Accounting for stock

Accounting for stock - LIFO, FIFO and AVCO

Accounting for the stock is an essential part of a business if you buy and sell goods.

The UK uses a Financial Reporting Standard (FRS102). Under this standard, there are two stock valuation methods FIFO and average cost AVCO). For the two ways, we will show examples. A third method LIFO can be used in limited circumstances.

Stock or inventory is shown on the balance sheet as a current asset. A current asset is something that can convert into cash within a year.

Accounting for Stock Transactions

When accounting for stock there are several different transactions that might take place with stock:

  • You purchase new stock, so you increase the stock
  • You sell stock and therefore transferred to the cost of sales on the profit and loss account
  • Stock write off – If the stock is no longer valid it might need to be written off
  • Stock adjustment – If the physical quantity is different from the quantity in the records, an adjustment is required

The easiest way to complete stock transactions is in accounting software. However, not all accounting software packages include stock, so check before you choose one. Two good accounting software packages that account for stock are XERO and Quickbooks.

An example of accounting for stock transactions are:

We are looking at a computer business that buys and sells. The product that we will follow with all the examples is a laptop.

At the beginning of the year, a business holds stock of 6 laptops. It purchases a further 15 and sells 17. At the year-end, the stock held is 4. The value for the remaining 4 will show in the current assets. If the laptops are all purchased for 250.00, the stock record will look like this:

DateDescriptionPurchases
QTY
ValueSales
QTY
ValueClosing Stock
Qty
Value
1 JanOpening Stock61500.00
3 Jan3750.003750.00
10 Jan10 @ 2602500.00133250.00
15 Jan102500.003750.00
17 Jan5 @ 6251250.0082000.00
22 JanClosing Stock41000.0041000.00

The opening balance of stock was 6 laptops @ 250.00 = 1500.00. Closing stock was 4 @ 250.00 = 1000.00. These will be the figures posted to the balance sheet.

We will use the above example in both the LIFO, AVCO and FIFO with different purchase costs. It will demonstrate how they are all calculated.

Accounting for Stock – Stock Check

Part of the year-end process is to complete a stock check. It will ensure that the figures in the accounts are the same as the actual quantity held. You can complete a stock check in various ways, including physically counting the stock or using a scanner to record each item.

If the physical stock levels are different from the figures in the accounts, the create a stock adjustment. Stock levels might be different for several reasons, including theft, accounting error and disposal of old stock.

Stock valuation methods

We will look at the following stock valuation methods: First In First Out (FIFO), the average cost (AVCO) and Last in First Out (LIFO).

What is FIFO?

The First in First Out method assumes that the first item purchased is the first item to be sold (oldest product). This is because the prices of goods purchased may change all the time, and you must make the changes into account.

We will look at this in more detail by using the laptop example above but change the cost price. The opening stock is purchased at 250.00 each. The further 2 purchases are 260.00 and 265.00.

DateDescriptionPurchases
QTY
ValueSales
QTY
ValueClosing Stock
Qty
Value
1 JanOpening Stock61500.00
3 Jan3750.003750.00
10 Jan10 @ 2602600.00133350.00
15 Jan3750.00
71820.003780.00
17 Jan5 @ 265132582105.00
22 Jan3780.00
1265.00
22 JanClosing Stock41060.00

The sales on each date now have different values. The first value is the oldest stock and the second value is the most recent purchase. The closing stock is 4 @ 265.00 = 1060.00

What is AVCO?

AVCO is the average cost method.

Using the example of keyboards above, it will look like this. Our example presumes that the average cost of the stock brought forward is £250.

DateDescriptionPurchases
QTY
ValueSales
QTY
ValueClosing Stock
Qty
ValueAverage
Value
1 JanOpening Stock61500.00
3 Jan3750.003750.00
10 Jan10 @ 2602600.00133350.00257.692
15 Jan102576.923773.08
17 Jan5 @ 2651325.0082098.08262.26
22 Jan41049.0441049.04

After the first purchase, although the goods were purchased at 260.00 the average price is 257.692.

After the second purchase, the average price is adjusted again and is 262.26.

Between the FIFO and AVCO in this example, the difference is 10.96, but if the cost were much higher, it would affect the stock value much more.

What is LIFO?

LIFO stands for Last in First out. Although it is not used much in the UK, it is worth knowing about. Again we will use the above example.

DateDescriptionPurchases
QTY
ValueSales
QTY
ValueClosing Stock
Qty
Value
1 JanOpening Stock61500.00
3 Jan3750.003750.00
10 Jan102600.00133350.00
15 Jan102600.003750.00
17 Jan51325.0082105.00
22 Jan41060.0041045.00

The final stock is made up of the following: 3 units @ 250.00 and 1 unit @ 265.00 = 1045.00

As you can see from all 3 methods the stock is calculated at different figures.

Should I use FIFO, AVCO or LIFO?

As we looked at in the beginning, when accounting for stock, most businesses will use either the first-in, first-out method or average cost. The most popular method is first in, first out. If you are not sure which method is the best one for your business, speak to your accountant. Once the company has a method in place, they need to stick to using the same process.

Accounting for Stock – Summary

  1. Stock is listed in the balance sheet as a current asset.
  2. There are three main methods for calculating the cost – LIFO, AVCO and FIFO.
  3. The easiest way to account for the stock is by using accounting software.
  4. Complete a stock take at a period end and make any adjustments necessary.

For further reading on accounting for stock, see our articles on balance sheet and manual stock control.