Inventory — full notes
Paper No. 1: Financial Accounting · Accounting for Assets and Liabilities - Inventory
Inventory
1. The valuation rule
Inventory is valued at the lower of cost and net realisable value (NRV) - the prudence concept doing real work. Never carry inventory at more than it is actually likely to realise.
Net realisable value = estimated selling price - estimated costs still needed to complete or sell it.
Example: inventory that cost KES 8,000 is now damaged. Expected selling price KES 9,500, but KES 2,000 of repair costs are needed first. NRV = 9,500 - 2,000 = KES 7,500. Since NRV is lower than cost, the inventory is valued at KES 7,500.
2. What is included in cost
Purchase price, import duties, and transport/handling costs needed to bring inventory to its present location and condition. Excluded: abnormal waste, storage costs (unless part of the production process), administrative overheads, and selling costs.
3. The valuation problem
When identical items are bought at different prices at different times, which price applies to what is left at year end? Two methods, same physical facts, different answers.
4. FIFO (First In, First Out)
Assumes the oldest inventory is sold first, so what is left is valued at the most recent purchase prices.
5. Weighted average cost (AVCO)
Blends all costs together into a single average cost per unit, applied to everything.
6. Worked example — same transactions, both methods
| Transaction | Units | Price/unit | Total |
|---|---|---|---|
| Opening inventory | 100 | 50 | 5,000 |
| Purchase 1 | 200 | 55 | 11,000 |
| Sale 1 | 150 sold | ||
| Purchase 2 | 200 | 60 | 12,000 |
| Sale 2 | 180 sold |
Total units available: 500. Total sold: 330. Closing inventory: 170 units, the same physical units under either method.
FIFO: Sale 1 (150 units) uses all 100 opening units plus 50 from Purchase 1, leaving 150 units in Purchase 1. Sale 2 (180 units) uses those 150 remaining Purchase 1 units plus 30 from Purchase 2, leaving 170 units from Purchase 2 at KES 60 each. Closing value: 170 x 60 = KES 10,200.
Weighted average: Average cost = 28,000 / 500 = KES 56 per unit. Closing value: 170 x 56 = KES 9,520.
Same 170 units, two different values - a KES 680 gap. Neither is wrong; the choice affects both closing inventory and Cost of Sales. Consistency is why a business picks one method and sticks with it.