You can help the site by talking about it around you. The more visitors and students we have, the more means we will get to develop it.

facebook   twitter   stumbleupon  mail

 

Introduction
1What is a firm
2History of firms
3History of accounting
  
II Example of a small firm
4A workshop making toys (1)
5A workshop making toys (2)
6Production of large quantities of information
7First principles taught by the example
8Most of the main concepts of accounting are in the toy example
  
III From single-entry to double-entry accounting
9Why single-entry accounting, like in our checkbook, is insufficient
10A page to record debtors, a page to record creditors: the emergence of double-entry accounting
11The basic concept of transaction: the "atom" of activity of a firm
12Posting transactions into accounts (1): general principles, the apparent paradox of "value coming in is a debit"
13Posting transactions into accounts (2): posting simple transactions, traditional vs real time inventory control
  
IV A complete accounting cycle up to the Trial balance
14The yearly accounting cycle: journal → accounts → Trial Balance → adjustments → Income Statement & Balance Sheet
15Posting a complete cycle of journal entries (1)
16Posting a complete cycle of journal entries (2)
17Balance of each account and Trial Balance (TB)
18Revenue accounts and Capital accounts in the TB
  
Adjustments to the Trial balance
19Why the TB needs to be adjusted to compute the Income Statement (IS)
20Adjustment for inventory
21Adjustment for amortization
22Provisions for bad or doubtful clients
23Prepayments and accruals
  
VI The Income Statement and the Balance Sheet
24From adjusted Trial balance to Income Statement (IS)
25From adjusted Trial balance to Balance Sheet (BS)
26IS and BS: a higher view
  
VII General principles of accounting and miscellaneous topics
27General rules and guidelines of double-entry accounting
28Stock valuation: FIFO, LIFO and other methods
29Impact of a series of transactions on the IS and BS: a complete exercise
30Alternate way to compute the COGS
  
VIII Money
31Money (1): what is money? 
32Money (2): how to get rich?
  
IX Accounting over several years
33Difference between the first accounting year and the following years
34From one BS to the next, and the IS in between
35Income tax and dividends
36Accounting documents over several years
  
A deeper look at the Balance Sheet
37Big measures in a balance sheet: equity, debt, capital employed, fixed assets, current assets, working capital
38The notion of liquidity
39The list of assets is fundamentally heterogeneous
  
XI Cash flow statement
40Cash flow statement (1): what is cash?
41Cash flow statement (2): reconciling cash evolution with the main accounting measures
  
XII Ratios
42Return on Capital Employed (ROCE)
43Other ratios
44Stock management
  
  
  
facebook   twitter   mail

General accounting

VII. 28. Methods of stock valuation

 

Video

Text

 

 

We saw that in order to prepare the Income Statement (IS) of a firm over an accounting cycle we must compute the exact Cost Of Goods Sold (COGS) corresponding to the sales.

Usually the COGS is not equal to the Purchases of the cycle. We may have sold more than we purchased, in which case the stock decreased between the beginning and the end of the cycle (this of course is not possible in the first accounting cycle). Or we may have purchased more than we sold, in which case the difference went to increase the stock.

The formula is COGS = Opening stock + Purchases - Closing stock.

Sometimes, it is written: COGS = Purchase - Δ Stock.

Δ means "variation of", that is Ending stock - Beginning stock.

 

 

So far in the example we presented life was simple, because the purchasing price of all the items was always the same (40€).

journal

So the calculation of the ongoing and of the final remaining stock posed no problem.

 

 

But if the purchasing price of items vary over time, we have to know which ones we sold, and which ones remain in stock.

Sometimes it is more an accounting decision than an actual observation: think of a fuel retailer who buys fuel, puts it in a tank, and sells it. When he sells fuel, it is not possible to say which gallons (at what purchasing price) were sold.

 

 

The three main methods to keep track of the COGS and remaining stocks are called:

The idea is very simple. Suppose I am a teddy bear retailer. On Nov 6, I buy one teddy bear, which goes into stock. The teddy bear has a purchasing price (for me) of 5€.

Here is my stock (if I had no stock before):

teddy bear

Then, before any sale, on Nov 7, I buy another identical teddy bear, at another purchasing price. Indeed, the prices of my supplier may vary from one date to another. This time I pay 6,5€.

Here is my stock now:

teddy bear  teddy bear

Then, on Nov 8, I sell one teddy bear. (The selling price is, say, 10€, but this selling price plays no role in stock valuation.)

What is the COGS corresponding to this sale?

Well,

and of course the remaining stock is the difference between the COGS and the beginning stock (just before the sale) which was 5 + 6,5 = 11,5€.

 

 

To monitor a stock (or a storeroom) the usual sheet is slightly more elaborate than what we presented above.

Here is a usual lay-out:

storeroom sheet

 

 

Let's fill it in with the example of Joe's business. We decide that we shall use the LIFO method.

On Jan 12, we purchase a first batch of items at 40€ apiece:

storeroom sheet

 

Then, on Jan 18, we sell 30 items.

storeroom sheet

(the choice of the method did not play a role yet)

 

On the 26th, we purchase a second batch of items, at 42€ apiece:

storeroom sheet

(again, the choice of method doesn't matter yet)

 

Then, on Jan 26 as well, we sell 30 items. Remember, the selling price doesn't matter for the stock and COGS valuation. But here the choice of method does matter:

storeroom sheet

In our calculation, we depleted the most recent part of the stock first. This is the meaning of "last in first out".

 

Finally we make another sale of 10 items.

storeroom sheet

 

 

So at the end of the accounting cycle (assuming Joe's journal, above, covers a whole accounting period), we have the following figures:

 

 

Choice of method.

Following the "consistency rule", once we have chosen a method of stock valuation, we must stick to it during all the future cycles.

In some countries the only legal method is the FIFO, while in others we have the choice.

The FIFO method may appear the most logical. Its drawback is that we compute COGS which may not represent current purchasing prices.

When purchasing prices steadily go up, the LIFO method produces the highest COGS figure, therefore the smallest profit before tax, and the smallest income tax to pay.

 

 

Exercises:

  1. Prepare the IS and BS of Joe's business with the LIFO-method figure for the ending stock we just computed.
  2. Recompute the ending stock using the FIFO method.
  3. Recompute the ending stock using the CWA method.

Course table of contents

Contact