Inventory Flashcards
Inventory (3 main types)
- they are assets
- raw materials
- work-in-progress
- finished goods - held for sale
What impacts can the inventory figure have on financial statements?
- potentially large balance in current assets
- opening/closing inventory have direct impact on costs of sales and so profit
What two ways must businesses ensure they accurately account for inventory?
- with the accounting adjustments open/close
- the valuation
Two Different ways to count/record inventory
Period end inventory records
- traditional method
- end of period physically counted
Continuous Inventory Records
- keep track of inventory in/out and records continuously updated
- use automated inventory system
Why does closing inventory need to be removed from SoP/L as Expense
it does not have any sales to match against the purchase so taken back to SoP/L as opening inventory in next period when will be matched with sales revenue produced from sale
Cost of Sales =
opening inventory + purchases (cost of production if manufacturing industry) - closing inventory
Where is cost of sales formula shown in statements?
Trading A/c
Opening Inventory
+costs of purchases/production
-closing inventory
cost of sales
How is the opening Inventory accounted for via journal?
Dr cost of sales Expense (SoP/L)
Cr Inventories Asset (SoFP)
The inventory is no longer asset of entity but will form part of cost of sales yo be matched against sales revenue.
How is the Closing inventory accounted for via a journal?
Dr Inventories Asset (SoFP)
Cr Cost of Sales Expense (SoP/L)\
At end of year remaining inventory is an asset that can be sold next yr.
CI must also be a deduction within cost of sales as not got a sale matched to
Inventory = (and how each obtained)
Quantity (inventory count) x Valuation (more subjective, guidance in IAS 2, lower of Costs vs NRV)
What is the basic rule for valuation per IAS2?
Inventories should be measured at the lower of cost and net reliable value.
Example of prudence
What are some situations where NRV is likely to be less than cost?
- increase in costs/fall in selling price
- physical deterioration
- obsolescence of products
- part of marketing strategy (January sale/new competitor)
- errors in production/purchasing
If inventory is expected to be sold at profit:
- value at cost
- do not anticipate profit
If inventory is expected to be sold at a loss:
- value at NRV
- Do provide for future loss
What makes up cost of item of inventory?
- Cost of Purchase
- Costs of Conversion
- Other costs to get to current/present location and condition
What can be included in Cost of Purchase?
- purchase price
- import duties
- transport/handling
- less any trade discounts/rebates
What can be included in Costs of Conversion?
- relating to production
costs directly related to units of production - direct labour
Fixed/Variable production overheads incurred to convert into finished, allocated on systemic basis - allocation of fixed overheads (electricity)
Fixed Production Overheads
- indirect costs of production that remain relatively constant
- regardless of volume of production
- factory management/admin
Variable Production Overheads
- indirect costs vary directly with volume of production
- indirect materials/labour
What Other Costs included in Cost of inventory item?
- carriage inwards
- NOT carriage outwards that is selling/distribution expense
Costs not to be included in cost of inventory item
- abnormal amounts of wasted material/labour
- storage unless necessary before next production stage
- selling costs
- admin overheads not contributing to get inventory to present condition/location
Net Realisable Value
estimated selling price
less estimated costs of completion
less estimated selling/distribution costs
Why is the cost of each item in inventory sometimes hard to find?
- rule should be applied on an item-by-item basis
- but if various batches purchased at different times/prices hard to determine aboveW
What methods can be used to approximate cost of inventories?
- First in, First Out (FIFO)
- Average Cost (AVCO)
Last in, first out - not permitted by IAS 2
What is assumed under FIFO:
- first goods purchased/produced fist to be sole
- remaining inventories are from most recent purchases
How to work out Closing Inventory using FIFO?
Purchases along x axis, sale down y
- sales come out of first purchase and so on
- once all sales accounted for, prices put in for inventory left and calculated
What are the two types of Average Cost to be calculated?
- Periodic AVCO cost of all purchases during year divided by total number of units purchased
Can’t be used for IAS 2 - Continuous weighted AVCO- weighted average of cost of similar items, recalculated each time new item is purchased
How to work out Closing Inventories with AVCO continuous weighted?
Across X axis- units, cost, average unit cost, total cost, cost of sales
purchases/sales filled in on y axis
Every time new purchase average cost is worked out from other columns
Each sale is put in with current average unit cost
total cost column on any sale is cost of sales
How should FIFO/AVCO be evaluated against each other?
- has to match way business operates
- FIFO more realistic value on SoFP if that is the way company operates
- AVCO can be complex as has to be weighted average- can be good if selling liquids/petrol
How would rising prices affect cost and profit?
- FIFO would produce higher closing inventory figure
- so a lower cost of sales figure
- therefor higher profit figure than AVCO
What are some methods to work out costs where inventory items are not interchangeable and so FIFO/AVCO can’t be used?
Standard Costs
- takes into account normal levels of materials/suppliers/labour/efficiency/capacity utilisation
- regularly reviewed/revised
Retail Method
- measure large number of rapidly changing items with similar margins
- cost of inventory = sales value - %gross margin
When should inventory items be written off/down?
if become
- lost/stolen
- damaged/thrown away
- obsolete
- out of fashion
-sold at lower priceH
How should inventory items be written off/down?
end of period any of these items value should be:
a) nothing if worthless
b) NRV, if less than original cost
means loss reported soon as foreseen and included in cost of sales as closing inventory
