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Accounting for Inventories

Inventories are the assets for any company, the inventory can be; goods that are finished goods held for sale, in process of production to be a finished good or can be raw materials that has to be used for production purpose. In a company's accounting the inventories holds a very major position as the valuation of the inventories has a direct impact on the amount of the goods charge for a accounting period and therefore it also impacts the income earned. The cost of goods is decided by adding the beginning inventory and purchases and subtracting the ending inventory from the total. In accounting, the inventory is all those merchandise which are purchased in a particular accounting period but are not sold, that is why the inventory is an asset for a company which requires a close monitoring.

The cost of inventories include all the facilities which are required to hold the inventory safely that may be cost of space i.e. ware house, Insurance, maintenance, staff and so on. The inventories for a company may be raw material, work in progress or finished goods; it can be said that the inventories are the merchandise which company possess but will sell it later. It is the physical good held by the company. It is very important to account for the value of unsold inventory at the end of period and various methods are used to calculate the same. The student of accounting has to give a importance to the study of inventories as it pay a very crucial role in a company's book. 

BASIC CONCEPT OF ACCOUNTING FOR INVENTORIES: Inventories are assets for business:

  • Inventory is used in the process for produce the goods for sale in the ordinary course of business
  • Such goods are sold in the normal route of the company
  • In the order of stuff (material) or provide (supplies) to be used in the process of producing the goods or giving the facilities.

Inventory valuation is the costs which associate with an entity's inventory at the end of a reporting period or accounting period. It forms an important part of the cost of goods sold calculation, and can also be used as additives for loans. The value of the stock is shown on the assets side of company's balance sheet.

The formula for calculating the cost of goods sold in an accounting period is:

COGS (COST OF GOODS SOLD) = PURCHASES + OPENING STOCK - CLOSING STOCK

Therefore, the COGS are based on the price or cost allocated to the closing stock. Deduct the numerals of the part that were sold during the accounting period from the number of item in stock.

•  SPECIFIC IDENTIFICATION METHOD: This is a method of finding out closing inventory amount. It involves a complete visible rate so that the entity or business realizes absolutely that how much closing stock is persisted at year end of all products which purchased during company hours.

    This method is the best method since it relates the closing stock directly to the specific price they were bought for. However, this method allows management to easily change closing stock price, since they can pick out to survey for first sold the low-cost material, therefore expand the closing stock cost and lowering cost of goods sold. This will increase the income. In another way, business management can choose low income, for the reduction in taxes which are paid by them.

     Because of changing the place of goods this method is used to hard. The main disadvantage of this method is that the net income can be easily manipulated.

ACCOUNTING INVENTORY METHOD: There is four type of accounting inventory method which is described below:

1.    First-in First-out (FIFO)

2.    Last-in First-out (LIFO)

3.    Highest in, First out (HIFO)

4.    Average cost or weighted average cost

FIRST-IN FIRST-OUT (FIFO): This is a most popular method because it uses the cost of the oldest items in inventory first. It is a process of valuing the price of material sold out. This method is based on the assumption that goods that are sold or used first are those goods that are bought first. The actual flow of stock may not match the FIFO pattern. First-in First-out (FIFO) method can be applied by two systems

O     In the periodic inventory system

O     The perpetual inventory system.

LAST-IN FIRST-OUT (LIFO): This is one of the common techniques used in the valuation of inventory on hand at the end of a period. LIFO assumes that goods sold which made their way to upcoming in stock are first sold out and which are produced or build in advance are sold out in last. Thus LIFO assigns the cost of new stock to cost of goods sold and cost of old stock to closing inventory account. This method is directly opposite to FIFO.

O    This method is used differently under periodic inventory system and perpetual inventory system.

  • HIGHEST IN, FIRST OUT (HIFO): In accordance with HIFO method, the items of stock or product should be valued at the lowest probable rates. Physical stock or product is issued/sold first without consideration of the date of purchase which is purchased at the highest price.

o    When the market is continuously sew-saw this method is suitable for an entity for the reason that the amount of large cost product or physical goods are recuperated from the production or sales at the earliest.

