Inventories

Question 1

What are inventories?

Answer 1

Goods produced or purchased and held for resale by a business

Question 2

Double entry for a purchase of inventory

Answer 2

Dr Purchases
Cr Cash or Payables

Question 3

Double entry for a sale of inventory

Answer 3

Dr Cash or Receivables
Cr Sales

Question 4

At the end of a period, how is the value of inventory that is still held by a company considered/recorded?

Answer 4

As an asset - recorded in SoFP

Question 5

How is the closing inventory value found?

Answer 5

By performing a period end count - this entry is made via a post trial balance journal entry
Dr Inventory (a current asset account in the SoFP)
Cr Profit or loss account

We must also remove opening inventory from the inventory account (also via post TB journal)
Dr Profit or loss account
Cr Inventory (SoFP)

Question 6

Cost of Sales (COS) =

Answer 6

Opening Inventory + Purchases - Closing inventory

Question 7

What is the golden rule of inventory valuation?

Answer 7

“Inventories should be valued at the lower of the cost and net realisable value”

Question 8

In context of the golden rule of inventory valuation, what is cost?

Answer 8

All the costs of purchase, conversion and other costs incurred, including irrecoverable taxes and duties, in bringing the inventories to their current location and condition.

Cost includes fixed and variable overheads allocated on a normal level of production.

Question 9

What are some of the costs associated with inventory?

Answer 9

Purchase price
Cost of transport/carriage
Factory staff wages / factory plant depreciation

COST OF STORING GOODS CANNOT BE INCLUDED IN THE COST OF INVENTORY

Question 10

What is the net realisable value (NRV)?

Answer 10

The estimated selling price less all further costs to be incurred in completing, converting, marketing, selling and distributing the inventory.

Question 11

What do selling costs include?

Answer 11

Carriage outward and sales commission

Question 12

Typically inventories are valued at cost. Why?

Answer 12

As businesses would hope to sell goods for more than the cost
(look at the valuation rule).

Question 13

When might an inventory be valued at the NRV?

Answer 13

If a new business was hoping to gain new customers, they may sell goods for less than cost to encourage customers to try their new product.

Question 14

What are cost flow assumptions?

Answer 14

Different assumptions in valuing closing inventories
. First in first out (FIFO)
. Weighed average cost (WAC) - using either periodic or continuous method
. Last in first out (LIFO) - not allowed in the prep. of financial statements

Question 15

How does FIFO work?

Answer 15

The first goods to be purchased are the first to be sold - meaning newer/more recently purchased items are always held as closing inventory - best for perishable goods.

Question 16

How does LIFO work?

Answer 16

The last items to be purchased are the first to be sold - meaning older items always held as closing inventory.

Question 17

How does WAC work?

Answer 17

Inventory is valued on a weighted average basis, taking into account changes in purchase price of goods over time - best for commodities where prices fluctuate regularly.

Question 18

How is the continuous weighted average calculated?

Answer 18

By taking the weighted average cost before each sale transaction to give the cost of sales. (this leaves a residual inventory figure at the end of the period).

Question 19

How is the periodic weighted average calculated?

Answer 19

By taking the weighted average cost of opening inventories and all purchases to give cost of sales and inventory, ignoring the timings of sales during the period.