ACCOUNTING FOR

INVENTORIES
BASIC PRINCIPLES

AJAY KUMAR V, NO-2

JOHN PAUL BEST, NO-6
PAVEN RAJ, NO-9
PRATISH THOMAS, NO-10
PRIYANKA. R.P, NO-11
WHAT IS INVENTORY?
o INVENTORIES ARE THE GOODS THAT ARE MEANT FOR
EVENTUAL CONVERSION INTO CASH IN THE NORMAL
COURSE OF BUSINESS.
o IT INCLUDES
• RAW MATERIALS
• WORK IN PROGRESS
• FINISHED GOODS
• STORES, SPARES AND ACCESSORIES
WHY IS INVENTORY AN
ASSET?
 HELD FOR SALE .
 IN THE PROCESS OF PRODUCTION FOR
SALE.
 IN THE FORM OF MATERIALS OR SUPPLIES
TO BE CONSUMED IN THE PRODUCTION
PROCESS.

INVENTORY APPEARS IN THE BALANCE SHEET AND THE

PROFIT AND LOSS ACCOUNT
TERMINOLOGY
•

 BEGINNING
COST INVENTORY
OF GOODS AVAILABLE
COST ◦OFTHE INVENTORY
GOODS AVAILABLE=ON HAND AT
BEGINNING THE BEGINNING
INVENTORY + NET COST
OF THE ACCOUNTING PERIOD
OF PURCHASE
 PURCHASE
COST ◦OFTHE INVENTORY
GOODS SOLD COMING IN DURING THE
ACCOUNTING
COST OF GOODS PERIODINVENTORY +
SOLD=BEGINNING
 CLOSING
NET INVENTORY
COST OF PURCHASES- ENDING INVENTORY
◦ THE INVENTORY ON HAND AT THE END OF
ACCOUNTING PERIOD
•

◦
◦
•
SAMPLE CASE TO EXPLAIN THE
CONCEPT OF COST OF GOODS
SOLD
MATCHING INVENTORY COSTS
WITH REVENUE
 THE MATCHING PROCESS FOR INVENTORIES CONSIST
OF DETERMINING THE AMOUNT THAT AN ENTERPRISE
SHOULD DEDUCT FROM THE COST OF GOODS
AVAILABLE FOR SALE DURING THE ACCOUNTING
PERIOD AND CARRY FORWARD AS INVENTORY.
 GROSS PROFIT = SALES - COST OF GOODS SOLD
PRICING THE ENDING
INVENTORY
§

§ IMPORTANCE AND CHALLENGES

◦ VALUE PLACED HAS HUGE EFFECT ON NET
PROFIT.
◦ ACCOUNTANT IS FACED WITH CONFLICTING
OBJECTIVES FOR INVENTORY VALUATION.
INVENTORY COSTING
METHODS
 WHY?
• THE PRICE OF THE MERCHANDISE
CHANGES DURING THE YEAR.
 METHODS:
◦ PHYSICAL FLOW
◦ COST FLOW
FOUR METHODS
 SPECIFIC IDENTIFICATION
 FIRST IN FIRST OUT (FIFO)
 LAST IN FIRST OUT (LIFO)
 WEIGHTED AVERAGE COST (WAC)
FOUR METHODS CAN BE EXPLAINED USING
THIS DATA
• UNITS UNIT COST TOTAL COST
•

• JAN1 BEGINNING INVENTORY 100 Rs.2 Rs.200

•

• MAR27 PURCHASE 100 Rs.3 300

•

• JUNE12 PURCHASE 100 Rs.4 400

•

• SEP19 PURCHASE 100 Rs.5 500

•

• NOV30 PURCHASE 100 Rs.6 600

•

• AVAILABLE FOR SALE 500 2000

• SOLD 350
•

• DEC31 ENDING INVENTORY 150

•

•
SPECIFIC IDENTIFICATION
• ASSIGNS SPECIFIC COST TO EACH UNIT SOLD AND
EACH UNIT ON HAND
• SUITABLE FOR INVENTORIES OF HIGH VALUE AND
LOW VOLUME
• CRITICISM- CANNOT BE USED FOR
HOMOGENEOUS AND HIGH VOLUME GOODS
•
•60 UNITS FROM THE PURCHASE OF MARCH 27 AT Rs.3 Rs.180
•70 UNITS FROM THE PURCHASE OF JUNE 12 AT Rs.4 Rs.280
•20 UNITS FROM THE PURCHASE OF SEPTEMBER 19 AT Rs.5 Rs.100
•

