Description
Material Accounting and it contains topics like inventory cycle, types of inventory, importance, inventory valuation, trading transactions, inventory formula, LIFO, FIFO
MATERIAL ACCOUNTING
INVENTORY CYCLE
Raw Material Work In Progress
Finished Goods
6/25/2011
TYPE OF INDUSTRIES AND INVENTORY
1.Manufacturing: Raw Material, WIP and Finished Goods. In manufacturing raw material is converted into finished goods. 2.Trading: Finished Goods. It is just buying and selling activity 3.Service: Preferably no inventory
6/25/2011
VALUATION OF INVENTORY
• Valuation of Inventory is a systematic process which is done at periodical intervals. • Inventory has two values; COST PRICE N E T R E A L I S A B L E VA L U E ( VA L U E O F I N V E N T O R Y I S = LOWER OF COST OR NET REALISABLE PRICE)
6/25/2011
IMPORTANCE OF INVENTORY • Inventory value is included in Profit & Loss Account which affects profit of the Company • Inventory in shown as Current Assets in Balance Sheet hence inventory value affects Balance Sheet position also. • So change in inventory value will change profit and financial position of company.
6/25/2011
Objectives of Inventory Valuation E X A M I N E A LT E R N AT I V E I N V E N TO RY VA L U AT I O N METHODS • Value = Quantity X Rate • Change in value of inventory will change profit
6/25/2011
Inventory & the Accounting Equation
ASSETS
=
LIABILITIES
+
OWNERS EQUITY
Current Assets
Non-current Assets
Current Liabilities
Non-current Liabilities
Cash
Receivables
Inventory
Other Specific Identification Weighted Average First-in, First-out
Inventory Recording Systems Periodic Inventory Perpetual Inventory
Cost flow assumptions
6/25/2011
Last-in, First-out
TRADING TRANSACTIONS
BUYER
Prepares requisition (internal) /Purchase order (external) sends to Seller
SELLER
Locates goods Prepare invoice Delivers to buyer
Goods received Checked with purchase order Invoice OK’d for payment Sends cheque to seller
Banks cheque Sends receipt
Receives Receipt
INVENTORY FORMULA
• COST OF GOODS SOLD = OPENING STOCK OF INVENTORY+ NET PURCHASES – CLOSING STOCK OF INVENTORY • Above formula can also be used in relation to WIP and Finished Goods to arrive at Cost of Goods Sold
6/25/2011
RECORDING TRADING TRANSACTIONS ACCOUNTING ISSUES CONSIDERED HERE:
• Recording of inventory (cost of goods sold and ending inventory) • Impact on presentation of financial statements
6/25/2011
INCOME STATEMENT FOR SERVICE FIRM
Power Services Statement of Financial Performance For the year ended 31/12/XX
Revenue Fees income 350,000 Less: Expenses Wages 20,000 Power 30,000 etc. 1,00,000 150,000 NET INCOME 200,000
INCOME STATEMENT FOR TRADING FIRM
Zapp Electronics Statement of Financial Performance For the year ended 31/12/XX
Sales 350,000 Less: Cost of goods sold 210,000 Gross Profit 140,000 Less: Operating expenses Selling expenses 81,000 Administrative expenses 38,000 Total Operating Expenses 119,000 NET INCOME 21,000
INVENTORY RECORDING SYSTEMS • Two systems for recording merchandise inventory
• PERPETUAL INVENTORY SYSTEM
Maintains a continuous inventory record of all goods bought and sold o COGS accumulated as inventory is sold
o
• PERIODIC INVENTORY SYSTEM
Physical stocktake (an actual count) of inventory is required at end of period to update inventory o Until then, COGS = ?
o
6/25/2011
INVENTORY VALUATION
• Inventory Valuation Process
o
At the end of the accounting period, accountants divide the cost of beginning inventory and inventory purchased between COGS and the cost of items remaining in inventory
This process involves a cost flow assumption
o
COGS Opening Inv
6/25/2011
+Purchase s
Closing Inv.
