INVENTORY

ACCOUNTING
PRESENTED BY TEAM 5
MANI KANT ROY 215121042
MEGHA GOHARE 215121045
M MADHAN - 215121046
MOHAMMAD BATHISH - 215121047
MOHAMMED SHAFI - 215121048
MOKESH KUMAR V - 215121049
NALLAGATLA DHARMA TEJA - 215121050
NAVEENKRISHNAN K - 215121051
MD SHAHRAN KHAN-215121044
M.ASHISH KUMAR-215121043
What is Inventory
● Inventory refers to the raw materials used in production as well as the goods produced that
are available for sale
● At its most basic level, inventory is the physical count of the commodities at any point during the
process.
● A company's inventory represents one of the most important assets
● For producers, inventory is the raw materials that are required to produce goods that will be
sold to intermediate or end consumers.
● Intermediate consumers often store inventory for shipment to end consumers or fulfillment
centers (like retail stores)
● At retail locations, inventory is simply the quantity of any product on hand at any given time.
Types of Inventory

● Three key types of inventory are used throughout the supply chain
Types of Inventory

● Raw Material Inventory:

○ The raw material inventory is at the beginning of the supply chain.
○ These are the materials the products will be created from
○ Eg: steel and rubber are used to produce vehicles while textiles and wood are the raw
material inventory used to produce furniture
Types of Inventory

● Work in Progress:
○ As raw materials are used, they move to the next step in the inventory management
process, designated as a work-in-progress
○ Anything identified as work-in-progress not only takes the cost of raw materials into
consideration but also adds labor and overhead costs into the process
○ This concept allows companies to determine the necessary costs of producing any
given item
Types of Inventory

● Finished Goods:
○ Finished goods are items that are ready to sell
○ From here, merchandise can either be sent to retailers or shipped directly to
the consumer through online sales.
○ Eg: Furniture, cars etc.
What is inventory management ?

•Inventory management can be defined simply as having the right inventory of the
right quantity at right place to be sold at the right time with the right cost.
• Inventory management encompasses the whole inventory management process,
from raw materials to completed goods.
•Inventory management attempts to simplify stockpiles in order to prevent both gluts
and shortages.
•Just-in-time (JIT) and materials need planning are two key approaches for inventory
management (MRP).
Advantages of Inventory Management Systems:
•Improved Inventory Accuracy
•Reduced Overselling Risk
•Savings on expenses
•Avoiding Stockouts and Excess Inventory
•Greater Insights
•Improved Relationships with Vendors and Suppliers
•Increased Productivity
•Profits Increased
•A More Organized Warehouse
•Customer Loyalty Increases
Disadvantages of Inventory Management Systems:

•Expensive for Small Businesses

•Learning Business Software Can Be Difficult
•System Crash Risk
•Malicious Hacking
•Reduced Physical Audits
INVENTORY SYSTEMS

