Accounting 2.1

Accounting for Inventory

Inventory

Goods that are purchased by a business with the intention of selling the goods at a higher price to make a profit.

Limitations of Inventory ledger account

• Only shows a summary of all the inventory items held by the business, not individual items or detailed information (quantity, cost price of each item)

• Only updated at the end of each reporting period

Inventory Card

An accounting record that records each individual transaction that affects a particular item of inventory (or line of inventory).

All transactions are recorded using the cost price of the inventory.

Benefits of using Inventory Cards

• Provides more detailed and timely information about the inventory; helps the business to better manage their inventory

• Slow-moving and fast-moving lines of inventory can be identified (via OUT column)

• Reordering inventory can be more efficient

• Inventory gains and inventory losses can be detected; can compare inventory card quantity with actual quantity counted

Disadvantages of using Inventory Cards

• Can result in additional costs for the business

• Additional record-keeping is required as the balance of the inventory card is updated after each transaction; time-consuming

First In, First Out (FIFO)

Assumes that the items purchased first will be the first items to be sold, withdrawn, donated (advertising), or lost.

Double Entry - Inventory used for Advertising Purposes

Dr	Advertising Expense
Cr	Inventory

Inventory Count / Stock Take

Involves physically counting every item of inventory on hand to verify the accuracy of the inventory cards and to identify if any inventory gain or loss occurred.

• Helps ensure the value of inventory reported in the Balance Sheet is faithfully represented

• Occurs on Balance Day (last day of the reporting period)

Inventory Loss

When the inventory count reveals fewer items of inventory on hand than listed in the inventory card.

• Expense

• FIFO is applied to determine the cost price of the inventory lost

Double Entry - Inventory Loss

Dr	Inventory Loss
Cr	Inventory

Inventory Gain

When the inventory count reveals more items of inventory on hand than listed in the inventory card.

• Revenue

• Assume that inventory gains are from the most recent purchase (cost price)

Accounting Assumption: The Period Assumption

Reports are prepared for a specified period of time (reporting period), such as a month or a year, in order to obtain comparability of results.

Any inventory gains or inventory losses should be reported in the Income Statement in the Period in which the revenue is earned or the expense is incurred.

Accounting Assumption: The Accrual Basis Assumption

Revenue is recognized in the period in which it is earned and expenses are recognized in the period in which they are incurred.

Profit is determined by subtracting expenses incurred for the period, from revenue earned in that same period.

Even though no cash has been paid or received, an inventory loss is recognized as an expense in the period it is incurred, and an inventory gain is recognized as revenue in the period it has been earned. This is important for an accurate profit to be calculated for the period.

Qualitative Characteristic: Comparability

Financial information should be able to be compared over time and compared with similar information about other businesses.

Having consistent accounting methods (e.g. FIFO) ensures that reports can be compared between periods to identify changes in performance.

Qualitative Characteristic: Faithful Representation

Financial information must be a truthful representation of the real-world economic event and is complete, free from material errors, and without bias.

A physical inventory count helps ensure the value of inventory reported in the Balance Sheet is faithfully represented by checking the accuracy of the inventory cards and detecting any inventory gains or losses.

Qualitative Characteristic: Relevance

Financial information must be capable of influencing decisions made by users to help them make predictions and/or confirm or change their previous evaluations.

By adjusting for inventory gain or loss, Relevance is achieved by ensuring all reports contain information that may influence decision-making.