Inventory

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)