inventory accounting

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Financial Accounting

CHAPTER-6. Accounting for Inventory

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Financial Accounting Accounting for Inventory Chapter Six

Importance Importance

Inventory appears in two principal financial statements.

► Income Statement

► Balance Sheet



Inventory appears in two principal financial statements. ► Income Statement

As an expense

► Balance Sheet

As a current asset


Importance Importance Inventory appears in two principal financial statements. ► Income StatementAs an expense

it is the largest item of expense in income statement

► Balance SheetAs a current asset

it is the largest item of current assets in balance sheet



Cost of Goods Sold

Cost of Goods Sold is deducted from revenue

to arrive at Gross Profit.



Cost of Goods Soldis calculated by

Beginning Inventory + Purchases= Goods Available.

&

Goods Available – Ending Inventory = Cost of Goods Sold


Inventory Systems Inventory Systems

Inventory balances are monitored following two principal types of inventory systems -

► Periodic System► Perpetual System


Inventory Systems Inventory Systems


Periodic System –

useful for inexpensive goods where need for accurately tracking inventory does not exist.


Inventory systems Inventory systems


Periodic System

Perpetual System - provides detailed record of inventory

throughout year and hence, used by most companies.


Methods of Inventory Costing Methods of Inventory Costing

GAAP provide for a number of acceptable inventory costing methods including –

• Specific Identification.• Average Cost • FIFO (First-in First-out)




• Specific Identification -

The inventory is valued at actual cost of each unit of inventory identified. Is used in case of high value inventory where identification is possible




Specific Identification.• Average Cost –

Here the value of inventory is taken on average cost. All costs incurred in respect of stock in inventory are added up and then divided by the number of units in stock.




Specific Identification.Average Cost

• FIFO (First-in First-out)

under FIFO, the first units acquired are assumed to be first units sold.



FIFO (First-in First-out)advantages –

► Reports current cost for Ending Inventory

► Reports higher Net Income.



FIFO (First-in First-out)disadvantages –

► Violates the matching Principle ► Results in higher taxes & lower cash flows. ► Does not adjust Cost of Goods sold for the effect of inflation.



There is one more method used called LIFO (Last-in First-out)

Under the LIFO method last units acquired are assumed to be the first units sold.



There is one more method used called LIFO (Last-in First-out)Advantages

► Always matches expense and revenues. ► Results in lower taxes and higher cash flow.



There is one more method used called LIFO (Last-in First-out) Disadvantages

► Reports lower net income.► Reports understated ending inventory.► Can be used to manipulate income



There is one more method used called LIFO (Last-in First-out) Disadvantages

► Reports lower net income.► Reports understated ending inventory.► Can be used to manipulate income► Hence frowned upon by GAAP


Closing Stock Valuation Closing Stock Valuation

Broad Guidelines –

Interest & other borrowing costs Abnormal costs of wasted materials or labourStorage costs, unless required by production processdistribution, selling and administrative costs

are not considered in valuation of inventory.




Closing stocks of finished goods are generally valued at

“ cost of market value, whichever is lower”




Closing stocks of finished goods are generally valued at “ cost of market value, whichever is lower”

except when a company is in the businessof mining industry ; where companies value closing stock at net realizable value.


Inventory - Accounting Principles Inventory - Accounting Principles Consistency Principle

Disclosure Principle

Materiality Principle

Conservatism Principle



The same accounting methods and procedures must be used

period-to-period.



The same accounting methods and procedures must be used period-to-period.

Once the entity opts for a certain methodof inventory costing, it is not to be changed.


Inventory - Accounting Principles Inventory - Accounting Principles Consistency Principle The same accounting methods and procedures must be

used period-to-period.Once the entity opts for a certain method of inventory

costing, it is not to be changed.

Only valid & compelling reasons can justify such change“and effect of change on net results

must be disclosed”



Disclosure Principle –

The entity should disclose all important information that would enable financial statement users to make informed decisions about the entity.


Inventory - Accounting Principles Inventory - Accounting Principles Consistency PrincipleDisclosure PrincipleMateriality Principle –

An entity must perform strictly proper accounting only for items and transactions that are significant to its financial statements.


Inventory - Accounting Principles Inventory - Accounting Principles Consistency PrincipleDisclosure PrincipleMateriality PrincipleConservatism Principle –

an entity should use the least favorable figure when preparing its financial statements.


Inventory - Accounting Principles Inventory - Accounting Principles Consistency PrincipleDisclosure PrincipleMateriality PrincipleConservatism Principle – an entity should use the least favorable figure when

preparing its financial statements.Lower of cost or market rule for ending inventory valuation is one of the applications of this principle


“ Accounting for Inventory is critical as inventory values

◘ appear on two principal financial statements – income statement & balance sheet◘ are generally largest item of expenses in income statement & largest item of current assets on balance sheet.

Accounting for inventory is vital for the business of the company.”

inventory accounting

Education

inventory chapter

importance inventory

valuation of inventory

value of inventory

unit of inventory

understated ending inventory

detailed record of inventory

case of high value inventory