Post on 20-Jan-2015
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Let’s have a quick look at…Let’s have a quick look at…
…… what we have done in …… what we have done in
the previous class.the previous class.
We started with …
Accounting for Inventory
Accounting for Inventory
First, we discussed…
What is Inventory?What is Inventory?What is Inventory?What is Inventory?
… are assets :
Held for sale in the ordinary course of business.
Held in the process of such sale.
Being used in the production of goods to be sold.
Held in the form of materials or supplies that will
be consumed in the production process, or in
rendering services.
Packing material for packing goods to be sold.
Spares used in case of fixed assets whose use is
not regular.
Inventory…
To be brief, inventory includes…
Raw Material
Work-in Progress
Finished Goods
Spares
Consumables
Packaging Material
Inventory Inventory
Flow?Flow?
Inventory Inventory
Flow?Flow?
Flows of Inventory …A Retailer or A merchandiser
MerchandiseMerchandisePurchasesPurchases
MerchandiseMerchandisePurchasesPurchases
Cost ofCost ofGoods SoldGoods Sold
Cost ofCost ofGoods SoldGoods Sold
MerchandiseMerchandiseInventoryInventory
MerchandiseMerchandiseInventoryInventory
MerchandisMerchandiserer
Flows of Inventory …A Producer or A Manufacturer
DirectDirectLabourLabour
DirectDirectLabourLabour
FactoryFactoryOverheadOverhead
FactoryFactoryOverheadOverhead
Raw MaterialsRaw MaterialsInventoryInventory
Raw MaterialsRaw MaterialsInventoryInventory
Work in ProcessWork in ProcessInventoryInventory
Work in ProcessWork in ProcessInventoryInventory
Finished GoodsFinished GoodsInventoryInventory
Finished GoodsFinished GoodsInventoryInventory
Cost ofCost ofGoods SoldGoods Sold
Cost ofCost ofGoods SoldGoods Sold
ManufacturManufacturerer
RawRawMaterialsMaterials
RawRawMaterialsMaterials
Where cost flows Where cost flows of Inventory have of Inventory have
impacts?impacts?
Where cost flows Where cost flows of Inventory have of Inventory have
impacts?impacts?
Balance Sheet…
Raw Material
s
Work in Process
FinisheFinished Goodsd Goods
Balance Sheet: Assets Balance Sheet: Assets SideSide
Manufacturing Overhead
Labour
Profit and Loss Account …
Profit and Loss Account: Expenses Profit and Loss Account: Expenses SideSide
Raw Material
s
Work in Process
FinisheFinished Goodsd Goods
Opening StockOpening Stock
Purchases and Production and
Conversions Expenses
Raw Material
s
Work in Process
FinisheFinished Goodsd Goods
Closing StockClosing Stock
COST O
F GO
ODS SO
LD
Impact of Inventory Flow…Impact of Inventory Flow…
BeginningBeginningInventoryInventory
BeginningBeginningInventoryInventory
PurchasesPurchasesfor the Periodfor the Period
PurchasesPurchasesfor the Periodfor the Period
Ending Inventory(Balance Sheet)
Ending Inventory(Balance Sheet)
Goods AvailableGoods Availablefor Salefor Sale
Goods AvailableGoods Availablefor Salefor Sale
Cost of Goods Sold(Income Statement)
Cost of Goods Sold(Income Statement)
+
+
When to recordWhen to record
Inventory in books Inventory in books
of accounts?of accounts?
When to recordWhen to record
Inventory in books Inventory in books
of accounts?of accounts?
The General Rule is …
… purchases should be recorded by the buyer when the legal title to the goods passes to the buyer.
But, in some cases, it is But, in some cases, it is difficult to determine difficult to determine when the legal title is when the legal title is passed to the buyer?passed to the buyer?
Exception to the General Rule…
Goods in transit
Goods received on approval basis
Consigned goods
Now, let’s proceed further…
Any question?
