# Process Inventories

In accounting, Inventories is a collective term used to represent raw materials, work in progress and finished goods.

Even in process cost accounting, inventories are classified similarly.

• # Raw Materials

Where the raw material charged to the process remains unused at the end of the period i.e. at the time the process account is being balanced, it forms part of closing inventory for that process.

The raw material used in a process may be one of these

• The output of a prior process that has been introduced as an input.

This will be relevant to a second and subsequent process. It is often referred to as primary material.

• Material directly introduced in the process in consideration.

This will be relevant to all processes. If this is the only material used it is referred to as primary material. Where there is other primary material, this is referred to as a secondary material.

• # Finished Stock

By Finished Stock in relation to a process, we mean the output or completed production of that process.

The output of a process may be transferred directly to the subsequent process or to the warehouse represented by a Process Stock a/c or Finished Product a/c if the process in consideration is the last process.

### No Output Stocks exist

Where all the output of a process is being transferred directly from the process to the subsequent process immediately on completion of production, there would be no closing stock of output (finished stock) in relation to the process.

### Output Stocks (of finished goods) exists

Where the transfer of output from one process to another is not done immediately on completion of production, there is a possibility for the presence of stock of output in relation to that process. Where the finished stock is present, it forms a part of the inventory for that process.

In such cases, the output, immediately on completion of production is transferred to a Process Stock account (created separately for each process). Any transfer of output would be done thereon from that account.

Where the closing finished stock is present, it can be identified within the process a/c either as a balance or as postings representing transfer.

• # Work-In- Progress

Where the processing of the input introduced into the process is not completed by the time the process account is being balanced, the partially completed production would form the work-in-progress for that process.

This also forms part of the process inventory.

# Inventories - aspects handled

In dealing with inventories, we would be handling the following two aspects.

1. # Valuation

Finding its value is the first requirement in dealing with inventories. For finding the value we need to know the quantity of the inventory and the rate at which it has to be valued.

## Raw Material and Finished Goods

In process costing, the quantity of inventory at the Raw Material Stage or Finished Stock stage is available within the information available and derived for preparing the process accounts.

There might be more than one possible rate available for being considered for valuation. The decision regarding the rate at which the inventories are to be valued has to be made.

## Work in Progress

Valuation of work in progress is a task which requires us to collect additional data and make additional calculations for arriving at the quantity of stock as well as the possible rates at which they can be valued.
2. # Accounting

How we account for Process Inventories is dependent on the type of inventory in consideration.

Finished stock inventory is accounted for through a separate stock account. The output of a process is carried over to a process stock account and any transfer of the output thereon is done through the process stock account.

Raw Material and Work In Progress Inventories can be accounted for using the process account itself. If the organisation so intends, it may maintain separate accounts for these even, thereby showing the raw material stock and work in progress stock distinctly instead of as a balance of the process account.

# Valuation - Methods and Rates

The concept of methods of valuation and the rate for valuation is relevant and applicable to all types of inventories, whether it be Raw Material or Work in Progress or Finished Goods.

The three common methods used for valuing inventories are

• FIFO [First in First Out] Method
• LIFO [Last in First Out] Method
• Average Method

The unit rate at which the inventory is to be valued is dependent on the method adopted for valuation. In general the unit rate works out to be a distinct figure under each method. In certain cases, the rates may work out to be the same under two or more methods.

## Example

Consider the following data relating to the stock of finished goods of a process.

There is an opening stock of 1,800 units @ 42/unit; The current period production is 18,000 units @ 40 per unit.

 Particulars Quantity Amount Rate Opening Stock + Received during the period 1,800 18,000 75,600 7,20,000 42.00 40.00 Total Stock 19,800 7,95,600 40.18
Data in the rate column should always be obtained as the quotient of $\frac{\mathrm{Amount}}{\mathrm{Quantity}}$

Rates for valuing closing stock

 FIFO method LIFO method Average method 40.00 42.00 40.18

## We find the Value of Closing stock

We decide on a rate to be used for valuation. We find the value of closing stock using that rate. This would leave the value of consumption as the balancing figure.
 Particulars Quantity Amount Rate Opening Stock + Received during the period 1,800 18,000 75,600 7,20,000 42.00 40.00 Total Stock − Closing Stock 19,800 1,200 7,95,600 – 40.18 ✔ Consumption (?) ? ? –

Taking a lower value for closing stock would result in attributing a higher value to consumption. This amounts to absorbing higher expenditure in the current period itself by valuing consumption at a higher figure.

