The Purchase Cost of Stocks
basically, when a company purchases stock from a creditor, whether by cash or on
credit, the company would gather the source documents, and enter the details in the
books of prime entry. Thus, the cost paid for each purchase is the purchase cost of
Not necessarily, because first of all, the cost paid for each item purchased may differ
during each purchase, either due to discounts, sale, inflation, etc. In addition, imagine
purchasing 100 items of stock every month, and at each month the amount paid for
each item differs slightly, how is it possible to calculate which item was sold and how
much money we made on each item?
Furthermore, imagine items being returned others being damaged or stolen. The
process of thinking about it is tedious enough imagine trying to record it!
NRV, Current Replacement Costs and the Selling Price of Stocks
basically, before we proceed, Stock is valued at the lower of its net realizable value and
its historical cost value. The net realizable value is the expected selling price for each
item of stock less any costs still to be incurred in getting them ready for sale. The
Current Replacement Cost is the amount it would cost to replace each item of cost.
Historical Cost is simply the cost at which they were originally bought.
The reason why stock is valued at the lower of the net realizable value and historical
cost is due to the prudence concept. The selling price is avoided because it would
include a profit figure for the business before the stock is even sold!
Furthermore, SSAP 9 encourages the use of two methods FIFO and AVCO, and
discourages the use of LIFO whilst valuing stock.
FIFO, AVCO and LIFO
FIFO stands for, First in, First Out, and it assumes that materials are issued out of
stock in the order in which they were delivered into stock. In other words, the first item
supplied is the first item sold. Hence, issues are priced at the cost of the earliest
delivery remaining in stock.
LIFO stands for Last in, First Out, and it assumes that materials are issued out of stock
in the reverse order to which they were delivered. In other words most recent deliveries
are issued before earlier ones, and are priced accordingly.
AVCO stands for Cumulative Weighted Average Pricing, which calculates a weighted
average price for all units in stocks. This could be very helpful in determining the cost
of consignment stock. Basically a new weighted average price is calculated whenever a
new delivery of materials into store is received.
Well basically it says that at the particular date we either had a receipt of goods into the
company, or we issued some goods. In other words receipts are purchases and issues
are sales (I used the terms receipts and issues as it was used in the BPP example). The number of units received or issued, their corresponding unit price and their market
value on the date of transacti