Book-keeping · Lesson 10

Lower of cost and NRV; FIFO, LIFO and weighted average

WAECNECO

What the syllabus asks

WAEC: (1) meaning, purpose and methods (FIFO, LIFO and weighted average); (2) computation of stock values. Extends fa6.10–6.11.

NECO: (1) meaning, purpose and methods (FIFO, LIFO and weighted average); (2) computation of stock values. Extends fa6.10–6.11.

What you will learn

Explain the meaning and purposes of stock valuation.
Determine the cost of stock.
Apply the lower of cost and NRV rule item by item.
Compute stock and cost of sales under FIFO.
Compute stock under LIFO (perpetual and periodic).
Compute stock under weighted average (running and simple).
Compare the methods and their effect on profit.
Explain perpetual and periodic systems, cut-off and stock control.

Key points

Stock valuation affects profit, assets and next year.
Cost includes purchase price and costs to bring goods to their location.
Lower of cost and NRV, item by item.
FIFO: issues at oldest prices.
LIFO: issues at newest prices; not permitted by IAS 2.
Weighted average: running or periodic.
Rising prices: FIFO > AVCO > LIFO for profit.
Perpetual systems use stores ledger and bin cards.
Include goods owned (in transit, sent on sale or return); exclude goods not owned.
Consistency: keep the same method.

Start here: Meaning and purpose of stock valuation

Stock (inventory) is goods held for resale, together with raw materials and partly finished goods in a manufacturing business, and consumable stores such as packaging. Stock valuation is the process of putting a money value on the stock held at the end of a period, so that it can be used in the final accounts.

At the end of the year, Jos Paint Depot has 65 tins of emulsion paint on its shelves. They were bought at different times and at different prices: some at ₦18,000, some at ₦21,000, some at ₦22,000. What are they “worth” in the books? The answer depends on the method of valuation, and the answer changes the profit.

Purposes of stock valuation

To calculate profit: cost of goods sold = opening stock + purchases − closing stock. Every naira added to closing stock adds a naira to gross profit.
To show current assets correctly in the balance sheet.
To carry forward the right opening stock to next year; an error in closing stock affects two years’ profits.
For tax: taxable profit depends on stock values.
For insurance claims after fire or theft.
For control: comparing the stock records with a physical count reveals losses.
For pricing and buying decisions.

Stocktaking

Valuation begins with stocktaking: physically counting every item, usually on the last day of the year after trading stops. Teams count in pairs, record quantities on numbered stock sheets, mark damaged and slow-moving items, and note goods received or sent out around the count date (“cut-off”). The quantities are then multiplied by the unit cost found by the chosen method.

Worked example 10.1

A trader’s closing stock is overstated by ₦50,000 by mistake. Explain the effect on this year’s and next year’s gross profit.

Solution. This year, cost of goods sold is ₦50,000 too low, so gross profit is ₦50,000 too high. Next year, the opening stock is ₦50,000 too high, so cost of goods sold is ₦50,000 too high and gross profit ₦50,000 too low. Over the two years the errors cancel, but each year’s profit is wrong.

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Practice questions

1. Stock is valued at

the lower of cost and net realisable value
selling price
replacement cost always
the higher of cost and NRV

Show answer

A: the lower of cost and net realisable value
Prudence.

2. Net realisable value is

cost plus profit
original cost
market price of new stock
expected selling price less costs to complete and sell

Show answer

D: expected selling price less costs to complete and sell
NRV.

3. Damaged bags: sell at ₦7,000 after ₦500 drying cost; cost ₦9,000. Value per bag is

₦9,000
₦7,500
₦6,500
₦7,000

Show answer

C: ₦6,500
Lower of 9,000 and 6,500.

4. 170 bags at ₦9,000 and 30 at ₦6,500 give stock of

₦195,000
₦1,725,000
₦1,800,000
₦1,530,000

Show answer

B: ₦1,725,000
1,530,000 + 195,000.

5. Under FIFO, goods issued are priced at

the oldest costs
the newest costs
the average cost
selling price

Show answer

A: the oldest costs
First in, first out.

Key words

Stock (inventory): Goods held for resale or production.
Stocktaking: Physical counting of stock.
Net realisable value: Selling price less costs to complete and sell.
FIFO: First in, first out.
LIFO: Last in, first out.
Weighted average cost: Average cost weighted by quantities.
Perpetual inventory: Stock records updated after each movement.
Periodic inventory: Stock found by count at period end.
Bin card: Store record of quantities.
Stores ledger card: Record of quantities and values.
Cut-off: Correctly assigning movements to periods.
Reorder level: Stock level at which to reorder.

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