Inventory
Inventory is basically a
current asset held by the company either for resale or for consumption in
production process. Therefore broadly we can classify inventory into two
classes i.e. inventory for sale or resale and inventory for manufacturing.
Types
of Inventory
· Inventory for sale- material bought for
resale or material manufactured for sales.
·
Inventory for Production- Material bought
for production (Raw material)
·
Used in production as supplies (tools)
The manufacturing
inventory can be further divided into three classes. I.e. raw material, work in
process and finished Goods.
Types
of Production Inventory
Inventory in production
may be in classified into three classes or stages in books of accounts.
·
Raw Material – Inventory is to be used in
manufacturing
·
Work in progress- Material under process
(partially processed inventory)
·
Finished Goods- Inventory has fully
manufactured/or converted.
Cost
Component of Inventory
Inventory cost includes the
following cost component
·
Purchase price
·
Custom duties
·
Conversion Cost
·
All other cost incurred to bring the
inventory to current condition
Conversion
Cost of Inventory
Cost incurred to convert
raw material to a product. Typical conversion cost includes direct labour and
production overheads. It is to be noted that direct labour is directly charged
to inventory, while production overheads are absorbed.
·
Direct Labour (Directly Charged)
·
Production overheads (Absorbed)
Productions overhead are
absorbed using normal capacity of production (not actual). Under or over
absorbed is not charged to inventory, rather shown separately in income
statement.
Journal
Entry for Production Overheads
Production overhead
incurred
Date
|
Particulars
|
Dr
|
Cr
|
|
Production
Overhead
|
10,000
|
|
|
Cash
|
|
10,000
|
Production overhead
charged to inventory
Date
|
Particulars
|
Dr
|
Cr
|
|
Inventory
|
10,000
|
|
|
Production overheads
|
|
10,000
|
Measurement
of Inventory
Initially inventory is
measured at cost, and subsequently the inventory is measured at lower of cost
or net realizable value. Net realizable value is the expected proceed of
inventory.
Methods
of Inventory Valuation
There are three famous
method of inventory valuation, which has been briefly explained below
·
FIFO (first in First Out)- First purchased
first consumed
·
LIFO (Last in First out)- Last purchased
first used or consumed
·
Average or weighted average
Valuation of inventory is
an important factor in financial statement preparation, because inventory has
direct impact on the profit calculation, Moreover inventory also forms an
important part of balance sheet.
Example
of FIFO
Particulars
|
Units
|
Rate
|
Opening
Stock
|
400
|
60
|
Purchase
|
600
|
60
|
Purchase
|
400
|
70
|
Sale
|
600
|
|
|
|
|
Solution
1.
Calculate Closing Stock units
Opening
Stock
|
400
|
Purchase
(600+400)
|
1000
|
Sale
|
(600)
|
Closing
Stock
|
800
|
2.
Valuation under FIFO
Unit
|
Rate
|
Value
|
400
(Second Purchase)
|
60
|
24,000
|
400
(First Purchase)
|
70
|
28,000
|
800
|
|
52,000
|
3. Valuation under LIFO
Unit
|
Rate
|
Value
|
400
(Opening Purchase)
|
60
|
24,000
|
400
(First Purchase)
|
60
|
24,000
|
800
|
|
48,000
|
Inventory
Recording System
·
Periodic
Inventory system
In periodic inventory
system the opening inventory credited and cost of sales is debited at the
beginning of the Year. During the year inventory purchased is charged to
purchases accounts .At the end of the year all purchases are charged to cost of
sales and closing inventory is physically counted and taken as asset by
debiting closing inventory and crediting cost of sales.
It means opening inventory
is added to cost of sales, while closing inventory is deducted from the cost of
sales. This process has been explained below
·
Opening inventory is charged to cost of
sales (Added to cost of sales)
·
Purchases during charged or debited to cost
of sales (Added to cost of sales)
·
Purchase return credited to cost of sales.
·
No entry for normal loss.
·
Abnormal loss is credited to purchases
account and then cost of sales.