INVENTORY VALUATION
• How we divide the costs between COGS and ending inventory depends on the inventory system • Perpetual system:
o o
We record the cost of each item sold This then gives us the cost of the remaining items
• Periodic system:
must determine the cost of items remaining in ending inventory to calculate COGS o individual sales are not tracked, an end of period stocktake determines ending inventory o cost flow assumption can significantly impact the calculation of ending inventory and COGS
o
6/25/2011
FOUR MAIN COST-FLOW ASSUMPTION/APPROACHES
1 . S P E C I F I C I D E N T I F I C AT I O N 2. FIFO - FIRST IN FIRST OUT 3. LIFO - LAST IN FIRST OUT* 4 . W E I G H T E D AV E R A G E ( AV E R A G E COST)
ALSO - REPLACEMENT COST - L O W E R O F C O S T O R N E T R E A L I S A B L E VA L U E ( * A S P E R A S - 2 : “ VA L U AT I O N O F I N V E N T O R Y ” , O N LY 1 , 2 A N D 4 A R E A L L O W E D I N I N D I A )
H T T P : / / W W W. I C A I . O R G / I C A I R O O T / R E S O URCES/AS_2.HTML#CF
6/25/2011
INVENTORY VALUATION - EXAMPLE
A retailer reports the following data: Beginning 6 items at Rs.10 Buy 10 items at Rs.11 10 items at Rs.13
4 items at Rs.15
Total Avail. 30 Sell 22 Remaining 8 Replacement cost Rs.16 per item What is the COST of the 8 remaining items?
6/25/2011
SPECIFIC IDENTIFICATION
PHYSICAL LINKING OF THE COST OF EACH ITEM OF INVENTORY
Goods Available Ending Inventory Unit Cost Total Unit Cost Total Beginning Inv 6 @ 10 = Rs. 60 2 @ 10 = Rs.20 Purchases: 10 @ 11 = Rs.110 1 @ 11 = Rs.11 10 @ 13 = Rs.130 1 @ 13 = Rs.13 4 @ 15 = Rs. 60 4 @ 15 = Rs.60 30 Rs.360 8 Rs.104 Cost of Goods available for sale Rs.360 Less: Ending inventory Rs.104 Cost of Goods Sold: Rs.256
6/25/2011
FIFO - FIRST IN, FIRST OUT
ASSUMES THE INVENTORY A C Q U I R E D F I R S T S O L D F I R S T. S O VA L U E I N V E N T O R Y AT E N D I N G Goods E S P R I C Available Ending Inventory
Units Cost Total Units Cost Total
Beginning inv. 6 @ 10 = Rs. 60 Purchases: 10 @ 11 = Rs.110 10 @ 13 = Rs.130 4 @ Rs.13 = Rs. 52 4 @ 15 = Rs. 60 4 @ Rs.15 = Rs. 60 30 Rs. 360 8 Rs.112 Cost of goods available for sale Rs.360 Less: Ending inventory Rs.112 Cost of goods sold Rs.248
6/25/2011
3. LIFO - LAST IN FIRST OUT
ASSUMES INVENTORY ACQUIRED L A S T I S S O L D F I R S T. S O VA L U E I N V E N T O R Y AT S TA R T I N G P R I C E S .
Goods Available Ending Inventory Units Cost Total Units Cost Total Beginning inv. 6 @ 10 = Rs.60 6 @ Rs.10 = Rs. 60 Purchases: 10 @ 11 = Rs.110 2 @ Rs.11 = Rs. 22 10 @ 13 = Rs.130 4 @ 15 = Rs. 60 30 Rs. 360 8 Rs. 82 Cost of goods available for sale Rs.360 Less: Ending inventory Rs. 82 Cost of goods sold Rs. 278
6/25/2011
WAC - WEIGHTED AVERAGE COST
ASSUMES ALL ITEMS ARE VA L U E D AT T H E AV E R A G E COST OF ALL PURCHASES
Ending Inventory Units Cost Total 8 @ Rs.12 = Rs. 96 Cost of goods available for sale Rs.360 Less: Ending inventory 96 Cost of goods sold Rs.264
6/25/2011
Comparison of Methods & Systems
• In periods of rising prices - profit & ending inventory under FIFO > AC > LIFO • The order is same under either inventory systems (perpetual or periodic) but actual Rs. values of COGS, Profit & Ending Inventory will differ under LIFO & AC • Judgment is required in method selection but method must be applied consistently from period to period • Material effects of method changes are required to be disclosed
6/25/2011
Rule - Lower of Cost or Net Realisable Value
• Inventories must be measured at the lower of historic cost or NRV on an item by item basis • Follows the conservatism principle • Means that no profit can be booked until sale has been realised. NRV = Estimated sale proceeds less marketing, selling and distribution costs
6/25/2011
Illustration
The following information is extracted from the ledger in respect of: Material X Opening stock: Purchases: Jan 1 Jan20 Issues Jan 22 Jan 23
6/25/2011
Nil 100@ Re. 1 per unit 100@ Re. 2 per unit 60 for job W 16 60 for job W 17
Complete the receipts and issues valuation by Adopting FIFO, LIFO and Weighted Average Methods.