First, let’s check the understanding of what all we discussed in the previous class…Indicate which of the following items will be typically
reported as inventory in the financial statements.1. Goods out on consignment at another entity’s
store.2. Goods sold on installment basis.3. Goods purchased f.o.b. shipping point that are in
transit on the closing day of the balance sheet.4. Goods held on consignment from another business.5. Temporary investments in bonds that will be sold in
the near future.6. Materials on hand not yet placed into production
process by the closing date of the balance sheet.7. Goods sold f.o.b. destination that are in transit by
the closing date of the balance sheet.8. Office supplies – stationery9. Goods sent to another business firm on approval
basis.
LEAR
NING
BY
TEST
ING
What costs to What costs to
be included be included
in inventory?in inventory?
What costs to What costs to
be included be included
in inventory?in inventory?
General Rule…
The cost of inventories should
comprise all costs of purchasecosts of purchase,
costs of conversioncosts of conversion and other other
costscosts incurred in bringing the
inventories to their present location
and condition.
COSTS OF PURCHASE…COSTS OF PURCHASE… It includes…
Purchase Price Duties and taxes (other than those subsequently
recoverable by the enterprise from the taxing authorities)
Inward freight and Insurance for goods-in-transit Other expenditure directly attributable to the
acquisition.Cost of purchases includes all those expenses that are
incurred to bring the raw material at the desired location.
COSTS OF PURCHASE…COSTS OF PURCHASE…What it does not include…
Trade Discounts and rebates.
Duty Drawbacks, Duties and taxes subsequently
recoverable by a firm from the taxing authorities.
Trade Discount Vs. Cash Discount
COSTS OF CONVERSIONCOSTS OF CONVERSION … It includes all those expenses that are incurred
to convert raw material into work-in-progress and finally, into finished goods. Such a cost is generally called CONVERSION COST.
Conversion Cost includes…
Direct Labour Cost
Indirect Labour Cost (Production)
Other fixed production overheads – Fixed or Variable.
COSTS OF CONVERSIONCOSTS OF CONVERSION …
Costs of Conversion do not include…•Storage Costs, unless those costs are necessary in the production process prior to a further production stage.•Administrative Overheads that do not contribute to bringing the inventories to their present location and condition.•Selling and Distribution Costs.
OTHER COSTSOTHER COSTS …
Other costs are included in the cost of
inventories only to the extent that they
are incurred in bringing the inventories to
their present location and condition.
Testing Understanding…Suggest which of the following will not be considered for the inventory costs…
1. Cost of Insurance of warehouse.
2. Cost of Spares used in production process.
3. Cash Discount.
4. Transportation costs to bring goods to warehouse.
5. Insurance of goods-in-transit.
6. VAT paid on the purchase of raw material.
7. Paid to workers for packing of goods.
8. Expenses related to heating of factory.
9. Salary paid to CEO of the firm.
10. Cost of issuing cheques to the vendors.
What are What are
inventory inventory
systems?systems?
What are What are
inventory inventory
systems?systems?
The issue of Inventory System is …
… should we record transactions related to
inventory INSTANTANEOUSLY or
PERIODICALLY?
… should we record transactions related to
inventory INSTANTANEOUSLY or
PERIODICALLY?
If we record transactions related to inventory INSTANTANEOUSLY, then we are using a System of Inventory which is known as …
PERPETUAL INVENTORY PERPETUAL INVENTORY SYSTEM SYSTEM
If we record transactions related to inventory INSTANTANEOUSLY, then we are using a System of Inventory which is known as …
PERPETUAL INVENTORY PERPETUAL INVENTORY SYSTEM SYSTEM
And, if we are recording transactions related to inventory periodically then, it is called … PERIODIC INVENTORY SYSTEM.
Overview of Perpetual and Periodic Systems
Perpetual system Inventory records are updated whenever a
purchase or a sale is made.
Advances in information technology have
made the cost of using this system practical.
Periodic system Inventory records are not updated when a
sale is made.
Perpetual Inventory System It is a method of recording changes in
inventories on a continuous basis in the Inventory Account.