• ENDING INVENTORY Rs.560

•Now,
•COST OF GOODS AVAILABLE FOR SALE Rs.2000
•LESS ENDING INVENTORY Rs.560
•

COST OF GOODS SOLD

• Rs.1440
•

•
FIRST IN, FIRST OUT (FIFO)
§ ASSUMPTION- FIRST UNITS ACQUIRED ARE THE FIRST
UNITS SOLD
§ COST OF UNITS IN THE ENDING INVENTORY IS THAT OF
MOST RECENT PURCHASES
§ CRITICISM- IMPROPER MATCHING OF COST WITH THE
REVENUES
§
• 50 UNITS FROM THE PURCHASE OF SEPT 19 @ RS 5 Rs 250
•100 UNITS FROM THE PURCHASE OF NOV 30 @ RS 6 Rs 600
• ENDING INVENTORY Rs.850
•

• UNDER FIFO, THE COST OF GOODS SOLD IS Rs.1150. IT IS COMPUTED AS FOLLOWS

•

•COST OF GOODS AVAILABLE FOR SALE Rs.2000

•LESS ENDING INVENTORY Rs.850
•COST OF GOODS SOLD Rs.1150
•
LAST IN, FIRST OUT (LIFO)
§ ASSUMPTION- LAST UNITS ACQUIRED ARE THE
FIRST UNITS SOLD
§ THE COST OF THE UNITS IN THE ENDING
INVENTORY IS THAT OF THE EARLIEST
PURCHASES
§ CRITICISM – BALANCE SHEET VALUES OF THE
INVENTORIES MAY BE OUTDATED AND
UNREALISTIC
• 100 UNITS THE INVENTORY ON JAN 1 @ RS 2 Rs 200
• 50 UNITS FROM THE PURCHASE OF MAR 27 @ RS 3 Rs 150
• ENDING INVENTORY Rs.350
• THE COST OF GOODS SOLD IS Rs.1650, COMPUTED AS FOLLOWS
• COST OF GOODS AVAILABLE FOR SALE Rs.2000
• LESS ENDING INVENTORY Rs.350
•

• COST OF GOODS SOLD Rs.1650

•
WEIGHTED AVERAGE
COST(WAC)
§ ASSUMPTION- GOODS AVAILABLE FOR SALES ARE
HOMOGENEOUS.
§ AVERAGE COST=COST OF GOODS AVAILABLE/
NUMBER OF UNITS AVAILABLE FOR SALE
§ CRITICISM – NO IMPORTANCE TO CURRENT PRICES
COMPARED TO PAST PRICES PAYED EARLIER
•

• COST OF GOODS AVAILABLE FOR SALE Rs.2000

• NO OF UNITS AVAILABLE FOR SALE Rs.500
• WEIGHTED- AVERAGE UNIT COST Rs.4
• ENDING INVENTORY:150 UNITS @ Rs.4 Rs.600
•

•THE COST OF GOODS SOLD IS Rs.1400, COMPUTED AS FOLLOWS

• COST OF GOODS AVAILABLE FOR SALE Rs.2000
• LESS ENDING INVENTORY Rs.600
• COST OF GOODS SOLD Rs.1400
•

§
FOUR METHODS CAN BE EXPLAINED USING
THIS DATA
• UNITS UNIT COST TOTAL COST
•

• JAN1 BEGINNING INVENTORY 100 Rs.2 Rs.200

•

• MAR27 PURCHASE 100 Rs.3 300

•

• JUNE12 PURCHASE 100 Rs.4 400

•

• SEP19 PURCHASE 100 Rs.5 500

•

• NOV30 PURCHASE 100 Rs.6 600

•

• AVAILABLE FOR SALE 500 2000

• SOLD 350
•

• DEC31 ENDING INVENTORY 150

•

•
COMPARISON OF THE
METHODS
 FIFO INVENTORY VALUE IS MORE REALISTIC
SINCE IT IS CLOSER TO CURRENT COSTS,
BUT IT PRODUCES A NET PROFIT
UNRELATED TO CURRENT INPUT COSTS
 LIFO DOES A FAIR JOB OF MATCHING
CURRENT SELLING PRICES AND COST OF
GOODS SOLD WHICH IS CLOSER TO
CURRENT REPLACEMENT COSTS, BUT
OFTEN PRODUCES AN OUTDATED
INVENTORY VALUE
COMPARISON OF THE
METHODS
 BOTH LIFO AND WAC ALLOW A BUSINESS TO
MANIPULATE A NET PROFIT BY CHANGING
THE TIMING OF ADDITIONAL PURCHASES
 A BUSINESS USING LIFO MUST ARRANGE
FOR TIMELY PURCHASES TO MAINTAIN THE
INVENTORY LEVEL.
 A BUSINESS IS FREE TO ADOPT ANY
INVENTORY METHODS FOR VALUATION.

CONCLUSION
 INVENTORY ACCOUNTING IS VERY
IMPORTANT IN THE MANUFACTURING AND
TRADING SECTORS.
 AN ERROR IN THE VALUE OF THE YEAR END
INVENTORY WILL MISREPRESENT THE COST
OF GOODS SOLD, PROFIT, ASSETS AND
EQUITY.
THANK
YOU