sales were RM 550 and sales return was RM 100.
2. Goods selling at RM 1,000 had been sent to a few customers on a Sale or Return

Basis during December. Of this RM 1,000, RM 500 had not been sold at 30 June
2021 and they had been omitted from the stock figure.
3. Goods received from suppliers between 1 July and 4 July were RM 450. The invoices
were dated July 2021.
4. A subtotal of RM420 had been carried to the stock summary sheet as RM240.
5. The stock included RM 400 worth of goods which were in fact the property of
Solehah Trading, a supplier. The stock was sent to Cure Trading for approval.
6. A stock sheet had been overcast by RM 120.
7. An item of 40 units priced RM 1.50 each had been extended as RM 600.
8. Some goods had been damaged and were now unsaleable. They could however be
sold for RM 140 as spares after repairs estimated at RM 55 had been carried out.
They had originally cost RM 230.

Required:
a) Prepare a Statement of Inventory Valuation as at 30 June 2021.
b) What is “Net Realisable Value”?

12