7: Inventory

Question 1

What is the double entry to record closing inventory?

Answer 1

Dr Inventory (SFP)
Cr Closing Inventory (SPL)

Question 2

What does inventory include, and when does an inventory count take place?

Answer 2

• raw materials
• work in progress
• finished goods

Takes place at year end, or are near to the end of the accounting period as possible

Question 3

How is inventory valued?

Answer 3

At the lower of:

COST. Includes all expenditure incurred in bringing the product or service to its present location and condition. Includes:
- materials, import duties, freight
- direct costs, production overheads

OR

NET REALISABLE VALUE. Revenue expected to be earned in the future when the goods are sold LESS any selling costs or rectification/modifications costs to enable sale.

Remember we look at this on a line by line basis, for each product line!

Question 4

What should you do with goods no longer in inventory

Answer 4

Cr Purchases (removing what is lost)
Dr Expenses (amount lost is an expense)

Bring in any insurance income!

Question 5

What are the three methods for calculating cost of inventory?

Answer 5

FIFO - first goods first out. Means inventory is always valued to up-to-date prices.

AVCO - weighted average for all units in inventory. Average cost and balance have the same unit valuation.

LIFO (but this is never used)

Only impacts closing inventory on the P&L

Question 6

Write out the steps for doing AVCO (long method)

Answer 6

1. Write out the sales, purchases and costs you have. Leave a line above each sale for recalculation!!
2. Fill in blanks, with the sales averages
3. Add up the value of the units

                          Unit.     Cost.     Value 1 Jan   Opening.   600.      £10.      6000 2 Feb.    Sale.        (400).    £10.     (4000) 5 May.   Purch.     900.       £12.    10,800

Recalc. 1,000. 12,800 =11.64

30 Nov. Sale. (700) £11.64. (8,148)

Question 7

Write out the AVCO method (short method)

Answer 7

1. Determine the number of remaining units
2. Determine average cost per unit purchased.

[Total value of units sold / how many there are]

3. Remaining units x average.

Can only do when no sales in the middle!

Question 8

What are the steps for doing FIFO?

Answer 8

1. Determine number of remaining units
2. Go backwards through purchases and add to get the cost for all units!

Question 9

How to record drawings of inventory?

Answer 9

Dr Drawings - to add onto the SFP
Cr Purchases - to take off the P&L

Question 10

What is the cost structure?

Answer 10

The relationship between the sales price, the cost of sales and the gross profit margin

Question 11

What is gross profit?

Answer 11

The profit made after deducting the cost of goods sold, as per the top part of the SPL.

The gross profit percentage is the gross profit as a proportion of sales.

Question 12

What is gross profit margin and what is mark-up?

Answer 12

Gross profit margin - where gross profit is expressed as a percentage of sales

• put Sales or Gross Profit as 100% and go from there

Mark-up on cost - where gross profit is expressed as a percentage of cost of goods sold.

• put Cost of Sales as 100%, and add on the percentage of whatever the mark-up is to get to Sales

Layout for both:

Sales
Cost of Sales
——————-
Gross Profit

Question 13

How does cost calculation on inventory change what’s higher in value etc?

Answer 13

If costs are falling over time
- FIFO has a lower closing inventory
- higher cost of sales than AVCO

If costs are rising over time
- FIFO has a higher closing inventory
- lower cost of sales than AVCO