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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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.