Basic records

Individual stock items can be quite valuable, e.g. household appliances like washing machines or tools like electric drills. In such cases the firm may well want to have a system for booking them in and out of the warehouse whenever they are bought or sold. The supplier’s delivery note will be the source document for the booking in; a requisition docket of some kind will be the source document for booking out. So there will always be a record of the stock that should be in hand; periodical physical stock checks (actually going round and counting the stock) will show up any discrepancies arising from errors or pilferage.

Stock valuation methods

At the end of the accounting period stocks have to be valued for the balance sheet. Such value is based on the cost price or replacement price, whichever is the lower. The idea is that the asset figures in the accounts should reflect the true values as closely as possible. Each item (or at least each group of items) should be treated separately in this valuation process.

If we are valuing the stock at cost price there may have been a number of price changes throughout the year, and if the goods are identical we may not be able to tell which ones cost which amounts. There are three main ways of dealing with this:

• FIFO (first in first out)
• LIFO (last in first out)
• average cost method.

First in first out

FIFO assumes that the remaining stock is the subject of the most recent prices. Suppose a firm had purchased 30 televisions, the first 10 at £50, another 10 some months later at £55, and near the end of the year another 10 at £60.00. Let’s suppose, also, that it sold 15 to one customer, a hotelier perhaps, just before the end of the accounting year. Since 30 had been purchased and only 15 sold there should be 15 left in stock. These 15 would be valued at the prices of the most recently purchased 15; that means all 10 of the most recent purchase at £60 each and 5 of the previous order at £55 each.

Last in first out

LIFO does the opposite. It says that all remaining stock on hand is valued at the earliest purchase price. To value stock according to LIFO you do the same as for FIFO, using the earliest invoices, instead of the most recent.

Average cost method

The average cost method (sometimes referred to as AVCO) requires you to divide the remaining stock (numbers of items) into the total cost of all that stock, each time an item is withdrawn from stock. You then apply the cost figure to the withdrawn stock, and to the stock remaining afterwards. When another withdrawal is made you add the last valuation to the cost of all purchases since; you then divide the total by the actual number of items in stock. Again you apply this value to the goods withdrawn and to the balance remaining. So the average value of remaining stock may change continuously.

Example

Let’s suppose a shop made purchases as in the example; it sells two televisions immediately after the second wholesale purchase and 10 more close to the end of the year. You would then value the stock as shown in the example in Figure 114.

FIFO is the most commonly used method. It also seems the most realistic, because businesses usually try to sell their oldest stock first.

Advantages of FIFO method

• Unrealised profits or losses will not occur, i.e. increases in stock values due to inflation.
• Issuing the oldest items first reduces likelihood of stock perishing.
• Stock valuation will be closer to current prices than with other methods.
• This method is acceptable to HM Inland Revenue.
• This method complies with SSAP9. This statement of standard accounting practice prescribes that stock should be valued at the lower of cost or net realisable value.

Disadvantages

• In inflationary times costs are understated and profits overstated. This is because the cost of replacing the stock is higher than the cost of the stock used and accounted for. The reverse is true in deflationary times.
• Material issue prices vary so that it is difficult to compare prices over a range of jobs.

Advantages of LIFO method

• It keeps stock values to a minimum.
• It causes the firm’s product prices to reflect the most recent component prices.
• It could, theoretically, enable the firm to weather the storm better in times of rising component costs, because it could produce goods more cheaply than other firms when the stock in its storeroom is valued at old prices.

Disadvantages

This method is not acceptable to HM Inland Revenue and does not comply with SSAP9, so all consideration of its advantages is purely academic.

Stock reorder levels

The stock levels that trigger reordering are calculated as follows:

buffer stock + (budgeted usage × maximum lead time)

i.e. the level of stock the firm keeps as a margin of safety plus (an order figure equal to the budgeted usage per day, or week multiplied by the number of days, or weeks it takes to receive the stock after ordering).

COMPUTERISING THE STOCK CONTROL SYSTEM

Computerised stock control systems offer many advantages over manual systems:

• Faster data processing.
• Increased accuracy.
• Savings in wages costs.
• Continuous analysis to establish economic order quantities.
• Automatic reordering made possible.
• Just in time stock ordering is made feasible, reducing stock holding costs to a minimum.
• More effective control of minimum and maximum levels.
• Point of sale stock control facilitated.
• Immediate and up to date reports on performance of particular stock lines made possible and easy to obtain.
• Stock keeping software can be integrated into the firm’s general accounting software.