inventory 1

Where do we stand…?

We are still half

way!!!

What Next?

Accounting for Inventory Accounting for Inventory

Dr. C. P. Gupta

It is expected that after this chapter a student

must be able to answer the following…

Inventory?

Types of Inventory?

Inventory systems?

Inventory Valuation?

Impact of inventory valuation on Profit and Loss Account and Balance Sheet?

Presentation and Disclosures?

In fact,

you will

be

In fact,

you will

be

learning all

learning all

necess

ary about

necess

ary about

Accountin

g for

Accountin

g for

Inventory!!!

Inventory!!!

So, let’s start with INVENTORY…

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…

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.

Give an example of the following…LEA

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LEA

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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

Manufacturing Overhead

LabourLabour

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

Goods in Transit…

In case of Goods in Transit, legal title depends upon the shipping terms.

Shipping termsShipping terms: FOB (free-on-board) destination

The seller is paying the shipping cost The seller owns the inventory until it is delivered

FOB shipping point The buyer is paying the shipping cost The buyer owns the inventory during transit

Ownership Transfer for Goods in Transit

FOB Shipping PointBuyer owns goods in transitOwnership changes at shipping point

Seller Buyer

FOB DestinationSeller owns goods in transitOwnership changes at destination

Ownership TransferOwnership Transfer

Goods received on Approval Basis

… as soon as the buyer informs

his/her intention to buy to the seller,

the purchases are to be recorded

and he/she takes the legal title of the

goods.

SELLER BUYEROwnership Transferred

Intention to buy communicated

Consigned Goods… Dealer holds and sells merchandise on the

behalf of the supplier/consignor

Has possession but not asset

Merchandise owned by supplier

Has asset but not possession/consignor

Dealer does not pay for the inventory unless it is sold; and the dealer remits the money after deducting his expenses and commission from the sale proceeds.

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 Cost of purchases includes all those expenses that are all those expenses that are incurred to bring the raw incurred to bring the raw

material at the desired material at the desired location. 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.

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?

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.

38

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.