Week 7 Inventories

Question 1

What are inventories?

Answer 1

Inventories are assets which are:

• Held for sale in ordinary course of business
• In the process of production for such sale
• In the form of materials or supplies to be consumed in the production process or rendering of services.

Question 2

What type of inventory do retail businesses hold?

Answer 2

For retail businesses, inventory comprises finished goods that are ready to be sold on to consumers, without modification.

Question 3

What types of inventory do manufacturing business hold?

Answer 3

Raw materials

Work in Progress

Finished Goods

Question 4

What is the dual effect inventory has in financial statements?

Answer 4

Current Asset in the Statement of Financial position

Cost of Sales in the Income statement

Question 5

How is cost of sales calculated?

Answer 5

Opening inventory + purchased - closing inventory

Question 6

What is Opening inventory

Answer 6

Goods held the start of the accounting period and normally sold within the same period.

No longer an asset therefore matched against revenues for the period, determining profit.

Question 7

What is closing inventory?

Answer 7

Unsold goods at the end of the period must be included within current assets and shown as a deduction from cost of sales.

Question 8

What are the elements that comprise the inventory value figure?

Answer 8

Quantity

Valuation

Question 9

How is inventory value calculated?

Answer 9

Quantity * Valuation

Question 10

If inventory will be sold at a profit how should it be valued at by the business?

Answer 10

It should be valued at cost (do not anticipate a profit)

Question 11

If inventory is expected to be sold at a loss how should ti be valued by the business?

Answer 11

It should be valued at net realisable value (provide for future loss)

Question 12

What is net realisable value?

Answer 12

The net selling proceeds after all completion / selling costs have been deducted.

E.g.

Estimated selling price -estimated costs of completion -estimated selling/distribution costs.

Question 13

What are the two theoretical methods for estimating cost of inventory?

Answer 13

First in, first out.

Weighted average cost.

Question 14

How does First in first out estimate cost of inventory?

Answer 14

It assumes that first goods purchased/produced will be the first to be sold.

Remaining inventories are from the most recent purchases/production.

Question 15

How does weighted average cost calculate estimate the cost of inventory.

Answer 15

The weighted average of the cost of similar items is recalculated each time a new item is purchased/produced during the period.

Question 16

What is better first in first out or weighted average cost?

Answer 16

FIFO method gives a more realistic value of inventory, as the most recent prices paid are reflected in the valuation.

Where as Weighted average cost can be complex as IAS2 requires that the weighted average cost is used

Question 17

What is the impact inflation has on FIFO (First in first out)?

Answer 17

It will give higher inventory values and higher profits.

Question 18

What are the advantages of holding excess inventory?

Answer 18

Avoids loss of sales caused by stock-outs, easier also to meet peak customer demand.

Protection against delated orders

Can often get bulk buying discounts

Assists with merchandising / promotions.

Production plans are completed more smoothly.

Question 19

What are the disadvantages of holding excess inventory?

Answer 19

Storage capacity and costs of warehousing

Risk of obsolescence/ deterioration/theft

Changes in demand / tastes

Need for deep discounting (reduced margins)

Tying up cash a key asset

Higher insurance premiums.

Question 20

What is a must for holding excess stock?

Answer 20

A strong inventory turnover.