Module 4 - Inventories Flashcards
Inventories (or “stock”) are assets that are:
Held for sale in the ordinary course of business (for example finished goods and goods for resale)
In the process of production for such sale
In the form of materials or supplies to be consumed in the production process or in the rending of services
What are inventories?
Current assets as it is expected they will be sold to customers in 12 months
When an entity recognises the cost of inventories purchased on credit it will record the following journal entry:
Dr P&L - purchases (increase in expenses)
Cr Trade creditors (liabilities increases)
This journal entry does what:
Creates purchases (a temporary expense)
Increases trade creditors (a liability) as this is an increase in the obligation to transfer an economic resource
Are purchases a temporary expense?
If so, why?
They are
As they are transferred to cost is sales (nominal account) at period end
How shall inventories be measured?
At the lower of cost and net realisable value
The cost of inventories can be assigned by using what methods?
First-in, first-out (FIFO)
Or
Weighted average cost formula
What does the FIFO formula assume?
The items of inventory that were purchased or produced first are sold first and consequently the items remaining in inventory at the end of the period are those most recently purchased or produced
How does the weighted average cost formula work?
The cost of each item is determined from the weighted average of the cost of similar items at the beginning of a period and the cost of similar items purchased or produced using the period
When calculating questions based on weighted average cost formula, you should what?
Round to the nearest point at each stage of the calculation
What is net realisable value (‘NRV’)?
It is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale
Sales price - costs of completion - costs necessary to make sale
The cost of inventories may not be recoverable if:
Those inventories are damaged
They have become wholly or partially obsolete
Their selling prices have declined (their value has been lowered in the market)
When inventories are sold, the carrying amount of those inventories shall be recognised as what?
An expense in the period in which the related revenue is recognised
(When one unit of inventories is sold, there will be a corresponding cost of sale)
Cost of sales equation
Cost of sales = opening inventories + purchases - closing inventories
The cost of sales formula represents what?
Opening inventories sold and, therefore, recognised as an expense in the period
Subsequent purchases then sold to customers and, therefore, recognised as an expense in the period - EXCEPT FOR
Closing inventories which have not been sold and, therefore, recognised as an expense in the period (closing inventories remain as a current asset on the balance sheet) - defer the expense to next year and hold as a current asset on our balance sheet
When an entity recognises cost of sales and an increase in inventories, it will record the following journal:
What does this journal entry do?
Dr: P&L - cost of sales (increase expenses)
Dr: Inventories (increase Assets) movement in closing inventory
Cr P&L - purchases (decrease expenses)
This journal entry
Creates cost of sale as an expense
Increases inventories (an asset)
Transfers the temporary purchases (an expense) to cost of sales (an expense)
The amount of any write-down of inventories to NRV and all losses of inventories shall be recognised as what?
An expense (e.g., cost of sales) in the period the write-down or loss occurs
When an entity recognises a write-down of inventories to NRV, it will record the following journal entry:
Dr P&L - cost of sales increase (Expenses increase)
Cr Inventories decrease (assets decrease)
Two key ratios are used when interpreting the relationship between sales, cost of sales and gross profit
Margin (profit as a % of the sales)
Markup (profit as a % of the cost of sales)
How is the ratio for margin calculated at?
Margin = (Gross profit / Sales) x 100
Ratio for markup is calculated as:
Markup = (gross profit / % markup) x 100
What are purchases?
And what happens to them at period end?
Purchases are a temporary expense
They are transferred to cost of sales at period end
How shall inventories be measured?
At the lower of cost and net realisable value
Equation for cost of sales
Cost of sales = opening inventories + purchases - closing inventories
