Inventory Accounting

ACCOUNTING FOR

INVENTORIES

BASIC PRINCIPLES

AJAY KUMAR V, NO-2 JOHN PAUL BEST, NO-6 PAVEN RAJ, NO-9 PRATISH THOMAS, NO-10 PRIYANKA. R.P, NO-11

WHAT IS INVENTORY? o INVENTORIES ARE THE GOODS THAT ARE MEANT FOR EVENTUAL CONVERSION INTO CASH IN THE NORMAL COURSE OF BUSINESS. o IT INCLUDES • • • •

RAW MATERIALS WORK IN PROGRESS FINISHED GOODS STORES, SPARES AND ACCESSORIES

WHY IS INVENTORY AN ASSET? HELD FOR SALE .  IN THE PROCESS OF PRODUCTION FOR SALE.  IN THE FORM OF MATERIALS OR SUPPLIES TO BE CONSUMED IN THE PRODUCTION PROCESS. 

INVENTORY APPEARS IN THE BALANCE SHEET AND THE PROFIT AND LOSS ACCOUNT

TERMINOLOGY •

 BEGINNING INVENTORY COST OF GOODS AVAILABLE COST ◦OFTHE GOODS AVAILABLE=ON BEGINNING INVENTORY + NET COST INVENTORY HAND AT THE BEGINNING OF THE ACCOUNTING PERIOD OF PURCHASE 

PURCHASE

INVENTORY COMING IN DURING THE COST ◦OFTHE GOODS SOLD ACCOUNTING PERIODINVENTORY + COST OF GOODS SOLD=BEGINNING  CLOSING INVENTORY NET COST OF PURCHASESENDING INVENTORY ◦ THE INVENTORY ON HAND AT THE END OF ACCOUNTING PERIOD •

◦ ◦ •

SAMPLE CASE TO EXPLAIN THE CONCEPT OF COST OF GOODS SOLD

MATCHING INVENTORY COSTS WITH REVENUE THE MATCHING PROCESS FOR INVENTORIES CONSIST OF DETERMINING THE AMOUNT THAT AN ENTERPRISE SHOULD DEDUCT FROM THE COST OF GOODS AVAILABLE FOR SALE DURING THE ACCOUNTING PERIOD AND CARRY FORWARD AS INVENTORY.  GROSS PROFIT = SALES - COST OF GOODS SOLD 

PRICING THE ENDING INVENTORY § § IMPORTANCE AND CHALLENGES ◦ VALUE PLACED HAS HUGE EFFECT ON NET PROFIT. ◦ ACCOUNTANT IS FACED WITH CONFLICTING OBJECTIVES FOR INVENTORY VALUATION.

INVENTORY COSTING METHODS WHY? • THE PRICE OF THE MERCHANDISE CHANGES DURING THE YEAR.  METHODS: 

◦ PHYSICAL FLOW ◦ COST FLOW

FOUR METHODS 

SPECIFIC IDENTIFICATION



FIRST IN FIRST OUT (FIFO)



LAST IN FIRST OUT (LIFO)



WEIGHTED AVERAGE COST (WAC)

FOUR METHODS CAN BE EXPLAINED USING THIS DATA UNITS

•

UNIT COST

TOTAL COST

• •

JAN1

BEGINNING INVENTORY

100

Rs.2

Rs.200

MAR27 PURCHASE

100

Rs.3

300

JUNE12 PURCHASE

100

Rs.4

400

SEP19 PURCHASE

100

Rs.5

500

NOV30 PURCHASE

100

Rs.6

600

• • • • • • • • • • •

AVAILABLE FOR SALE SOLD 350

• • • •

DEC31 ENDING INVENTORY

150

500

2000

SPECIFIC IDENTIFICATION • ASSIGNS SPECIFIC COST TO EACH UNIT SOLD AND EACH UNIT ON HAND • SUITABLE FOR INVENTORIES OF HIGH VALUE AND LOW VOLUME • CRITICISM- CANNOT BE USED FOR HOMOGENEOUS AND HIGH VOLUME GOODS • 60 UNITS FROM THE PURCHASE OF MARCH 27 AT Rs.3 Rs.180 •70 UNITS FROM THE PURCHASE OF JUNE 12 AT Rs.4 Rs.280 •20 UNITS FROM THE PURCHASE OF SEPTEMBER 19 AT Rs.5 •

• •

ENDING INVENTORY

Now, •COST OF GOODS AVAILABLE FOR SALE •LESS ENDING INVENTORY

Rs.560

•

Rs.2000 Rs.560

•

COST OF GOODS SOLD

•

• •

•

Rs.1440

Rs.100

FIRST IN, FIRST OUT (FIFO) § ASSUMPTION- FIRST UNITS ACQUIRED ARE THE FIRST UNITS SOLD § COST OF UNITS IN THE ENDING INVENTORY IS THAT OF MOST RECENT PURCHASES § CRITICISM- IMPROPER MATCHING OF COST WITH THE REVENUES