  • WEIGHTED AVERAGE COST OR AVERAGE COST: This procedure uses the average of the costs of the goods to allocate cost. The main distinction between another method like FIFO, LIFO and Weighted average method is accounting is the difference in which each method calculates inventory and cost of goods sold. In it, we calculate closing stock cost.

WAC= OPENING STOCK+PURCHASES/NO. OF UNITS AVAILABLE FOR SALE

INVENTORY ACCOUNTING JOURNAL ENTRIES:-

ACCOUNTS                        DEBIT        CREDIT

Merchandise Inventory A/C            Dr.    XXX

Purchase A/C                     Dr.         XXX

    TO Accounts Payable A/C                                            XXX

(Being inventory purchased thought accounts payable system)

NOTE: Debit account depending on the nature of the goods purchased under inventory system.

Accounts Receivable A/C            Dr.    XXX

    To Sales A/C                            XXX

(Being goods sold on credit)

Inventory A/C                    Dr.                    XXX

    To Cash A/C                                                    XXX

(Being expenses paid in cash)

 

Accounts payable A/C                Dr.                XXX

    To Inventory A/C                                                XXX

(Being goods are returned to supplier)

 

Overhead cost A/C                Dr.                    XXX

    To Accounts Payable A/C                                            XXX

(Being expenses during manufacturing occurs at the time

of initial accounts payable recordation)

 

Overhead cost A/C                Dr.                    XXX

    To Wages expenses A/C                                            XXX

(Being record production labor in overhead)

 

Work-in-process inventory A/C        Dr.                XXX

    To Raw material A/C                                                XXX

(Being Move Raw Materials to Work In Progress)

 

Overhead cost pool A/C            Dr.                XXX

    To Work-in-process inventory A/C                                    XXX

(Being record inventory scrap value)

 

Finished goods inventory A/C            Dr.                XXX

    To work-in-process inventory A/C                                XXX

(Being record finished goods)

 

Work-in-process A/c            Dr.        XXX

Finished goods inventory A/C     Dr.         XXX   

Cost of goods sold A/C        Dr.        XXX

    To Overhead cost A/C                                            XXX

(Being allocate overhead)

 

Cost of goods sold expenses A/C        Dr.        XXX

     To finished goods inventory A/C                    XXX

(Being goods sold)

 

Loss on inventory valuation A/C        Dr.         XXX

    To Raw materials inventory A/C                     XXX

    To Work-in-process A/C                        XXX

    To finished goods Inventory A/C                                XXX

(Being cost of goods sold is recorded)

NOTE: You have to periodically test inventory to see if the market cost of any inventory item is lower than its cost under the lower of goods sold or market value. As a result, you may need to reduce the carrying amount of the inventory item to its market value and charge the loss on inventory valuation expense for the decrease in recorded cost of the inventory in short stock is recorded in which cost or market price whichever is lower.

Difficulties encountered in writing accounting for Inventories assignment/assessments?

In accounting book a company; inventories hold a separate section like purchase and sales. The cost of goods depends largely on the cost of inventories. The inventories is valued at cost or market value which is ever is lower. There are many ways to calculate the cost of inventories; specific identification method, first in first out (FIFO), last in first out (LIFO) and weighted average cost method. In specific identification method, every item in inventory is tracked separately and so the cost of goods is decided by evaluating each of the inventories. This method requires lot of tracking, even if one item from inventory is missed, it would lead to the wrong costing of the good. Therefore this is approach is used for the high cost items where tracking is possible.

When an item is purchased and stocked, it can happen that the price of that item changes over period time so while accounting this factor has to be considered in valuation of inventories. Hence the methods of FIFO, LIFO and weighted average method are used. The valuation of inventories is very crucial for the accounting; hence the students have to understand these concepts at glance so they can face the assignments or assessments on accounting of inventories. Therefore the students need to understand the various methods of stock valuation; FIFO method implies that inventories that are first in are first sold out so that the stock present at the time of accounting is the newest one. The LIFO method considers that the stock which is the lasted is used first hence the inventories present at the time of valuation is the old stock and in weighted average method, the average is cost is applied for all the stocks.

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