## Finding the value of Consumption

The value of consumption can be derived straightaway only if the rate at which consumption has to be valued is ascertainable.

Knowing the rate relating to every unit of consumption would be possible if the rate at which the stock being consumed is ascertainable on the go. This is possible by making additional efforts in the form of creating identifications for physical stock and maintaining appropriate records for every in and out of stock.

## Why not value Consumption?

We can find the value of consumption and then find the value of closing stock as a balancing figure.

We prefer valuing closing stock over valuing consumption for the following reasons.

• ### Cost vs Benefit

One reason why valuing consumption may not be resorted to is that the cost that would be incurred in making additional efforts to enable such ascertainment is far greater than the benefit derived out of it.
• ### Not Possible

In some cases the nature of the stocks is such that it would be nearly impossible to create identifications for physical stock like in the case of liquids. However if needed this may be achieved by putting up and consuming the stock in containers which would have identifications which again raises the question of cost vs benefit.
• ### Concept of conservatism

Based on the concept of conservatism, we value closing stocks at the lowest possible value so that a greater part of the cost of the total stock goes into the value of consumption which gets absorbed in the current period itself and is recovered through the revenue earned in the current period.

The value of consumption, if ascertained, would be the cost incurred in acquiring the stock thereby leaving the value of closing stock to be the cost incurred in acquiring the closing stock.

In valuing closing stock, we may choose to use the least of the possible rates that can be used for its valuation, thereby minimising its value and ensuring that greater value is attributed to stock consumed.

## Methods not for physical usage

The FIFO, LIFO and Average methods are methods used to arrive at a rate for being used in valuation of stocks. They are not methods indicative of physical usage of stocks.

The physical usage of stocks would mostly follow the FIFO method, as older stocks would have to be used up first to avoid them losing value or becoming obsolete.

## Are there any rules for choosing a method?

The method to be adopted for arriving at the rate for valuation is to be chosen by the organisation adopting it. The choice is based on a number of factors relevant to the organisation and the industry relevant to it. In most cases, there is no rule that a particular method has to be followed. The only requirement might be that organisations follow a method consistently.

# Valuation - FIFO [First In First Out] Method

This method of valuation assumes that the current period inventory is used only after using up the previous period inventory (i.e. the current period Opening Inventory) and the closing inventory at the end of the current period would consist of stock received during the current period whereby valuing the inventory at the current period rate would be appropriate.

## Example

Consider the following data relating to the stock of finished goods relating to a process.

There is an opening stock of 1,800 units @ 42/unit; The current period production is 18,000 units @ 40 per unit and the closing stock is 1,200 units whose value is to be ascertained by choosing an appropriate rate for valuation. The balance of stock is used up in transfer to next process.

 Particulars Quantity Amount Rate Opening Stock + Received during the period 1,800 18,000 75,600 7,20,000 42.00 40.00 Total Stock − Closing Stock 19,800 1,200 7,95,600 40.18 Consumption 18,600

Stock Used up

 = Opening Stock + received in Current Period − Closing Stock = 1,800 + 18,000 − 1,200 = 18,600

Current period stock used up

 = Stock Used up − Opening Stock = 18,600 − 1,800 = 16,800

Stock used up or consumed during the current period

 = All of opening stock + Current period stock used up = 1,800 + 16,800 = 18,600

Stock received in the current period not consumed

 = Stock received in the current period − Current period stock used up = 18,000 − 16,800 = 1,200

Thus, Closing stock = Stock received in the current period not consumed

Rate for valuing closing stock under FIFO method

 = Rate at which stock is acquired during the current period = 40/unit
Under FIFO method stocks are valued at rates at which they are acquired in the current period.

