Stock Evalaution – SS2 Book Keeping Lesson Note (Second Term)

Stock valuation, also called inventory valuation, is the process of determining the value of goods a business holds for resale. It fixes the cost of goods sold and the value of closing stock shown on the balance sheet. The main methods are FIFO, LIFO, weighted average cost and specific identification.

Behavioural objectives

By the end of the lesson, students should be able to:

1. Explain the meaning of valuation and of stock valuation.
2. State five reasons for valuing stock.
3. Name the four methods of valuing stock.
4. Describe how FIFO, LIFO, weighted average cost and specific identification work.
5. Calculate cost of goods sold and closing stock using FIFO, LIFO and weighted average cost.

What is valuation?

Valuation is the process of determining the money worth of an asset, investment, business or financial instrument.

• Basis: it looks at physical condition, financial performance, future earning power and market conditions.
• Use: it guides decisions on investment, financing, mergers, financial reporting and taxation.

What is stock valuation?

Stock valuation is the process of finding the money value of goods a business holds for resale.

• Purpose: it allows the business to report cost of goods sold (COGS) and closing stock correctly.
• Closing stock: the goods unsold at the end of the trading period, shown as a current asset on the balance sheet.
• Cost of goods sold: opening stock plus purchases, less closing stock.
• Methods: FIFO, LIFO, weighted average cost and specific identification.

Why do businesses value stock?

Businesses value stock to report profit and assets correctly. There are five main reasons.

1. Financial reporting: it is needed to prepare the income statement and balance sheet.
2. Taxation: it affects cost of goods sold, taxable profit and tax payable.
3. Decision making: pricing, purchasing and stock control depend on correct stock values.
4. Performance evaluation: it shows how profitable and efficient stock management is.
5. Investor relations: investors and other stakeholders use it to judge the health of the business.

What are the methods of valuing stock?

There are four methods of valuing stock: FIFO, LIFO, weighted average cost and specific identification.

FIFO (First-In-First-Out)

FIFO assumes that the oldest stock is sold first.

• Cost of goods sold: taken from the cost of the oldest purchases.
• Closing stock: valued at the cost of the most recent purchases.
• Example: a provision store sells the oldest tins of tomato paste first.

LIFO (Last-In-First-Out)

LIFO assumes that the newest stock is sold first.

• Cost of goods sold: taken from the cost of the most recent purchases.
• Closing stock: valued at the cost of the oldest purchases.

Weighted average cost

Weighted average cost values all units at one average price.

• Formula: average cost per unit = total cost of goods available for sale ÷ total units available for sale.
• Use: multiply the average cost by units sold and by units left.
• Best for: goods that are alike and mixed together, such as rice, sugar or fuel.

Specific identification

Specific identification tracks and costs each item individually.

• Cost of goods sold: the actual cost of each item sold.
• Closing stock: the actual cost of each item left.
• Best for: unique, high-value goods such as cars, generators and jewellery.

How do you calculate stock value? (worked example)

A trader bought 300 units in three lots and sold 150 units at ₦100 each.

Units sold = 150. Units left = 300 − 150 = 150. Sales = 150 × ₦100 = ₦15,000.

Step 1: FIFO

1. Cost of goods sold: 100 × ₦50 + 50 × ₦60 = ₦5,000 + ₦3,000 = ₦8,000.
2. Closing stock: 50 × ₦60 + 100 × ₦70 = ₦3,000 + ₦7,000 = ₦10,000.
3. Check: ₦8,000 + ₦10,000 = ₦18,000.

Step 2: LIFO

1. Cost of goods sold: 100 × ₦70 + 50 × ₦60 = ₦7,000 + ₦3,000 = ₦10,000.
2. Closing stock: 100 × ₦50 + 50 × ₦60 = ₦5,000 + ₦3,000 = ₦8,000.
3. Check: ₦10,000 + ₦8,000 = ₦18,000.

Step 3: Weighted average cost

1. Average cost = ₦18,000 ÷ 300 = ₦60 per unit.
2. Cost of goods sold: 150 × ₦60 = ₦9,000.
3. Closing stock: 150 × ₦60 = ₦9,000.

Step 4: Compare the results

• Rising prices: FIFO gives the highest profit and highest closing stock.
• Rising prices, LIFO: LIFO gives the lowest profit and lowest closing stock.
• Weighted average: it gives results between the two.

What are the differences between FIFO and LIFO?

FIFO charges the oldest cost to sales, while LIFO charges the newest cost to sales.

What is the rule for the lower of cost and net realisable value?

Stock is valued at the lower of its cost and its net realisable value.

• Cost: the price paid to buy the goods and bring them to the shop.
• Net realisable value: the expected selling price less any cost needed to make the sale.
• Reason: it stops profit and assets from being overstated.
• Example: damaged goods that cost ₦500 but can only sell for ₦400 are valued at ₦400.

Evaluation

1. What is valuation?
2. Define stock valuation.
3. State five reasons for valuing stock.
4. Name the four methods of valuing stock.
5. How is the weighted average cost of stock calculated?

Assignment

1. A trader had 40 units at ₦200, then bought 60 units at ₦220 and 100 units at ₦250. He sold 120 units. Calculate the cost of goods sold and closing stock under FIFO, LIFO and weighted average cost. State which method gives the highest closing stock.