Inventories Flashcards
What are Inventories?
Inventories are assets. They are either held for sale in the ordinary course of business, held in the process of production for such sale or held in the form of materials or supplies to be consumed in the production process or in the provision of services in a service business.
Journal Entry for Purchase of Inventory on Credit
Debit - Inventory
Credit - Trade Payables
Journal Entry of Return of Inventory to Supplier
Debit - Trade Payables
Credit - Inventory
Journal Entry for Sales of Inventory on Credit or Cash
- To Record The Sales Revenue:
Debit - Trade Receivables
Credit - Sales Revenue - To Record the Cost of Sales
Debit - Cost of Sales
Credit - Inventory
(Both entries come tgt in a pair)
What is FIFO?
Under FIFO method, the earliest inventories are the first costs assigned to cost of goods sold. The goods which come in first are the first to leave upon a sale.
This method of assigning costs to both inventory and COGS assumes that inventory is sold in the order required.
What is Weighted Average Cost Method?
The Weighted Average Cost method of assigning costs requires the use of the weighted average cost per unit of inventory at the time of sale.
After each new purchase of goods, the new unit cost of the goods held is re-calculated.
This method evens out price fluctuations but there is a time lag between mkt price and inventory valuation.
WAC Equation
Total Cost of Goods Available for Sale / Total Quantity of Goods
WAC Equation
Total Cost of Goods Available for Sale / Total Quantity of Goods
Effects of Different Cost Flow Methods on Financial Statements
When purchase prices do not change, the same cost amounts are assigned with each method.
When purchase prices are different, the cost flow method can significantly affect the gross proft reported in the income statement.
Comparison Between FIFO and WAC
- First, when costs regularly rise,
FIFO assigns the lower aount to cost of goods sold, yielding the higher GP and NP.
WAC yields higher cost of goods sold and lower profit as it averages the recent higher costs with the earlier lower costs.
- Second, when costs regularly decline, the reverse occurs for both FIFO and WAC. When purchase prices do not change, each inventory costing method assigns the same costs amounts to inventory and to cost of goods sold.
Advantage of FIFO
FIFO assigns an amount to inventory on the statement of financial position that approximates its current cost. It also mimics the actual flow of goods for most businesses.
Advantage of FIFO
FIFO assigns an amount to inventory on the statement of financial position that approximates its current cost. It also mimics the actual flow of goods for most businesses.
Advantage of WAC
WAC tends to smooth out erratic changes in costs. However, the COGS and ending inventory may not reflect the mkt price
Change of Costing Methods
Inventory costing methods can have very different effects on the reported profits in the Income Statement and Inventory in BS. Therefore, companies select the method with great care.
Consistency Concept has to be applied but it does not mean a company is not permitted to change its accounting methods as long as the chnage reflects a more relevant and faithful representation of an underlying economic phenomenon and be disclosed to users by way of a footnote in the accounts.
What is Net Realisable Value?
It refers to the price the ending inventory could be sold for less all selling costs incurred.
It is sometimes referred to as the mkt price of the goods.
