A business had the following inventory transactions during April 2025. Date Transaction Units Cost per unit $ 1 Apr Opening inventory 80 10.00 8 Apr Purchas...

(a) Closing inventory using the FIFO method

After the purchase on 8 April, there are 200 units in stock: 80 @ $10.00 and 120 @ $11.00.

Sale on 15 April (150 units) under FIFO: issue the oldest first.

Issue: 80 @ $10.00 + 70 @ $11.00 [1]

Remaining after sale: 50 @ $11.00 [1]

Purchase on 25 April: 100 @ $12.00

Closing inventory (FIFO) = (50 x $11.00) + (100 x $12.00) [1]

= $550 + $1 200 = $1 750 [1]

(b) Closing inventory using the AVCO method

After the purchase on 8 April:

Total units: 80 + 120 = 200

Total cost: (80 x $10.00) + (120 x $11.00) = $800 + $1 320 = $2 120

Weighted average cost per unit = $2 120 / 200 = $10.60 [1]

Sale on 15 April (150 units): issued at $10.60 each = $1 590 [1]

Remaining: 50 units @ $10.60 = $530

Purchase on 25 April: 100 @ $12.00 = $1 200

New total: 150 units, $530 + $1 200 = $1 730

New weighted average = $1 730 / 150 = $11.53 per unit (rounded to 2 d.p.) [1]

Closing inventory (AVCO) = 150 x $11.53 = $1 730 [1]

(c) Which valuation should be used

Inventory should be valued at the lower of cost and net realisable value (NRV). [1]

NRV per unit = $10.50, so total NRV = 150 x $10.50 = $1 575 [1]

Since NRV ($1 575) is lower than both FIFO cost ($1 750) and AVCO cost ($1 730), the NRV figure should be used. [1]

(d) Value of closing inventory in the financial statements

Closing inventory = 150 units x $10.50 = $1 575 [1][1]

This applies the lower of cost and NRV rule. [1]

(e) Accounting concept

Prudence (also known as conservatism). [1]

This concept requires that losses are anticipated and provided for, while gains are not recognised until they are realised. Using the lower of cost and NRV ensures that inventory is not overstated on the balance sheet.

(f) Net realisable value

Net realisable value is the estimated selling price of the inventory in the ordinary course of business. [1] It is calculated after deducting any further costs expected to be incurred in completing the goods and making the sale (such as finishing costs, packaging, or selling expenses). [1]

(g) Effect on the income statement if inventory is overvalued

If closing inventory is overvalued, the cost of sales will be understated (since closing inventory is deducted from cost of sales). [1]

As a result, gross profit will be overstated. [1]

Consequently, the profit for the year will also be overstated, and the financial statements will not show a true and fair view of the business performance. [1]