Opening and closing stocks are included in Trading Accounts to calculate cost of sales and gross profit. Closing stock is included as a current asset in Balance Sheets as part of working capital. Therefore, the value placed upon stocks is of very great importance. Three possible ways in which stock may be valued are
• At its cost price.
• At its selling price.
• At net realisable value.
The third way, at the stock’s worth, should be ruled out immediately. ‘Worth’ is a very subjective term; it can mean different things to different people, and even different things to the same person at different times and in different circumstances. Obviously ‘profit’ and ‘working capital’ should not mean different things at different times.
Selling price is also an unsatisfactory way of valuing stocks as the following example shows.
ABC Limited makes up his accounts to 31 December each year and values his closing stock at selling price. He purchased goods for $800 on 30 November 2016. He sold the goods on 30 January 2017 for $1,000. If these were the company’s only transactions, his Trading Accounts would show a net profit of $200 & $0 for the years ended 31 December 2016 and 2017 respectively.
This example shows the company making a profit of $200 in the year ended 31 December 2016 although he has not sold the goods, but not making any profit in the next year when he sold them. Valuing the stock at selling price offends three important accounting principles:
• Realisation – no profit was realised in the year ended 31 December 2016 because no sale had taken place.
• Matching – the profit has not been matched to the time the sale took place.
• Prudence – the profit was overstated in 2016; it was not even certain then that the goods could be sold at a profit.
It is an important principle that stocks should never be valued at more than costs. Valuing stocks at a historic cost observes the principles of realisation, matching and prudence.
Another important principle is that the method used to value stocks should be used consistently from one accounting period to the next. The methods are considered next.
Three methods of valuing stock at cost:
In a very few cases, it may be possible to value goods at the price actually paid for them. For example, the owner of an art gallery might be able to say from whom she bought each of the pictures in her gallery and how much she paid for them. There would probably be a limited number of paintings and she would be able to recall how much she paid for them.
A manufacturer of computers, however, would not find it easy to say how much he paid for the stocks of parts he needed for the computers. Purchases of hard drives, for example, would be in bulk and made at different times and at different prices. It would be impossible to say at the year-end how much had been paid for any particular hard drive still in stock. The problem is solved by assuming that stock movements occur in a particular pattern, even if that is not strictly so. This is often called a convention: something that is assumed to happen even if it is not strictly true, at least all the time. The three methods considered here are:
• First In, First Out (FIFO), which assumes that stock is used or sold in the same order in which it was received.
• Last In, First Out (LIFO), which assumes that the latest delivery of stock is used or sold before stock received earlier.
• Weighted average cost (AVCO), which involves calculating the weighted average cost of stock- on- hand after every delivery to the business. Stock-on-hand at any given time, and stock sold or issued, is valued at weighted average cost.
There are many companies providing the best bookkeeping services in Singapore, who can assist you in accurately valuing your inventory and stock. For any technical matter, we suggest you seek their advice.