Perpetual system
Periodic system
PERPETUAL INVENTORY SYSTEMS
•The inventory account is updated after every inventory purchase or sale.
•The perpetual inventory system involves tracking and updating inventory records
after every transaction of goods received or sold through the use of technology.
• The perpetual inventory system is a more strong or tough system than the periodic
inventory system, which is where a company undertakes regular audits of stock to
update inventory information.
•These audits include regular physical inventory counts on a scheduled and periodic
basis.
•Perpetual inventory systems in the past were not widely used, as it was difficult to
record and process the large amounts of data quickly and accurately.
 PERIODIC INVENTORY SYSTEM
•A careful evaluation of inventory occurs only at the end of each accounting period.
•The periodic inventory system refers to conducting a physical inventory count of
goods/products on a scheduled basis.
•A periodic inventory system is a commonly used alternative to a perpetual inventory system.
•Maintaining physical inventories can be costly because the process eats up time and
manpower.
•As the physical accounting for all goods and products in stock is so time-consuming, so most
companies conduct them from time to time, which often means once a year, or maybe up to
three or four times per year.
•all transactions conducted are listed in a purchase account for the company, which monitors
inventory based on deduction of the cost of goods sold (COGS).
HISTORICAL COST ​
● Historical cost .(IAS 2) represents the aggregate of:​
● • cost of purchase-purchase price, duties taxes, freight inwards, etc​
● • cost of conversion-direct and indirect manufacturing costs​
● • other costs incurred in the normal course of business in bringing the inventories to their
present locations and conditions. ​
● - It does not include storage costs, selling and Distribution costs, costs of abnormal wastage
and cost of administration overheads.​
INVENTORY COSTING METHODS​
● Are the methods for assigning historical costs to inventory.​
● Inventory prices keep fluctuating during the year.​
● Proper costs have to be assigned to inventory as well as goods sold so as to ensure proper determination of
income the assigning of costs need not conform to the physical flow of goods but conforms to the cost flow ​
● Physical flow refers to the actual sequence in which goods are physically used or sold in the operations of
the business. ​
● Cost flow refers to the association of costs with the assumed sequence in which the goods are used or
sold.​

● ----------------------------------------------------------------------------------------------------------------------------------- ​
● Inventory costing methods​
● The two commonly used methods for assigning historical costs to inventory and goods sold include: ​
● 1. First-in, first-out (FIFO) ​
● 2. Last-in, first-out (LIFO) ​
● 3. Weighted-average cost (WAC)​
● Others include: Specific identification, HIFO, NIFO, base stock and standard cost methods. ​
FIFO
• Assumes materials received first in the stores are the first to be issued (or sold)
and therefore, materials in stock are the materials purchased last. ​
• Inventory items are issued at the oldest price listed in the stores ledger until the
first batch is fully utilized. • This does not mean that the physical flow is FIFO!!!​

● Advantages : 1. Simple and easy ● Disadvantages :1. Improper matching of

​ costs with revenues since the cost of
● 2. Closing stock valued nearer to goods sold is computed on the basis of
current market prices ​ old prices that are possibly unrealistic. ​
● 3. Based on realistic assumption ● 2. Difficult to compare 2 jobs using the
because the actual physical flow same type of material if different prices
too often follows the FIFO are charged​​
sequence. ​
LIFO
Last-in, First-out (LIFO) • Assumes that the materials or goods received last in the
stores are the first to be issued or sold. • Therefore the cost of the units in the
ending inventory is that of the earliest purchases.​

● Disadvantage :1. The balance sheet value

● Advantages 1.Ensures that the
of inventories is unrealistic as it does not
current revenues are matched with
reflect current market conditions ​
the recent purchases, thus resulting
● 2.Cost comparison of similar jobs is
in realistic reported profits ​
difficult​
FIFO AND LIFO EXAMPLE ​
● Ted’s Televisions is a business in New York City. Ted has been in operation now for a year. This is what his
inventory costs looks like:​
● Month Amount Price Paid​
● January 100 Units $800.00​
February 100 Units $800.00​
March 100 Units $825.00​
April 100 Units $825.00​
May 100 Units $825.00​
June 100 Units $850.00​
July 100 Units $850.00​
August 150 Units $875.00​
September 150 Units $875.00​
October 150 Units $900.00​
November 150 Units $900.00​
December 150 Units $900.00​

