Closing stock definition
/What is Closing Stock?
Closing stock is the amount of inventory that a business still has on hand at the end of a reporting period. This includes raw materials, work-in-process, and finished goods inventory. Certain items charged to expense as incurred, such as production supplies, are not considered to be part of closing stock. The amount of closing stock can be ascertained with a physical count of the inventory. It can also be determined by using a perpetual inventory system and cycle counting to continually adjust inventory records to arrive at ending balances.
How to Calculate Closing Stock
The amount of closing stock (properly valued) is used to arrive at the cost of goods sold in a periodic inventory system with the following calculation:
Opening stock + Purchases - Closing stock = Cost of goods sold
The opening stock for the next reporting period is the same as the closing stock from the immediately preceding period.
There are a variety of methods available for calculating the recorded value of closing stock, including the methods noted below.
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First In, First Out Method
Under the first in, first out method, the costs of all separately-purchased goods are stored in cost layers. When a unit is sold, the cost of the oldest item in inventory is assigned to it. Assuming inflation is present, this tends to result in a lower cost of goods sold, and therefore more reported profits.
Last In, First Out Method
Under the last in, first out method, the costs of all separately-purchased goods are stored in cost layers. When a unit is sold, the cost of the newest item in inventory is assigned to it. Assuming inflation is present, this tends to result in a higher cost of goods sold, and therefore lower reported profits.
Retail Inventory Method
Under the retail inventory method, retailers estimate their ending inventory balances based on the relationship between the cost of merchandise and its retail price. It is not an entirely accurate method, and so is not sufficient for the year-end financial statements, for which a higher level of inventory record accuracy is required.
Weighted Average Method
Under the weighted average method, the costs of all separately-purchased goods are combined to create a weighted-average cost. Since it results in an average cost, it tends to result in reasonable cost of goods sold and profit figures, irrespective of the inflation rate.
Lower of Cost or Market Rule
After one of these methods has been used to calculate the value of closing stock, it may be further adjusted due to the lower of cost or market (LCM) rule, which states that an inventory item must be recorded at the lower of its cost or its current market value. From a practical perspective, the LCM rule is followed perhaps once a year, in order to be in compliance with Generally Accepted Accounting Principles (GAAP) for the annual audit. During most months, LCM is not an issue.
Terms Similar to Closing Stock
Closing stock is also known as ending inventory.
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