Inventory is crucial for financial reporting, appearing as a major expense on the income statement and a key asset on the balance sheet. Various inventory accounting methods are outlined, including FIFO and LIFO, each with distinct advantages and disadvantages regarding tax implications and cash flow. The document emphasizes the importance of adhering to accounting principles such as consistency and disclosure when valuing inventory.

1. Importance
Importance
Inventory appears in two principal financial statements.
► Income Statement
► Balance Sheet

2. Importance
Importance
Inventory appears in two principal financial statements.
► Income Statement
As an expense
► Balance Sheet
As a current asset

3. Importance
Importance
Inventory appears in two principal financial statements.
► Income Statement
As an expense
it is the largest item of
expense in income statement
► Balance Sheet
As a current asset
it is the largest item of
current assets in balance sheet

4. Importance
Importance
Cost of Goods Sold
Cost of Goods Sold
is deducted from revenue
to arrive at Gross Profit.

5. Importance
Importance
Cost of Goods Sold
is calculated by
Beginning Inventory + Purchases
= Goods Available.
&
Goods Available – Ending Inventory
= Cost of Goods Sold

6. Inventory Systems
Inventory Systems
Inventory balances are monitored
following two principal types of
inventory systems -
► Periodic System
► Perpetual System

7. Inventory Systems
Inventory Systems
Inventory balances are monitored
following two principal types of inventory
systems -
Periodic System –
useful for inexpensive goods where
need for accurately tracking inventory
does not exist.

8. Inventory systems
Inventory systems
Inventory balances are monitored
following two principal types of inventory
systems -
Periodic System
Perpetual System -
provides detailed record of inventory
throughout year and hence, used by
most companies.

9. Methods of Inventory Costing
Methods of Inventory Costing
GAAP provide for a number of
acceptable inventory costing
methods including –
• Specific Identification.
• Average Cost
• FIFO (First-in First-out)

10. Methods of Inventory Costing
Methods of Inventory Costing
GAAP provide for a number of
acceptable inventory costing
methods including –
• Specific Identification -
The inventory is valued at actual cost of each unit
of inventory identified. Is used in case of high
value inventory where identification is possible

11. Methods of Inventory Costing
Methods of Inventory Costing
GAAP provide for a number of acceptable
inventory costing methods including –
Specific Identification.
• Average Cost –
Here the value of inventory is taken on
average cost. All costs incurred in respect of
stock in inventory are added up and then
divided by the number of units in stock.

12. Methods of Inventory Costing
Methods of Inventory Costing
GAAP provide for a number of acceptable
inventory costing methods including –
Specific Identification.
Average Cost
• FIFO (First-in First-out)
under FIFO, the first units acquired are
assumed to be first units sold.

13. Methods of Inventory Costing
Methods of Inventory Costing
FIFO (First-in First-out)
advantages –
► Reports current cost for
Ending Inventory
► Reports higher Net Income.

14. Methods of Inventory Costing
Methods of Inventory Costing
FIFO (First-in First-out)
disadvantages –
► Violates the matching Principle
► Results in higher taxes & lower
cash flows.
► Does not adjust Cost of Goods
sold for the effect of inflation.

15. Methods of Inventory Costing
Methods of Inventory Costing
There is one more method used
called LIFO (Last-in First-
out)
Under the LIFO method last units
acquired are assumed to be the first
units sold.

16. Methods of Inventory Costing
Methods of Inventory Costing
There is one more method
used called LIFO (Last-in
First-out)
Advantages
► Always matches expense and revenues.
► Results in lower taxes and higher cash
flow.

17. Methods of Inventory Costing
Methods of Inventory Costing
There is one more method used
called LIFO (Last-in First-
out)
Disadvantages
► Reports lower net income.
► Reports understated ending inventory.
► Can be used to manipulate income

18. Methods of Inventory Costing
Methods of Inventory Costing
There is one more method used
called LIFO (Last-in First-
out)
Disadvantages
► Reports lower net income.
► Reports understated ending inventory.
► Can be used to manipulate income
► Hence frowned upon by GAAP

19. Closing Stock Valuation
Closing Stock Valuation
Broad Guidelines –
Interest & other borrowing costs
Abnormal costs of wasted materials or labour
Storage costs, unless required by production process
distribution, selling and administrative costs
are not considered in valuation of inventory.

20. Closing Stock Valuation
Closing Stock Valuation
Broad Guidelines –
Closing stocks of finished goods are generally valued at
“ cost of market value, whichever is lower”

21. Closing Stock Valuation
Closing Stock Valuation
Broad Guidelines –
Closing stocks of finished goods are generally valued at
“ cost of market value, whichever is lower”
except when a company is in the business
of mining industry ; where companies value
closing stock at net realizable value.

22. Inventory -- Accounting Principles
Inventory Accounting Principles
Consistency Principle
Disclosure Principle
Materiality Principle
Conservatism Principle

23. Inventory -- Accounting Principles
Inventory Accounting Principles
Consistency Principle
The same accounting methods
and procedures must be used
period-to-period.

24. Inventory -- Accounting Principles
Inventory Accounting Principles
Consistency Principle
The same accounting methods and procedures
must be used period-to-period.
Once the entity opts for a certain method
of inventory costing, it is not to be changed.

25. Inventory -- Accounting Principles
Inventory Accounting Principles
Consistency Principle
The same accounting methods and procedures
must be used period-to-period.
Once the entity opts for a certain method of
inventory costing, it is not to be changed.
Only valid & compelling reasons
can justify such change
“and effect of change on net results
must be disclosed”

26. Inventory -- Accounting Principles
Inventory Accounting Principles
Consistency Principle
Disclosure Principle –
The entity should disclose all important
information that would enable financial statement
users to make informed decisions about the
entity.

27. Inventory -- Accounting Principles
Inventory Accounting Principles
Consistency Principle
Disclosure Principle
Materiality Principle –
An entity must perform strictly proper accounting
only for items and transactions that are significant
to its financial statements.

28. Inventory -- Accounting Principles
Inventory Accounting Principles
Consistency Principle
Disclosure Principle
Materiality Principle
Conservatism Principle –
an entity should use the least favorable figure
when preparing its financial statements.

29. Inventory -- Accounting Principles
Inventory Accounting Principles
Consistency Principle
Disclosure Principle
Materiality Principle
Conservatism Principle –
an entity should use the least favorable figure
when preparing its financial statements.
Lower of cost or market rule for ending inventory
valuation is one of the applications of this
principle

30. “ Accounting for Inventory is critical as
inventory values
◘ appear on two principal financial
statements – income statement &
balance sheet
◘ are generally largest item of expenses
in income statement & largest item of
current assets on balance sheet.
Accounting for inventory is vital for the
business of the company.”