3.4 Accounting for inventory

Three of the most commonly used methods of accounting for inventory are:

• actual cost;

• average cost;

• standard cost.

The simplest is the actual cost, which is based on the purchase price of items as they arrive into a business, the costs being derived directly from the purchase accounting system. More sophisticated systems may incorporate a handling cost frequently calculated as a percentage of purchase price to include, in some way, the costs associated with such functions as purchasing, receiving, quality control, etc.

Whilst actual cost is conceptually simple, it is rather more complicated to use in practice because, at a time of varying prices, each order received may be at a different price and so each consignment has to be held and identified in stores separately. When an order is despatched, it is quite possible that identical goods are despatched that carry different costs. Stocks costed on an actual cost basis are frequently assumed to be held in stores on a FIFO basis for the purposes of inventory accounting. United States accounting requirements frequently call, nevertheless, for stock to be accounted for on a last in first out, or LIFO basis. This has the effect, particularly in inflationary times, of reducing the costs that can be inventoried.

In the example in Table 3.2, the opening stock of 1000 items are valued at 1 each so the initial stock value is 1000. The first three deliveries (lines 2, 3 and 4) are valued at 1...