Chapter 7 Inventory

Question 1

1.1 Accounting for inventory

Answer 1

The double entry to record closing inventory is Dr Inventory (statement of financial position) Cr Closing inventory/ cost of sales (statement of profit or loss). This ensures that the inventory remaining at the year-end is:
- Shown on the statement of financial position as an asset
- Not included in cost of sales

Question 2

2.1 Valuation of inventory

Answer 2

Inventory may include raw materials, work in progress and finished goods. IAS 2 inventories requires that inventory is included in the statement of financial position at the lower of cost (all expenditure incurred in bringing the produce to its present location including purchase and costs of conversion) and the net realisable value (revenue expected to be earned when the goods are sold less any selling costs).
If goods are stolen or destroyed, they have a value of zero. They will have been included in purchases at cost, they are given no value in closing inventory, therefore their cost is charged in cost of sales even though they have never been sold, this will distort gross profit.
Therefore, an alternative method of accounting will be used: original cost of the goods is removed from purchases, cost of the goods is now charged as an expense in arriving at profit or loss, if the goods were insured any receipt from the insurance company is treated as other income.

Question 3

3.1 LIFO, FIFO and AVCO

Answer 3

This assumes that the last goods purchased are the first to be sold. This assumption means inventory is always valued at old prices. IAS 2 does not allow this method of valuation.
FIFO assumes the first goods purchased are the first to be sold. This assumption means inventory is always valued at up to date prices.
AVCO, a weighted average price for all units in inventory is calculated. Issues are priced at the average cost and the balance of inventory remaining has the same unit valuation. A new weighted average is calculated after every purchase of goods.

Question 4

4.1 Drawings of inventory

Answer 4

The double entry to record this is:
- Dr Drawings (cost of the inventory taken)
- Cr Purchases (cost of inventory taken)
This ensures the cost of inventory taken is not included as part of the cost of inventory sold in the statement of profit or loss.

Question 5

5.1 Cost structures – mark up and margin percentages

Answer 5

Many businesses price their inventory to a specific gross profit margin. The relationship between the sales price, the cost of sales and gross profit margin is known as the cost structure and this can be stated in one of two ways:
- Gross profit margin on sales: where gross profit is expressed as a percentage of sales
- Mark up on cost: where gross profit is expressed as a percentage of the cost of goods sold
We can use the cost structure to establish the cost of an item of inventory