§ 50 UNITS FROM THE PURCHASE OF SEPT 19 @ RS 5 •100 UNITS FROM THE PURCHASE OF NOV 30 @ RS 6 • ENDING INVENTORY •

Rs 250 Rs 600 Rs.850

• •

UNDER FIFO, THE COST OF GOODS SOLD IS Rs.1150. IT IS COMPUTED AS FOLLOWS

•

COST OF GOODS AVAILABLE FOR SALE •LESS ENDING INVENTORY •COST OF GOODS SOLD

Rs.2000

•

•

Rs.850 Rs.1150

LAST IN, FIRST OUT (LIFO) § ASSUMPTION- LAST UNITS ACQUIRED ARE THE FIRST UNITS SOLD § THE COST OF THE UNITS IN THE ENDING INVENTORY IS THAT OF THE EARLIEST PURCHASES § CRITICISM – BALANCE SHEET VALUES OF THE INVENTORIES MAY BE OUTDATED AND UNREALISTIC • • • • • •

100 UNITS THE INVENTORY ON JAN 1 @ RS 2 Rs 200 50 UNITS FROM THE PURCHASE OF MAR 27 @ RS 3 Rs 150 ENDING INVENTORY Rs.350 THE COST OF GOODS SOLD IS Rs.1650, COMPUTED AS FOLLOWS COST OF GOODS AVAILABLE FOR SALE Rs.2000 LESS ENDING INVENTORY Rs.350

• • •

COST OF GOODS SOLD

Rs.1650

WEIGHTED AVERAGE COST(WAC) § ASSUMPTION- GOODS AVAILABLE FOR SALES ARE HOMOGENEOUS. § AVERAGE COST=COST OF GOODS AVAILABLE/ NUMBER OF UNITS AVAILABLE FOR SALE § CRITICISM – NO IMPORTANCE TO CURRENT PRICES COMPARED TO PAST PRICES PAYED EARLIER •

COST OF GOODS AVAILABLE FOR SALE NO OF UNITS AVAILABLE FOR SALE WEIGHTED- AVERAGE UNIT COST ENDING INVENTORY:150 UNITS @ Rs.4

• • • •

Rs.2000 Rs.500 Rs.4 Rs.600

•

THE COST OF GOODS SOLD IS Rs.1400, COMPUTED AS FOLLOWS • COST OF GOODS AVAILABLE FOR SALE • LESS ENDING INVENTORY Rs.600 • COST OF GOODS SOLD Rs.1400 •

• •

§

Rs.2000

FOUR METHODS CAN BE EXPLAINED USING THIS DATA UNITS

•

UNIT COST

TOTAL COST

• •

JAN1

BEGINNING INVENTORY

100

Rs.2

Rs.200

MAR27 PURCHASE

100

Rs.3

300

JUNE12 PURCHASE

100

Rs.4

400

SEP19 PURCHASE

100

Rs.5

500

NOV30 PURCHASE

100

Rs.6

600

• • • • • • • • • • •

AVAILABLE FOR SALE SOLD 350

• • • •

DEC31 ENDING INVENTORY

150

500

2000

COMPARISON OF THE METHODS FIFO INVENTORY VALUE IS MORE REALISTIC SINCE IT IS CLOSER TO CURRENT COSTS, BUT IT PRODUCES A NET PROFIT UNRELATED TO CURRENT INPUT COSTS  LIFO DOES A FAIR JOB OF MATCHING CURRENT SELLING PRICES AND COST OF GOODS SOLD WHICH IS CLOSER TO CURRENT REPLACEMENT COSTS, BUT OFTEN PRODUCES AN OUTDATED INVENTORY VALUE 

COMPARISON OF THE METHODS BOTH LIFO AND WAC ALLOW A BUSINESS TO MANIPULATE A NET PROFIT BY CHANGING THE TIMING OF ADDITIONAL PURCHASES  A BUSINESS USING LIFO MUST ARRANGE FOR TIMELY PURCHASES TO MAINTAIN THE INVENTORY LEVEL.  A BUSINESS IS FREE TO ADOPT ANY INVENTORY METHODS FOR VALUATION. 



CONCLUSION INVENTORY ACCOUNTING IS VERY IMPORTANT IN THE MANUFACTURING AND TRADING SECTORS.  AN ERROR IN THE VALUE OF THE YEAR END INVENTORY WILL MISREPRESENT THE COST OF GOODS SOLD, PROFIT, ASSETS AND EQUITY. 

THANK YOU