1. IB Business & Management
Stock Valuation
IB Business & Management

2. Lesson objectives
Make calculations of closing stock using FIFO and LIFO
Calculate the effect of different stock valuations on profit

3. Stock Valuation… What is it?
Stock valuation is the technique used to measure the value of raw materials, work-in-progress or finished goods.

4. Stock valuation – Why it matters
For many businesses, stocks (or inventories) represent a significant proportion of assets so must be accurately recorded
Where will this figure be recorded in the businesses final accounts?

5. Closing Stock and Final Accounts
The Balance Sheet
The Profit and Loss Account
This valuation will be recorded in the Current Assets section of the Balance Sheet.
It will also be recorded as the Closing Stock figure in the profit and loss account.
Remember….
COGS = Opening Stock + Purchases - Closing Stock

6. Last In First Out
This methods involves assuming that the most recent batches of stocks are used first Therefore the oldest stock remains

7. FIFO - First In First Out
This is a method of stock valuation whereby it is assumed that the oldest stock is used first Therefore it is the newest stock that remains

8. A Simple Example
Why does it make a difference which method is used? Look at the scenarios on the next 2 slides. Answer the questions on the slides Then consider this: Which method (FIFO/LIFO) would result in a higher gross profit figure on the P&L account? Which method (FIFO/LIFO) would result in a higher working capital figure on the Balance Sheet

9. January – Stock Cupboard at the start of the month The business uses 3 units of stock during the month. They purchase replacement stock, but the price has increased to $6 £5 £5 £5 £5 £5 £5 £5 £5 £5

10. February – Stock Cupboard at the start of the month (price of stock has gone up) If the business uses 4 of the units of stock…. 2. Which 4 units will be used if we take a FIFO approach? What would the COGS and closing stock figures be? (assuming they haven’t replaced the used stock) 3. Which of the 4 units will be used if we take a LIFO approach? What would the COGS and Closing Stock figures be? (assuming they haven’t replaced the used stock) £5 £5 £5 £5 £5 £5 £6 £6 £6

11. Questions:
1. In reality which method of stock management would businesses actually use? Why?
For stock valuation purposes:
2. What effect would a higher value of closing stock have on the COGS
What effect would a higher value of closing stock have on profits (net and gross)?
Why might a business want to look more profitable?
Why might a business want to look less profitable?
What effect would a higher value of closing stock have on Working Capital?

12. Impact of a high closing stock
COGS is lower
Gross/Net Profit is higher
Higher Taxation
Closing stock value is high
Current assets value is higher
Current ratio is higher

13. Impact of a low closing stock
COGS is higher
Gross/Net Profit is lower
Lower taxation
Closing stock value is low
Current assets value is lower
Current ratio is lower

14. Example Crude oil prices change on a daily basis
It is difficult to distinguish between different batches of stocks.
This means a firm’s inventories will consist of different batches of deliveries valued at different purchase costs

15. An Example Calculate the value of closing stock
Date
Stock Purchased
Stock Sold
1st March
30 $25 p/u
5th March
20 Units
8th March
20 $30 p/u
10th March
15 units
Calculate the value of closing stock
Assuming a FIFO approach
Assuming a LIFO approach

16. Top Tip – Use a table like this
Date
Stock bought
Stock sold
Stock remaining
Stock valuation
1st March
5th March
8th Match
10th March

17. FIFO $450 Date Stock bought Stock sold Stock Remaining Stock valuation
1st March
30 $25 p/u
30 x $25
$750
5th March
20 $25 p/u
10 x $25
$250
8th Match
20 $30 p/u
$25
$30
$850
10th March
25 p/u
30 p/u
$30
$450

18. LIFO $400 Date Stock bought Stock sold Stock remaining Stock valuation
1st March
30 $25 p/u
30 x $25
$750
5th March
20 $25 p/u
10 x $25
$250
8th Match
20 $30 p/u
$25
$30
$850
10th March
15 30 p/u
$30
$400

19. Task
Assume that Revenue is $1750 and Expenses are $ Draw a P&L account for FIFO 2. Draw a P&L account for LIFO

20. Effects on P&L
LIFO FIFO
Sales
Purchases
Closing stock
COGS
Gross Profit
Expenses
Net Profit
Will a FIFO approach always lead to higher profits on the P&L account?

21. Ready for an IB Question?
Extract from the balance sheet for BBT for the year ended 31 October 2010
(b) (i) Calculate the missing figures X, Y, Z and with those figures and from the financial information provided, construct a complete balance sheet for BBT for [7 marks]
Try it:
17 minutes

22. Top Tip – Use a table like this
Date
Stock bought
Stock sold
Stock remaining
Stock valuation
Opening Stock
July
August
September
October
November
December

23. Answers - FIFO

24. Answers - LIFO

25. How the marks are allocated

26. Comment on…..

27. Choosing between LIFO and FIFO
If there were no price changes over time LIFO and FIFO would get the same results, however the reality this is rarely the case
Laws are in place to stop firms switching between FIFO and LIFO, the same has to be used when account presented to the government and the shareholders
In UK and Canada LIFO is not permitted for tax but it is in USA

28. Homework
Crystal Arts is a producer of expensive chandeliers. Each chandelier sells for £1000. During this month the firm has taken orders for 15 chandeliers. It has 10 units as opening stock, purchased at a cost of £500 each. Crystal arts replenishes its stock by ordering another 10 units, but inflation has raised costs to £600 per unit. Operating expenses are £1000 per month and the rate of corporation tax is 30%
Define the term opening stock [2 marks]
Using both FIFO and LIFO methods of stock valuation, construct a simplified profit and loss account for Crystal Arts to show the effects on gross profit and net profit. [ 8 marks]