● 1450 units acquired.​

Units = Televisions.​
​
FIFO AND LIFO EXAMPLE ​
● FIFO method​ ● LIFO method​
● Going by the FIFO method, Ted needs to use ● Going by the LIFO method, Ted needs to go
the older costs of acquiring his inventory and by his most recent inventory costs first and
work ahead from there.​ work backwards from there.​
● So Ted’s COGS calculation is as follows:​ ● So Ted's COGS calculation is as follows​
● 200 units x $800 = $160,000​ ● 450 units x 900 = $405,000​
300 units x $825 = $247,500​
300 units x 875 = $262,500​
200 units x $850 = $170,000​
200 units x 850 = $170,000​
300 units x $875 = $262,500​
150 units x $825 = $125,750​
100 units x $900 = $90,000​
● Ted’s cost of goods sold is $930,000.​
● Ted’s cost of goods sold is $961,250.​
​
● You can see how for Ted; the LIFO method may be more attractive than FIFO. This is because the LIFO number reflects
a higher inventory cost, meaning less profit and less taxes to pay at tax time.​​
● The LIFO reserve in this example is $31,250. The LIFO reserve is the amount by which a company’s taxable income has
been deferred, as compared to the FIFO method.​​
● The remaining unsold 350 televisions will be accounted for in “inventory”.​​
Market Fluctuations
● In period of rising and falling prices both FIFO & LIFO have
conflicting result.
Market Fluctuation FIFO
● The cost of production will be lower.
● Higher profitability, and higher income tax
Rising prices liability.
● More meaningful balance sheet but less
realistic income statement
● Production will be relatively overcharged.
● Deflate the profits and reduce the income
Falling market tax liability.
● More meaningful income statement but a
less realistic balance sheet
LIFO
● Charging products at highest materials
cost.
● Lower profitability, in turn will reduce
income tax liability.
● More meaningful income statement but a
less realistic balance sheet
● The cost of product will tend to be low.
● Inflate profits and increases the tax liability.
● More meaningful balance sheet but less
realistic income statement
 Highest-in-First-out (HIFO)

● Highest priced materials are treated as being issued first irrespective of the
date of purchase.
● The inventory of materials or goods are kept at the lowest possible price.
● The closing inventory is undervalued, and secret reserves are created.
● This method is very appropriate when the prices are frequently fluctuating.
● As this method involves calculation more than that of LIFO and FIFO methods,
it has not been adopted widely.
 Base stock method
● Each business firm whether small or large maintain a minimum quantity of materials
or finished Goods in order to carry on business smoothly.
● These minimum quantities of inventories are valued at the cost at which the base
stock was acquired. It is assumed that the base stock is created out of the first lot
purchased.
● Inventories over and above the base stock are valued according to some other
appropriate method such as FIFO, LIFO, etc.
● The base stock method has the advantage of charging out materials or goods at
actual cost.
● Other merits and demerits depend on the method which is used for valuation other
than the base stock method.
 Specific Identification Method
● Under this method, each item of inventory is identified with its cost.
● The value of inventory will be constituted by the aggregate of various
cost.
● Very suitable for job order industries which carry out individual or goods
have been purchased for a specific job or customer.
● Can be adopted by a company handling only a small number of items.
● Not appropriate in most industries because of practical problems.
● Also, it promotes the chances of manipulating the cost of goods sold. It
can be done by selecting items that have a relatively high cost or a
relatively low cost, as he desires.
 Next in First Out (NIFO) Method
● Value materials issued or goods sold at actual price which is as near as possible to the
market price.
● Issues of goods for further processing or sale are made at the latest price at which the
company has been committed even though materials/goods have not yet been physically
received.
● This method is better than the marked price method under which every time when materials
or goods are issued or sold, their market price will have to be ascertained.
● The materials or goods will be issued at the price at which a new order has been placed and
this price will hold good for all future issues till a next order is placed.
● The value of inventory on a particular date is ascertained by deducting the cost of materials
issued or goods sold from the total value of materials or goods purchased.
● Calculations of issue prices are complicated in this method and, therefore, the method is not
widely used.
 Weighted Average Price (WAP)
● The quantity of material purchased in various lots of purchases is considered
as weight while pricing the materials.
● Weighted average price is calculated by dividing the total cost of material in
stock by the total quantity of material at the end.
● When this method is adopted, the question of profit or loss out of varying
prices does not arise because it evens out the effect of widely fluctuating
prices of different lots of purchases.
● This method is very popular because it reduces calculations and is based on
quantity and value of material purchased.
NET REALIZABLE VALUE (NRV)
As per IAS: 2(International Accounting
Standard: 2)
Types:
❏ Aggregate or Total Inventory Method
❏ Group Method
❏ Item by Item Method

