That the stock levels identified at a stocktake need to be adjusted to the level they would have been at had the stocktake taken place on the balance sheet date.

9 That the stock levels identified at a stocktake need to be adjusted to the level they would have been at had the stocktake taken place on the balance sheet date.

Answers to activities

29.1 This is not as easy a question to answer as it first appears, especially if you have never studied this topic before. Firstly, applying the historic cost convention you learnt about in Chapter 10, we should value the stock at the cost of having it available for sale. That is, it should be valued at cost. If all purchases during the year cost the same per unit, arriving at the value to place on stock would be trivially easy. For example, if all of the units cost £30 each, the closing stock would be

8 × £30 = £240. However, the goods in this example have been purchased at different prices. To cope with this, we look at it from the perspective of which of the goods purchased have been sold. Knowing which of them has been sold allows us to know which ones remain unsold, which will make valuing the stock very straightforward. In this case, purchases were made at £30, £34, and £40. If all the £34 and £40 purchases have been sold, we know to use £30 as the unit cost of the stock.

Unfortunately, many businesses do not know whether they have sold all the older units before they sell the newer units. For instance, a business selling spanners may not know if the older span- ners had been sold before the newer ones were sold. A petrol station doesn’t know whether all the fuel it has in stock was from one delivery or is a mixture of all the deliveries received from the supplier. Accounting deals with this by selecting the method of valuation that is most likely to fairly represent the cost of the goods sold and, hence, the value of the remaining stock.

To answer the question, you don’t have enough information to decide what value to place on the 8 units of stock, but it should be based upon the best estimate you can make of the cost of those 8 units.

29.2 As at least 8 units were received in the last batch purchased, you can simply take the unit cost of that batch and multiply it by the units in stock. If you are asked to show your workings for calcula- tion of closing stock under FIFO, this is a perfectly acceptable approach to adopt.

29.3 It’s not so simple under LIFO. If you receive three batches of purchases of 10, 4, and 6 units respec- tively and you have 10 left in stock, there is no guarantee that they will all be from the first batch. You may have sold all 10 of the first batch before the second batch was received. Alternatively, you may have sold 3 before the second batch of 4 was delivered and then sold 6 before the last batch of 6 was received and then sold 1 before the year end. You do have 10 in stock, but 5 are from the first batch received and 5 from the last one. There is no shortcut available under for ascertaining in which batch the remaining stock was received.

29.4 There have been no further deliveries of new stock received so the average value of stock is still £37.

29.5 The AVCO stock valuation is between the values of FIFO and LIFO. FIFO has the highest value because the cost of purchases has been rising. Had they been falling, it would have been LIFO that had the greatest closing stock value. AVCO will lie between the other two whichever way prices are moving.

29.6 (a) Gross profit will be understated if closing stock is undervalued because the lower the value of closing stock, the higher the cost of goods sold.

Chapter 29 l The valuation of stock (b) Gross profit will be overstated if closing stock is overvalued because the higher the value of

closing stock, the lower the cost of goods sold.

29.7 It may be impossible. However, whatever the quality of your stock records, all businesses must retain evidence of their transactions. As a result, you could have a record of what was purchased, when, from whom, and for how much, but you may well have no record at all of what was sold, when, to whom, or for how much – if all sales are for cash, your only record may be the till receipt for each transaction, and that frequently shows no more than the date and value of the sale.

Review questions

29.1 From the following figures calculate the closing stock in trade that would be shown using (i) FIFO, (ii) LIFO, (iii) AVCO methods.

130 for £24 each September

100 at £16 each

December

220 at £19 each

29.2 For question 29.1 draw up the trading account for the year showing the gross profits that would have been reported using (i) FIFO, (ii) LIFO, (iii) AVCO methods.

29.3A From the following figures calculate the closing stock-in-trade that would be shown using (i) FIFO, (ii) LIFO, (iii) AVCO methods on a perpetual inventory basis.

Bought

Sold

125 at £22 each April

January

120 at £16 each

June

210 at £25 each October

80 at £18 each

November

150 at £19 each

29.4A Draw up trading accounts using each of the three methods from the details in question 29.3A.

29.5 The sixth formers at the Broadway School run a tuck shop business. They began trading on 1 December 20X9 and sell two types of chocolate bar, ‘Break’ and ‘Brunch’.

Their starting capital was a £200 loan from the School Fund. Transactions are for cash only. Each Break costs the sixth form 16p and each Brunch costs 12p. 25% is added to the cost to determine the selling price. Transactions during December are summarised as follows:

December 6 Bought 5 boxes, each containing 48 bars, of Break; and 3 boxes, each containing 36 bars of Brunch. December 20 The month’s sales amounted to 200 Breaks and 90 Brunches.

(a) Record the above transactions in the cash, purchases and sales accounts. All calculations must be shown. (b) On 20 December (the final day of term) a physical stocktaking showed 34 Break and 15

Brunch in stock. Using these figures calculate the value of the closing stock, and enter the amount in the stock account.

(c) Prepare a trading account for the tuck shop, calculating the gross profit / loss for the month of December 20X9. (d) Calculate the number of each item that should have been in stock. Explain why this informa- tion should be a cause for concern.

(Edexcel, London Examinations: GCSE )

Part 4 l Adjustments for financial statements