Inventory valuation and internal control are crucial aspects of accounting, especially for Grade 12 students studying the subject. Understanding how to value inventory and maintain internal controls is essential for accurate financial reporting and decision-making.
In this blog post, we’ll explore some common questions and provide detailed answers to help Grade 12 accounting students grasp these important concepts.
What is Inventory Valuation?
Inventory valuation refers to the method used to assign value to the inventory held by a business. There are several methods of inventory valuation, including First-In, First-Out (FIFO), Last-In, First-Out (LIFO), and Weighted Average Cost. Each method has its own impact on the financial statements and tax implications.
Why is Inventory Valuation Important?
Accurate inventory valuation is crucial for determining the cost of goods sold, gross profit, and the value of the inventory on the balance sheet. It directly affects the financial statements and influences key financial ratios such as inventory turnover and gross margin.
What are Internal Controls?
Internal controls are the processes, procedures, and mechanisms put in place by a company to ensure the reliability of financial reporting, compliance with laws and regulations, and the effectiveness and efficiency of operations. Internal controls help prevent fraud, errors, and misstatements in financial statements.
Why are Internal Controls Important in Accounting?
Internal controls are essential for safeguarding assets, ensuring accuracy in financial reporting, and promoting operational efficiency. They provide assurance to stakeholders that the financial information is reliable and that the company is operating in a compliant and ethical manner.
Sample Questions and Answers
- Question: What is the impact of using the FIFO method for inventory valuation? Answer: The FIFO method assumes that the first inventory items purchased are the first to be sold. This can result in a higher valuation of ending inventory during periods of rising prices, leading to a higher reported net income and lower cost of goods sold.
- Question: How does internal control help prevent inventory theft? Answer: Implementing physical controls such as security measures, restricted access, and periodic inventory counts can help prevent inventory theft. Additionally, segregation of duties and proper documentation of inventory movements are important internal control measures.
- Question: What is the significance of the lower of cost or market rule in inventory valuation? Answer: The lower of cost or market rule requires that inventory be valued at the lower of its historical cost or its market replacement cost. This ensures that inventory is not overstated on the balance sheet, providing a conservative approach to inventory valuation.
An effective internal control structure for inventory includes a company’s plan of organization and all the procedures and actions it takes to:
- Protect its assets against theft and waste.
- Ensure compliance with company policies and federal law.
- Evaluate the performance of all personnel to promote efficient operations.
- Ensure accurate and reliable operating data and accounting reports.
Makro Stores sells television sets to the public. The financial year ended on 28Â February 2019. They are unsure which method to use in valuing their stock. The cost price of the products has changed significantly during the current year. The owner Naidoo, has decided to keep selling the same model of TV set (Ekasi TV sets), despite the fact that other shops are now selling newer models.
- Calculate the value of closing stock using the FIFO (first-in-first-out) method.
- Calculate the value of closing stock using the weighted average method.
- Which method of stock valuation would you advice the owner to use? Explain your answer.
| Stock Records: | Number of TV Sets | Cost per unit | Total value | ||
| TV sets on hand on 1 March 2018 | 50 | R11 000 | R550 000 | ||
| TV Sets bought during the year | 750 | R8 090 000 | |||
| Â Â Â Â Â Â May 2018 | 300 | R12 000 | R3 600 000 | ||
| Â Â Â Â Â Â September 2018 | 250 | R11 560 | R2 890 000 | ||
| Â Â Â Â Â Â February 2019 | 200 | R8 000 | R1 600 000 | ||
| Sub total | 800 | Â | R8 640 000 | ||
| TV sets sold during the year | 440 | R16 000 | R7 040 000 | ||
| TV sets on hand on 28 February 2019 | 360 | ? | ? |
Apart from TV sets, Makro Stores also sell other products. You are provided with information taken from their stock records on 28 February 2019. The owner Naidoo is uncertain if he should be satisfied with control of all these items.