Tabulate the values allocated to Job W 16, W 17 and the closing stock under the aforesaid methods.
6/25/2011
Solution
1.Valuation of receipts (for all methods) Jan 1 100*1.00= Rs. 100 Jan 20 100*2.00= Rs. 200 200 Units Rs. 300 b) Weighted Average Rate = Rs. 300 200 Units = Rs. 1.50 per unit
6/25/2011
FIFO Method:
Issues Date
Jan 22 - W 16 Jan 23 - W 17
Quantity Rate Units Rs.
60 40 20 1.00 1.00 2.00
Amt Rs.
60.00 40.00 40.00 140.00 160.00
Closing Stock 80
6/25/2011
2.00
LIFO Method:
Issues Date
Jan 22 - W 16 Jan 23 - W 17
Quantity Rate Units Rs.
60 40 20 2.00 2.00 1.00
Amt Rs.
120.00 80.00 20.00 220.00 80.00
Closing Stock 80
6/25/2011
1.00
Weighted Average Method:
Issues Date
Jan 22 - W 16 Jan 23 - W 17
Quantity Units
60 60
Rate Rs.
1.50 1.50
Amt Rs.
90.00 90.00 180.00
Closing Stock 80
6/25/2011
1.50
120.00
Values allocated to individual jobs: W 16 Rs. W 17 Rs.
FIFO LIFO Weighted Average
60 120 90
80 100 90
6/25/2011
doc_610228438.ppt
Material Accounting and it contains topics like inventory cycle, types of inventory, importance, inventory valuation, trading transactions, inventory formula, LIFO, FIFO
MATERIAL ACCOUNTING
INVENTORY CYCLE
Raw Material Work In Progress
Finished Goods
6/25/2011
TYPE OF INDUSTRIES AND INVENTORY
1.Manufacturing: Raw Material, WIP and Finished Goods. In manufacturing raw material is converted into finished goods. 2.Trading: Finished Goods. It is just buying and selling activity 3.Service: Preferably no inventory
6/25/2011
VALUATION OF INVENTORY
• Valuation of Inventory is a systematic process which is done at periodical intervals. • Inventory has two values; COST PRICE N E T R E A L I S A B L E VA L U E ( VA L U E O F I N V E N T O R Y I S = LOWER OF COST OR NET REALISABLE PRICE)
6/25/2011
IMPORTANCE OF INVENTORY • Inventory value is included in Profit & Loss Account which affects profit of the Company • Inventory in shown as Current Assets in Balance Sheet hence inventory value affects Balance Sheet position also. • So change in inventory value will change profit and financial position of company.
