Inventory Accounting

Welingkar’s Distance Learning Division
Financial Accounting
CHAPTER-6. Accounting for Inventory
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Financial Accounting Accounting for Inventory Chapter Six
Importance
Inventory appears in two principal financial statements.
► Income Statement
► Balance Sheet

Importance
As an expense
► Balance Sheet
As a current asset

Importance
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

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

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

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

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.

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.

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

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

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.

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.

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

Accounting for Inventory
Chapter Six
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.

Chapter Six
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.

Chapter Six
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.

Chapter Six
out)
Disadvantages
► Reports lower net income.
► Reports understated ending inventory.
► Can be used to manipulate income

Chapter Six
out)
Disadvantages
► Reports lower net income.
► Reports understated ending inventory.
► Can be used to manipulate income
► Hence frowned upon by GAAP

Chapter Six
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.

Chapter Six
Closing stocks of finished goods are generally valued at
“ cost of market value, whichever is lower”

Chapter Six
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.

Chapter Six
Inventory - Accounting Principles
Consistency Principle
Disclosure Principle
Materiality Principle
Conservatism Principle

Chapter Six
The same accounting methods
and procedures must be used
period-to-period.

Chapter Six
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.

Chapter Six
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”

Chapter Six
Disclosure Principle –
The entity should disclose all important information that
would enable financial statement users to make informed
decisions about the entity.

Chapter Six
Materiality Principle –
An entity must perform strictly proper accounting only for
items and transactions that are significant to its financial
statements.

Chapter Six
Conservatism Principle –
an entity should use the least favorable figure when
preparing its financial statements.

Chapter Six
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

Chapter Six
“ 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.”

Inventory Accounting

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Inventory Accounting