Inventories are to be valued at cost or NRV

whichever is less.
NO CRITERION for the values to match by
the 3 methods.
ANTICIPATED PRICE DECLINE
❏ Should not include the future decrease in price when NRV is calculated
❏ But it can be indirectly made through speculations up to decent levels
through Operation Costs
❏ As per the clarifications of American Institute of Certified Public Accountants:
VALUATION OF INVENTORY FOR BALANCE SHEET

If Inventory is taken on a date

CASE – I: After the balance CASE – II: Before the balance

sheet date sheet date
❏ Value of Inventory ❏ Value of Inventory
❏ Less: Purchases ❏ Less: Purchase returns
❏ Less: Sales returns * ❏ Less: Sales *
❏ Add: Sales * ❏ Add: Sales returns*
❏ Add: Purchase returns ❏ Add: Purchases
*Should be calculated at Cost price not at NRV
 ACCOUNTING STANDARD 2: VALUATION OF
INVENTORIES
● The revised supersedes Accounting Standard 2, Valuation of inventories: June 1981
● Issued by Council of the Standard Charted Accountants of India
● Comes into effect for accounting periods beginning on or after April 1, 1999. Mandatory.

❏ Objective:
❖ Determination of statement of value of which inventories are carried in financial statements until
related revenues are recognised.
❖ Includes cost of inventories and net realisable value

❏ Scope:
❖ Applicable for inventories other than:-
➔ Construction contracts that are work in progress.
 .

➔ Work in progress under ordinary course of business of service providers.

➔ Shares, debentures and other financial instruments held as stock-in-trade.
➔ Producer’s inventories of livestock, agricultural and forest products, and mineral oils,
ores and gases.
❏ Definitions:

❖ Terms used in statements as per the meaning.

➔ Inventories are assets:-
1. Held for sale in the ordinary course of business.
2. In the process of production for sale.
3. In the form of materials or supplies to be consumed in the production process or
in the rendering of services.
➔ Net realisable value:-
The difference between the estimated selling price in the ordinary course of business
and the estimated costs of completion along with the estimated costs necessary to
make the sale.
 .

❏ Inventories encompass goods purchased and held for resale

❖ Example: Merchandise purchased by a retailer and held for resale / computer software held
for resale
❏ Measurement of inventories
❖ It should be valued at:-
➔ Lower of cost
➔ Net realisable value
❏ Cost of Inventories
❖ It comprises of:-
➔ Costs of purchase
➔ Costs of conversion
➔ Costs incurred in bringing the inventories to their present location and condition.
 .

❏ Costs of Purchase
❖ consist of the purchase price including duties and taxes
❖ freight inwards and other expenditure directly attributable to the acquisition
❖ rade discounts, rebates, duty drawbacks and other similar items are deducted in
determining the cost of purchase
❏ Costs of Conversion
❖ costs directly related to the units of production
❖ Fixed and variable production overheads costs

❏ Other Costs
❖ 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.
 .

❏ Cost Formulas
❖ The cost of inventories of items that are not ordinarily interchangeable and goods or services
produced and segregated for specific projects should be assigned by specific identification of
their individual costs

❏ Net Realisable Value

❖ Inventories are usually written down to net realisable value on an item-by-item basis. However,
materials and other supplies held for use in the production of inventories are not written down
below cost if the finished products in which they will be incorporated are expected to be sold at
or above cost.

❏ Disclosure
❖ It comprises of:-
➔ the accounting policies adopted in measuring inventories, including the cost formula used
➔ the total carrying amount of inventories and its classification appropriate to the enterprise.
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