6/25/2011
Objectives of Inventory Valuation E X A M I N E A LT E R N AT I V E I N V E N TO RY VA L U AT I O N METHODS • Value = Quantity X Rate • Change in value of inventory will change profit
6/25/2011
Inventory & the Accounting Equation
ASSETS
=
LIABILITIES
+
OWNERS EQUITY
Current Assets
Non-current Assets
Current Liabilities
Non-current Liabilities
Cash
Receivables
Inventory
Other Specific Identification Weighted Average First-in, First-out
Inventory Recording Systems Periodic Inventory Perpetual Inventory
Cost flow assumptions
6/25/2011
Last-in, First-out
TRADING TRANSACTIONS
BUYER
Prepares requisition (internal) /Purchase order (external) sends to Seller
SELLER
Locates goods Prepare invoice Delivers to buyer
Goods received Checked with purchase order Invoice OK’d for payment Sends cheque to seller
Banks cheque Sends receipt
Receives Receipt
INVENTORY FORMULA
• COST OF GOODS SOLD = OPENING STOCK OF INVENTORY+ NET PURCHASES – CLOSING STOCK OF INVENTORY • Above formula can also be used in relation to WIP and Finished Goods to arrive at Cost of Goods Sold
6/25/2011
RECORDING TRADING TRANSACTIONS ACCOUNTING ISSUES CONSIDERED HERE:
• Recording of inventory (cost of goods sold and ending inventory) • Impact on presentation of financial statements
6/25/2011
INCOME STATEMENT FOR SERVICE FIRM
Power Services Statement of Financial Performance For the year ended 31/12/XX
Revenue Fees income 350,000 Less: Expenses Wages 20,000 Power 30,000 etc. 1,00,000 150,000 NET INCOME 200,000
INCOME STATEMENT FOR TRADING FIRM
Zapp Electronics Statement of Financial Performance For the year ended 31/12/XX
Sales 350,000 Less: Cost of goods sold 210,000 Gross Profit 140,000 Less: Operating expenses Selling expenses 81,000 Administrative expenses 38,000 Total Operating Expenses 119,000 NET INCOME 21,000
INVENTORY RECORDING SYSTEMS • Two systems for recording merchandise inventory
• PERPETUAL INVENTORY SYSTEM
Maintains a continuous inventory record of all goods bought and sold o COGS accumulated as inventory is sold
o
• PERIODIC INVENTORY SYSTEM
Physical stocktake (an actual count) of inventory is required at end of period to update inventory o Until then, COGS = ?
o
6/25/2011
INVENTORY VALUATION
• Inventory Valuation Process
o
At the end of the accounting period, accountants divide the cost of beginning inventory and inventory purchased between COGS and the cost of items remaining in inventory
This process involves a cost flow assumption
o
COGS Opening Inv
6/25/2011
+Purchase s
Closing Inv.
INVENTORY VALUATION
• How we divide the costs between COGS and ending inventory depends on the inventory system • Perpetual system:
o o
We record the cost of each item sold This then gives us the cost of the remaining items
• Periodic system:
must determine the cost of items remaining in ending inventory to calculate COGS o individual sales are not tracked, an end of period stocktake determines ending inventory o cost flow assumption can significantly impact the calculation of ending inventory and COGS
o
6/25/2011
FOUR MAIN COST-FLOW ASSUMPTION/APPROACHES
1 . S P E C I F I C I D E N T I F I C AT I O N 2. FIFO - FIRST IN FIRST OUT 3. LIFO - LAST IN FIRST OUT* 4 . W E I G H T E D AV E R A G E ( AV E R A G E COST)
ALSO - REPLACEMENT COST - L O W E R O F C O S T O R N E T R E A L I S A B L E VA L U E ( * A S P E R A S - 2 : “ VA L U AT I O N O F I N V E N T O R Y ” , O N LY 1 , 2 A N D 4 A R E A L L O W E D I N I N D I A )
H T T P : / / W W W. I C A I . O R G / I C A I R O O T / R E S O URCES/AS_2.HTML#CF
6/25/2011
INVENTORY VALUATION - EXAMPLE
A retailer reports the following data: Beginning 6 items at Rs.10 Buy 10 items at Rs.11 10 items at Rs.13
4 items at Rs.15
Total Avail. 30 Sell 22 Remaining 8 Replacement cost Rs.16 per item What is the COST of the 8 remaining items?
