4. Inventory and VAT Flashcards
What is the definition of inventory?
Purchasing or manufacturing items with the intention of reselling them to customers at a higher price to make a profit.
What are the three types of inventory?
- Finished goods and goods for resale
- Work in progress
- Raw materials and consumables
What costs are included in the cost of inventory?
- Purchase price of materials/components
- Irrecoverable import duties and other
taxes - Transport and handling (carriage inwards) costs directly attributable to the acquisition of the goods
- Less any trade discounts, rebates and subsidies received
What are the two types of cost of inventory?
1) Purchase cost only - Businesses that purchase inventory that has already been manufactured in order to sell it on to customers for a profit.
2) Production cost - which includes purchase costs + costs of conversion: This applies to manufacturers who purchase materials or components, and then convert these into finished goods to sell on to customers or retailers.
What costs are excluded from the cost of inventory?
- Non-manufacturing overheads, such as general administration costs
- Storage costs, unless necessarily incurred in the production of inventory
- Selling costs, such as commission paid to sales staff
- Abnormal wastage costs, such as production costs suffered in producing a batch of goods that is considered not suitable for sale, perhaps due to being sub-standard quality
What is the correct journal entry to account for the initial purchase of inventory on credit?
Dr Inventory (Inventory increased)
Cr Trade payables.
How is closing inventory measured?
IAS 2
IAS 2 requires that closing inventory is measured at the lower of cost and NRV.
What does ‘the lower of cost and Net Realisable Value (NRV)’ mean?
Whichever number is lower is the price that the inventory must be measured at.
e.g. Net realisable value (NRV) is the estimated selling price for inventory in the ordinary course of business, less the estimated costs necessary to make the sale.
What is the FIFO cost formula, and how is it used to measure inventory?
Cost of sales = opening inventory + purchases – closing inventory.
The FIFO method assumes that the oldest inventory, ie that purchased first, is sold first.
What is the AVCO cost formula, and how is it used to measure inventory?
AVCO = Total Cost Amount / Units total = Avg. Cost.
It is used when there has been differing prices in the goods bought for inventory to resell.
e.g. 1000 bolts at £5 and then another date £10. hence avg. cost is £7.50
What do we mean by ‘writing down’ the cost of inventory?
When the NRV becomes 0 and the inventory needs to be taken out of the rest of the total to not distort the true value of the inventory.
What are some examples where NRV goes below cost of inventory?
- The inventory may become damaged, perhaps because it has not been stored in the correct manner
- The inventory becomes wholly or partially obsolete, perhaps due to changing consumer tastes and trends
- The selling price has significantly declined, perhaps because a rival has launched an equivalent product at a cheaper price.
Whats the NRV formula?
NRV = Est. Selling price - Costs to Complete - Costs to make sale
What is cost of sales, and what is the formula to calculate it?
COS is when some goods will be sold to customers throughout the year and recognised as Cost of sales (Cost of goods sold) expense.
COS = OPENING INV + PURCHASES - CLOSING INV
What is the correct journal entry to recognise the cost of sales for a period?
1) Dr SPL - Cost of Sales (ITS AN EXPEN HENCE DEBIT)
2) CR SPL - Purchases (Closing down purchases GL)
3)
If inv increases: Dr Inventory
If inv Decreases: Cr Inventory