·
Closing inventory is credited to cost of
sales (deduct from cost of sales)
Date
|
Particulars
|
Dr
|
|
|
|
|
Opening
Stock
|
10,000
|
|
Purchase
Return
|
5,000
|
|
Purchases
|
20,000
|
|
Sales
|
40,000
|
|
Gross
profit
|
25,000
|
|
Closing
Stock
|
10,000
|
|
|
55,000
|
|
|
55,000
|
|
|
|
|
|
|
At
begging of Year
Date
|
Particulars
|
Dr
|
Cr
|
|
Cost
of Sales
|
10,000
|
|
|
Opening Inventory
|
|
10,000
|
During
the Year
Date
|
Particulars
|
Dr
|
Cr
|
|
Purchases
|
20,000
|
|
|
Cash
|
|
20,000
|
Closing
Year
Purchases are charged to Cost of Sales
Date
|
Particulars
|
Dr
|
Cr
|
|
Cost
of Sales
|
20,000
|
|
|
Purchases
|
|
20,000
|
Closing
inventory as an asset
Date
|
Particulars
|
Dr
|
Cr
|
|
Closing
Inventory
|
5,000
|
|
|
Cost of Sales
|
|
5,000
|
Trial Balance
|
|
|
Opening
Stock
|
10,000
|
|
Purchases
|
20,000
|
|
Sales
|
|
30,000
|
Closing
inventory 5,000
Opening
Stock 10,000
Add:
Purchases 20,000
Less:
Closing inventory (5,000)
Cost
of Sales 25,000
Characteristics
of Periodic inventory System
·
Inventory is not regularly updated
·
Closing inventory is counted at the end of
each year and treated as asset.
·
Trial balance contains purchases and
opening inventory.
·
Closing inventory appears as adjustment
entry.
·
Cost of sales is calculated by passing
different entries at year end.
Perpetual
inventory System
In perpetual inventory
system one Inventory account is maintained and such stock account is updated regularly
with each transaction. It means that every purchase is debited to stock account
and every issue is credited to stock account. Furthermore any other movement in
stock (normal loss and purchase return) is also recorded in stock account
directly.
Purchase
(Receipt)
Date
|
Particulars
|
Dr
|
Cr
|
|
Stock
|
20,000
|
|
|
Cash
|
|
20,000
|
Issue to Production or Sales (Issue)
Date
|
Particulars
|
Dr
|
Cr
|
|
Cost
of Sale
|
10,000
|
|
|
Stock
|
|
10,000
|
It
is important to note that updating in inventory record is done on the bases of
cost
·
Receipt recorded at cost
·
Issue recorded at cost or average cost
Characteristics of Perpetual inventory
System
·
Stock account is automatically updated with
each receipt or issue of stock
·
only one stock account is maintained (no
concept of opening and closing inventory)
·
There is no need to maintain purchases
account
Example
of perpetual inventory System
Opening
inventory is 20,000
Purchases
is 40,000
Issue
30,000
Prepare
an inventory account
Solution
Inventory A/C
Date
|
Particulars
|
Debit
|
Date
|
Particulars
|
Credit
|
|
Opening
|
20,000
|
|
Cost
of sales
|
30,000
|
|
Cash
(Purchases)
|
40,000
|
|
Closing
|
30,000
|
|
|
|
|
|
|
|
|
60,000
|
|
|
60,000
|
Example of Perpetual Inventory
(Purchase Return & Normal Loss)
Opening
inventory is 20,000
Purchases
is 40,000
Purchases
Return 5,000
Normal
Loss 7,000
Issue
30,000
Inventory A/C
Date
|
Particulars
|
Debit
|
Date
|
Particulars
|
Credit
|
|
Opening
|
20,000
|
|
Cost
of sales
|
30,000
|
|
Cash
(Purchases)
|
40,000
|
|
Cash
(Return)
|
5,000
|
|
|
|
|
Normal
loss
|
7,000
|
|
|
|
|
Closing
|
18,000
|
|
|
60,000
|
|
|
60,000
|
Stock
Take
Physical counting or
verification of the inventory is known as stock take. There are number of
reasons or advantages of stock take, which includes
·
Theft identification
·
Identification of damaged items
·
omission of recording the stock receipt or
issue
·
Mistakes in recording of receipt or issues
Stock
Take Procedures or Guidelines
·
Proper sheet used for inventory count
·
Stock count issue and receipt should be
stopped during the count.
·
Stock count should begin from one side and
end on other side.
·
Inventory country should be supervised by
an experienced person.
·
Difference between stock record and stock
count should be investigated.
·
Inventory count results should be reported
to the management.
Inventory
Disclosure Requirements
·
Accounting policy for inventory
·
Inventories carried out at cost
·
Inventory carried out at NRV
·
Circumstance which resulted inventory
written down to NRV
·
Inventory written down expense
·
Any reversal of written down amount and
reasons for such reversal.
Backward
Counting of Inventory
Inventory physical
verification on a specific date may not be possible for some reason. In such
cases inventory may be calculated on that specific date by using the formula.
Closing inventory future
date + Sales unit – Purchases unit
Backward
Counting of Inventory Example
January
10
Units =
40,000
Purchases=
5,000
Sales=
15,000
Solution
40,000+15,000-5,000
= 50,000 (Units)
