ACCOUNTING FOR INVENTORY

ACCOUNTING
FOR INVENTORY
AUTHORED BY DR. MEERA SHARMA

CONTENTS
• INVENTORY
• COSTING INVENTORY
• COST FORMULAE
• COST OF SALES
© 2023 Dr. Meera Sharma

INVENTORY
• NATURE OF INVENTORY DEPENDS
ON TYPE OF BUSINESS, i.e.
– MERCHANDISE
– MANUFACTURING
– SERVICES

INVENTORY
• MERCHANDISING BUSINESS
– SELLS GOODS IN SUBSTANTIALLY THE
SAME FORM AS IT ACQUIRES THEM IN
– INVENTORY IS CALLED MERCHANDISE
INVENTORY

INVENTORY
• MANUFACTURING BUSINESS
– CONVERTS RAW MATERIAL AND PARTS
INTO FINISHED GOODS
– INVENTORY INCLUDES
 RAW MATERIALS
 WORK IN PROGRESS
 FINISHED GOODS

INVENTORY
• SERVICE BUSINESS
– PROVIDES INTANGIBLE SERVICES
– INVENTORY INCLUDES
 JOBS IN PROGRESS

COSTING
INVENTORY
• Cost of inventories comprises all
– costs of purchase,
– costs of conversion and
– other costs, i.e. costs incurred in
bringing the inventories to their present
location and condition.

COSTING
INVENTORY
• COSTS OF PURCHASE ARE PRIMARILY MATERIAL
COSTS
• COSTS OF CONVERSION INCLUDE DIRECT AND
INDIRECT LABOUR AND OTHER COSTS
INVOLVED IN THE PRODUCTION PROCESS
• ANY OTHER COSTS INCURRED IN BRINGING
THE INVENTORY TO THEIR PRESENT LOCATION
AND CONDITION SUCH AS COST OF
CUSTOMIZED PRODUCT DESIGN

COSTING
INVENTORY
• IN CASE OF MERCHANDISE BUSINESS
COST OF INVENTORY COMPRISES MOSTLY
COSTS OF PURCHASE
• FOR A MANUFACTURING BUSINESS COST
OF INVENTORY INCLUDES COST OF
PURCHASE, COST OF CONVERSION AND
OTHER COSTS

COSTING
INVENTORY
• IN CASE OF SERVICE BUSINESS
COST OF INVENTORY COMPRISES
ALL COSTS OF PRODUCTION
• THESE CONSIST PRIMARILY OF
LABOUR COST ENGAGED IN
PROVIDING SERVICE

COST FORMULAE
 SPECIFIC IDENTIFICATION METHOD
 FIRST IN, FIRST OUT (FIFO) METHOD
 WEIGHTED AVERAGE METHOD

COST FORMULAE
 FIRST IN, FIRST OUT (FIFO) METHOD ASSUMES
THAT INVENTORY ACQUIRED OR PRODUCED
FIRST IS THE FIRST TO BE SOLD
 WEIGHTED AVERAGE METHOD USES THE
WEIGHTED AVERAGE COST CALCULATED TO
VALUE ALL INVENTORY

COST FORMULAE
 THE WEIGHTED AVERAGE COST CAN BE
CALCULATED EITHER ON A PERIODIC BASIS OR
EVERYTIME NEW INVENTORY IS ADDED (I.E.
PERPETUAL BASIS)

COST FORMULAE
• THE COSTS OF INVENTORIES OF ITEMS
THAT ARE NOT ORDINARILY
INTERCHANGEABLE (i.e. UNIQUE) SHALL
BE ASSIGNED USING SPECIFIC
IDENTIFICATION OF THEIR INDIVIDUAL
COSTS
• THE COST OF ITEMS PRODUCED AS PART
OF A SPECIFIC PROJECT WILL ALSO BE
ASSIGNED USING SPECIFIC
IDENTIFICATION

COST FORMULAE
• THE COST OF INVENTORIES THAT
ARE INTERCHANGEABLE IS
ASSIGNED USING THE FIRST IN,
FIRST OUT (FIFO) OR WEIGHTED
AVERAGE COST FORMULA

COST FORMULAE
• INVENTORIES ARE REPORTED AT LOWER OF
COST AND NET REALIZABLE VALUE
• NET REALIZABLE VALUE IS THE ESTIMATED
SELLING PRICE OF INVENTORIES IN THE
NORMAL COURSE OF BUSINESS LESS THE
ESTIMATED COSTS OF COMPLETION AND THE
COSTS NECESSARY TO MAKE THE SALE

COST FORMULAE
• THUS IF NET REALIZABLE VALUE IS LOWER
THAN COST, INVENTORIES CANNOT BE
REPORTED AT COST
• THE COST AT WHICH INVENTORIES ARE
REPORTED, I.E. LOWER OF COST OR REALIZABLE
VALUE IS CALLED THE CARRYING AMOUNT

COST OF SALES
• WHEN INVENTORIES ARE SOLD, THEIR
CARRYING AMOUNT IS RECOGNIZED AS AN
EXPENSE IN THE PERIOD IN WHICH THE
REVENUE RELATED TO THEM IS RECOGNIZED
• THIS EXPENSE IS CALLED COST OF GOODS
SOLD OR COST OF SERVICES PROVIDED

ACCOUNTING FOR INVENTORY

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