This would be the rate at which the stock in closing stock has been acquired if the physical usage of stock is also on FIFO basis and the closing stock ≤ stock received during the current period. In other cases this rate would be a notional rate used for valuing closing stock.

## Rationale

This method for valuing inventory is appropriate to follow in conditions of falling rates. The stocks that are acquired later would be at lower rates. Thus, the closing stock which is assumed valued at current period rates would be valued at the lower of the rates.
 Particulars Quantity Amount Rate Opening Stock + Received during the period 1,800 18,000 75,600 7,20,000 42.00 40.00 Total Stock − Closing Stock 19,800 1,200 7,95,600 48,000 40.18 40.00 Consumption (?) 18,600 7,47,600 40.20

Of the possible rates at which the stock can be valued 42, 40 and 40.18, 40 is the least. Valuing the closing stock at 40 amounts to attributing it the lowest of the possible values.

## Problem solving

In problem solving, following FIFO method for valuing stocks requires us to value the closing stock at the current period rates irrespective of the quantity of closing stock.

# Valuation - LIFO [Last In First Out] Method

This method of valuation assumes that the previous period inventory (i.e. the current period Opening Inventory) is used only after using up the current period inventory and the closing inventory at the end of the current period would consist of stock from the opening inventory.

## Example

Consider the following data relating to the stock of finished goods relating to a process.

There is an opening stock of 5,000 units @ 26/unit; The current period production is 20,000 units @ 30 per unit and the closing stock is 2,000 units whose value is to be ascertained by choosing an appropriate rate for valuation. The balance of stock is used up in transfer to next process.

 Particulars Quantity Amount Rate Opening Stock + Received during the period 5,000 20,000 1,30,000 6,00,000 26.00 30.00 Total Stock − Closing Stock 25,000 2,000 7,30,000 29.20 Consumption 23,000

Stock used up

 = Opening Stock + received in Current Period − Closing Stock = 5,000 + 20,000 − 2,000 = 23,000

Opening stock used up

 = Stock used up − Current period stock = 23,000 − 20,000 = 3,000

Stock used up or consumed during the current period

 = Opening stock used up + All of Current period stock used up = 3,000 + 20,000 = 23,000

Opening Stock not consumed

 = Opening stock − Opening stock used up = 5,000 − 3,000 = 2,000

Thus, Closing stock = Opening stock not consumed

Rate for valuing closing stock under LIFO method

 = Rate at which opening stock is valued = Rate at which previous period stocks are valued = 26/unit
Under LIFO method stocks are valued at rates at which they are valued at the end of the previous period.

This would be the rate at which the stock in closing stock has been acquired if the physical usage of stock is also on LIFO basis and the closing stock ≤ opening stock. In other cases this rate would be a notional rate used for valuing closing stock.

## Rationale

This method for valuing inventory is appropriate to follow in conditions of rising rates. The stocks that are acquired earlier would be at lower rates. Thus, the closing stock which is assumed valued at previous period rates would be valued at the lower of the rates.
 Particulars Quantity Amount Rate Opening Stock + Received during the period 5,000 20,000 1,30,000 6,00,000 26.00 30.00 Total Stock − Closing Stock 25,000 2,000 7,30,000 52,000 29.20 26.00 Consumption 23,000 6,78,000 29.48
Of the possible rates at which the stock can be valued 26 (LIFO), 30 (FIFO) and 29.20 (Average), 26 is the least. Valuing the closing stock at 26 amounts to attributing it the lowest of the possible values.

## Problem solving

In problem solving, following LIFO method for valuing stocks requires us to value the closing stock at the previous period rates (opening stock rate) irrespective of the quantity of closing stock.

# Valuation - Average Method

This method of valuation assumes that all the stocks are pooled up and there is no specific identification as to whether previous period stocks are being used up or the stocks from the current period receipts are being used up and the closing inventory at the end of the current period would consist of a mix of the stock from the opening inventory as well as stock received during the current period.

## Example

Consider the following data relating to the stock of finished goods relating to a process.

There is an opening stock of 4,000 units @ 34/unit; The current period production is 16,000 units @ 38 per unit and the closing stock is 2,500 units whose value is to be ascertained by choosing an appropriate rate for valuation. The balance of stock is used up in transfer to next process.