6/25/2011
SPECIFIC IDENTIFICATION
PHYSICAL LINKING OF THE COST OF EACH ITEM OF INVENTORY
Goods Available Ending Inventory Unit Cost Total Unit Cost Total Beginning Inv 6 @ 10 = Rs. 60 2 @ 10 = Rs.20 Purchases: 10 @ 11 = Rs.110 1 @ 11 = Rs.11 10 @ 13 = Rs.130 1 @ 13 = Rs.13 4 @ 15 = Rs. 60 4 @ 15 = Rs.60 30 Rs.360 8 Rs.104 Cost of Goods available for sale Rs.360 Less: Ending inventory Rs.104 Cost of Goods Sold: Rs.256
6/25/2011
FIFO - FIRST IN, FIRST OUT
ASSUMES THE INVENTORY A C Q U I R E D F I R S T S O L D F I R S T. S O VA L U E I N V E N T O R Y AT E N D I N G Goods E S P R I C Available Ending Inventory
Units Cost Total Units Cost Total
Beginning inv. 6 @ 10 = Rs. 60 Purchases: 10 @ 11 = Rs.110 10 @ 13 = Rs.130 4 @ Rs.13 = Rs. 52 4 @ 15 = Rs. 60 4 @ Rs.15 = Rs. 60 30 Rs. 360 8 Rs.112 Cost of goods available for sale Rs.360 Less: Ending inventory Rs.112 Cost of goods sold Rs.248
6/25/2011
3. LIFO - LAST IN FIRST OUT
ASSUMES INVENTORY ACQUIRED L A S T I S S O L D F I R S T. S O VA L U E I N V E N T O R Y AT S TA R T I N G P R I C E S .
Goods Available Ending Inventory Units Cost Total Units Cost Total Beginning inv. 6 @ 10 = Rs.60 6 @ Rs.10 = Rs. 60 Purchases: 10 @ 11 = Rs.110 2 @ Rs.11 = Rs. 22 10 @ 13 = Rs.130 4 @ 15 = Rs. 60 30 Rs. 360 8 Rs. 82 Cost of goods available for sale Rs.360 Less: Ending inventory Rs. 82 Cost of goods sold Rs. 278
6/25/2011
WAC - WEIGHTED AVERAGE COST
ASSUMES ALL ITEMS ARE VA L U E D AT T H E AV E R A G E COST OF ALL PURCHASES
Ending Inventory Units Cost Total 8 @ Rs.12 = Rs. 96 Cost of goods available for sale Rs.360 Less: Ending inventory 96 Cost of goods sold Rs.264
6/25/2011
Comparison of Methods & Systems
• In periods of rising prices - profit & ending inventory under FIFO > AC > LIFO • The order is same under either inventory systems (perpetual or periodic) but actual Rs. values of COGS, Profit & Ending Inventory will differ under LIFO & AC • Judgment is required in method selection but method must be applied consistently from period to period • Material effects of method changes are required to be disclosed
6/25/2011
Rule - Lower of Cost or Net Realisable Value
• Inventories must be measured at the lower of historic cost or NRV on an item by item basis • Follows the conservatism principle • Means that no profit can be booked until sale has been realised. NRV = Estimated sale proceeds less marketing, selling and distribution costs
6/25/2011
Illustration
The following information is extracted from the ledger in respect of: Material X Opening stock: Purchases: Jan 1 Jan20 Issues Jan 22 Jan 23
6/25/2011
Nil 100@ Re. 1 per unit 100@ Re. 2 per unit 60 for job W 16 60 for job W 17
Complete the receipts and issues valuation by Adopting FIFO, LIFO and Weighted Average Methods.
Tabulate the values allocated to Job W 16, W 17 and the closing stock under the aforesaid methods.
6/25/2011
Solution
1.Valuation of receipts (for all methods) Jan 1 100*1.00= Rs. 100 Jan 20 100*2.00= Rs. 200 200 Units Rs. 300 b) Weighted Average Rate = Rs. 300 200 Units = Rs. 1.50 per unit
6/25/2011
FIFO Method:
Issues Date
Jan 22 - W 16 Jan 23 - W 17
Quantity Rate Units Rs.
60 40 20 1.00 1.00 2.00
Amt Rs.
60.00 40.00 40.00 140.00 160.00
Closing Stock 80
6/25/2011
2.00
LIFO Method:
Issues Date
Jan 22 - W 16 Jan 23 - W 17
Quantity Rate Units Rs.
60 40 20 2.00 2.00 1.00
Amt Rs.
120.00 80.00 20.00 220.00 80.00
Closing Stock 80
6/25/2011
1.00
Weighted Average Method:
Issues Date
Jan 22 - W 16 Jan 23 - W 17
Quantity Units
60 60
Rate Rs.
1.50 1.50
Amt Rs.
90.00 90.00 180.00
Closing Stock 80
6/25/2011
1.50
120.00
Values allocated to individual jobs: W 16 Rs. W 17 Rs.
FIFO LIFO Weighted Average
60 120 90
80 100 90
6/25/2011
doc_610228438.ppt