Inventories Part 1 Notes

Updated Inventories Part 1 Notes

Accounting (Special Edition)

Approximately 126 pages

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Inventories – Part 1

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Definition

Inventories mean goods and stocks which are purchased or produced for the purpose of resale. it is one of the organization's most important current assets.

Inventory cost is the net invoice price (less discounts) plus any freight and transit insurance plus taxes and tariffs.

In other words

The raw materials, partly finished goods and completely finished goods of a business are known as inventories.

Inventory consists of:

• goods purchased for resale

• consumable stores (such as oil)

• raw materials and components (used in the production process)

• semi finished goods (usually called work in progress – WIP)

• finished goods (manufactured by the business).

Why is it important?

Inventory is a current asset on your company’s balance sheet. More important, it is a major part of your ongoing business operations. Inventory is necessary for a business to earn revenues and make profits.

Lecture Notes

Capitalisation vs expenses

There are many cost related to inventories, some of them will be capitalized and the others will be charged as a periodic expense

Following cost will be capitalized as a current asset (inventory) in the balance sheet

Purchase price of inventory
Conversion cost
fixed production overheads (allocated on appropriate basis)
Any other cost necessary to bring inventory into its present condition and location.

Following cost will be treated as a periodic expense in the income statement.

Non production overheads
abnormal losses such as wastages, accidents
storage costs
selling and distribution costs

Inventory Accounting

Different method are used in the accounting for inventory:

Specific unit identification
First in First out (FIFO)
Last in First out (LIFO)
Weighted average cost

Method	Characteristics
Specific unit identification	This is the actual cost of purchasing identifiable units of inventory Only used when items of inventory are individually distinguishable and of high value
First in First out (FIFO)	For costing purposes, the first items of inventory received are assumed to be the first ones sold. The cost of closing inventory is the cost of the latest inventory.
Last in First out (LIFO)	The last items of inventory received are assumed to be the first ones sold. closing inventory is valued at old prices
Weighted average cost	The cost of an item of inventory is calculated by taking the average of all inventory held. The average cost can be calculated periodically or continuously

Effect of costing methods in inflation / deflation on financial statements

Under Inflation (Rising Prices)

Method	Effect on income statement	Effect on balance sheet
FIFO	Lower cost of goods sold which results in higher profits	Higher amount of inventories.
LIFO	Higher cost of goods...

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