It provides a continuous record of the balances in both Inventory Account and Cost of Goods Sold Account.
The affordability of the computerized accounting software have made the perpetual system of inventory cost effective for many kind of businesses.
Periodic Inventory System Under this method, some changes in
inventories are record on periodic basis and thus, inventory balances and the cost of goods sold can be determined only on period basis.
It provides a continuous record of the balances in both Inventory Account and Cost of Goods Sold Account.
The affordability of the computerized accounting software have made the perpetual system of inventory cost effective for many kind of businesses.
Taking a Physical Count of InventoryThe actual quantity on hand is determined by
taking a physical count in case of periodic inventory system and a cost is attached to the quantity counted.
With a perpetual system, closing balance of inventory can be taken from the Inventory Account and a physical count can reveal inventory shrinkage or clerical error.
How to find How to find
the the Value of Value of
InventoryInventory??
How to find How to find
the the Value of Value of
InventoryInventory??
The issue of Inventory Valuation requires…
…an assumption about the flow of flow of
inventoryinventory so that we can judge the flow of cost of inventory!!!
Remember…Flow of physical inventory is difficult
to know and hence, there is a need of making an assumption about the physical movement of inventory.
And, according to the physical physical movement assumptionmovement assumption, cost flow is presumed.
In real life, the actual physical flow of inventory and the cost
flow assumption are quite different.
COST FLOW ASSUMPTIONS …
Four assumptions are made with regard to inventory cost flow:
1.Specific Identification,
2.FIFO,
3.LIFO, and
4.Average Cost.
Cost Flow Assumption #1:
Specific Identification
Specific Identification…
In it, identify the movement of each and every item!
When you buy record an item, record it in Inventory Account as a distinct item.
It requires that when an item is sold, charge it against revenue as Cost of Goods Sold (COGS).
Specific Identification…This method requires no assumption about
the flow of inventory units.
This method is used when items:
…are unique.
…can be directly identified with a specific purchase and its invoice.
…are relatively small in number.
…are easily distinguishable.
Where Specific Identification Method can be used?
Examples: Automobiles, custom Examples: Automobiles, custom
furniture, some types of jewelry, art.furniture, some types of jewelry, art.
Examples: Automobiles, custom Examples: Automobiles, custom
furniture, some types of jewelry, art.furniture, some types of jewelry, art.
Cost Flow Assumption #2:
FIFO – Fast In, First Out.
FIFO… First In, First Out.The assumption about the flow of inventory
made under FIFO is …
•The items are sold/issued in the order they are acquired. It means that an item received FIRST will be sold/issued FIRST.
It means that the oldest units are sold and the newest units remain in inventory.
FIFO… First In, First Out.When a Sale/an issue occurs:When a Sale/an issue occurs:
The The earliest unitsearliest units purchased are purchased are
charged to charged to Cost of Goods SoldCost of Goods Sold..
The cost of the most The cost of the most recent recent
purchasespurchases remain remain in inventoryin inventory..
Cost Flow Assumption #3:
LIFO – Last In, First Out.
LIFO… Last In, First Out.The assumption about the flow of inventory
made under LIFO is …
•The items are sold/issued in the reverse order they are acquired. It means that an item received LAST will be sold/issued FIRST.
It means that the newest units are sold and the oldest units remain in inventory.
LIFO… Last In, First Out.When a Sale/an issue occurs:When a Sale/an issue occurs:
The The LATEST unitsLATEST units purchased are purchased are
charged to charged to Cost of Goods SoldCost of Goods Sold..
The cost of the The cost of the OLDEST unitsOLDEST units
remain remain in inventoryin inventory..
Cost Flow Assumption #4:
Average Cost
Average Cost Method…Under this method, no specific assumption is
made about the flow of inventory made.Cost of Goods Sold/Issued is computed by
multiplying the number of units sold/issued by the average cost per unit.
Average Cost is computed for all inventory available for sale during the period.
Average cost per unitAverage cost per unit
Cost of goods available for saleCost of goods available for saleNumber of units available for saleNumber of units available for sale==