 Particulars Quantity Amount Rate Opening Stock + Received during the period 4,000 16,000 1,36,000 6,08,000 34.00 38.00 Total Stock − Closing Stock 20,000 2,500 7,44,000 37.20 Consumption 17,500

Stock used up

 = Opening Stock + received in Current Period − Closing Stock = 4,000 + 16,000 − 2,500 = 17,500

Rate for valuing closing stock under Average method

 = Average Rate at which the total stock is acquired = Average of the Rates at which the current period and previous stocks have been acquired = 37.20/unit
Under Average method stocks are valued at the weighted average of the rate at which they are valued at the end of the previous period and the rate at which they are acquired during the current period using quantities as weights.

This would be the rate at which the stock in closing stock has been acquired if the physical usage of stock is a mix of previous period stock and the current period stock taken in opening stock : current period receipt ratio. This though theoretically possible, is highly improbable. Thus in all cases this rate would be a notional rate used for valuing closing stock.

## Rationale

This method for valuing inventory is appropriate to follow in conditions of fluctuating rates. Moreover, using this method does not ensure that the closing stock would be valued at the lower of the rates. The weighted average rate would be an intermediary rate that falls somewhere between the higher and lower rates.
 Particulars Quantity Amount Rate Opening Stock + Received during the period 4,000 16,000 1,36,000 6,08,000 34.00 38.00 Total Stock − Closing Stock 20,000 2,500 7,44,000 93,000 37.20 37.20 Consumption 17,500 6,51,000 37.20
Of the possible rates at which the stock can be valued 38 (LIFO), 34 (FIFO) and 37.20 (Average),37.20 is an intermediary rate.

Using weighted average method for valuing closing stock would result in both the closing stock and the consumption being valued at the same rate.

## Problem solving

In problem solving, following Average method for valuing stocks requires us to value the closing stock at the weighted average of the previous period rate and the current period rate taking the quantities as weights irrespective of the quantity of closing stock.

# Weighted Average Rate

Weighted Average Rate

= Average of Rates taking quantities as weights
=
 Rate1 × Quantity1 + Rate2 × Quantity2 + ... Quantity1 + Quantity2 + ...
=
 Value1 + Value2 + ... Total Quantity
=
 Total Value Total Quantity

Any of these interpretations can be used based on the available data.

Weighted Average Rate

=
 (4,000 units × 34/unit) + (16,000 units × 38/unit) (4,000 units + 16,000 units)
=
 1,36,000 + 6,08,000 20,000 units
=
 7,44,000 20,000 units
= 37.20/unit

# Simple Average Rate

Simple average of rates is the average of just the rates.

Simple Average Rate

= Average of Rates taking quantities as weights
=
 Rate1 + Rate2 + ... Number of Rates
=
 Total of Rates Number of Rates

Simple Average Rate

=
 34/unit + 38/unit 2
=
 72/unit 2
= 36.00

If no mention is made, assume average to be weighted average unless when the quantity data is not available.

# Same Rate under all methods

Under the following conditions, we will notice that the rate for valuation would be the same whatever may be the method we assume.

# Where there is no Opening Stock

Where there is no opening stock, the total stock at the end would be related to the stock received during the current period. The method of valuation would be irrelevant as all the three methods would yield the same rate.
 Particulars Quantity Amount Rate Opening Stock + Received during the period – 22,000 – 7,70,000 – 35.00 Total Stock 22,000 7,70,000 35.00

Rates for valuing closing stock

 FIFO method LIFO method Average method 35.00 – 35.00

# Where the Previous and Current Period Rates are the Same

Where there is opening stock and the rates relating to the opening stock as well as the current period stock are the same, all the three methods would yield the same rate.
 Particulars Quantity Amount Rate Opening Stock + Received during the period 1,600 24,000 60,800 9,12,000 38.00 38.00 Total Stock 25,600 9,72,800 38.00

Rates for valuing closing stock

 FIFO method LIFO method Average method 38.00 38.00 38.00
Author : The Edifier