Introduction of inventory
Explore What is the concept of inventory in accounting, its management importance, cost components, valuation basis, and methods of inventory valuation. A detailed guide for accurate financial reporting and business profitability.
(toc)#Concept Of Inventory=(Table of Content)
The inventory involve goods purchase and held for resale for example goods purchase by retailer/wholesaler (for the purpose of resale) .
The inventory may be computer software ( intangible assets) and land( tangible assets) and other property held for resale.
It is a current assets inventory also consist finished good or works in progress produced by the enterprises and includes materials maintenance supply, consumable, and loose equipment's intended for use in the production process
Inventory can not be machine’s part As per AS-10, property plant and equipment
Knowledge point !
What is the accounting treatment for inventory stored in the go down for more than one accounting year?
As per Accounting Standard 2 ,it is treated as inventory too.
Business Income
It can be termed as the net profit of organizations as per financial statement .
Business income is calculated after deducting all expenses and losses, it is mainly used for estimation of income tax as per taxation rules.
Meaning of Inventory
As per AS-2 issued by the Institute of Chartered Accountants of India (ICAI), the inventory assets are:
1. Held for sale in the normal course of business.
2. In the production for such sale, including maintenance supplies and consumables other than machinery, spares, servicing equipment, and standby equipment.
Importance of Inventory Management
Inventory is the most important current asset for every organization, whether trade or manufacturing. Excess inventory and its scarcity have an impact on production activity and profitability in any firm, whether it be manufacturing or trade. Accurate inventory valuation helps in determining a business's profit and loss, among other things.
Let's look at how crucial valuation is for a business
1. Determination of Income :-
Inventory valuation is important to determine a business's true income during a period. Gross profit is calculated by comparing cost of goods sold to revenue for each accounting period. The cost of Goods sold is determined as follows:
- Cost of Goods sold = Inventory Opening + Purchase + Direct Expense - Closing Inventory
- Closing inventory= Inventory Opening+ Purchase + Direct Expenses-Cost Of Goods Sold
Inventory valuation will have a significant influence on income determination. Any over/under statement may be stated as follows.
So, it is necessary to proper calculation of cost of good sold and for that matter, proper valuation of inventory is necessary for determination of net income.
*Merchandise cost = inventory cost
Ascertainment of Financial Position/situation
Inventories refers to the current assets of the business. The value of the inventory on the date of preparation of the balance sheet which helps to determine financial position of business. Usually, slow-moving or Non-living inventory basic reason for bad financial performance as well as financial position of an enterprise
Slow moving:- The stock which is sold less, and its demand is less by the customers.
Liquidity Analysis
As we all know, inventory is a current asset. Inventory valuation helps in determining the current ratio which is helpful for investors, creditors and customer etc.
*Current ratio :- the current ratio is the ratio of current assets and current liability
Statutory Compliances
Schedule III of Companies Act, 2013 requires valuation of each class of goods (i.e. raw material, work in progress, and finished goods)
As per requirement of Accounting Standard, financial statement should disclose:
(a) The accounting policies adopted in measuring inventories, including the cost formula used.
(b) The total carrying number of inventories and their classification appropriate to the enterprise.
BASIS OF INVENTORY VALUATION
Inventories would be valued at lower cost or net realizable value. This is because of the Principle of Conservative Accounting
Cost
As per Accounting Standards, cost of inventories should comprise:
- All costs of purchase
- Cost of conversion
- Other costs incurred in bringing the inventories to their present location and condition.
Cost of Purchase
Cost purchase price of purchase includes duties and taxes (other than those subsequently recoverable by the enterprise from the tax authority). Freight inward and other expenditures directly attributable will be added to cost of purchase.
Trade discounts, rebates, duty drawbacks, and other similar items are deducted to in determining cost of purchase.
Example
Cost of Purchase
Price = 100/-
Amount = 100x100
= 10,000
Plus GST = 18%
= 1,800
Note - GST will not be included in cost of purchase hence, the cost of purchase will be 10,000 only and not 11,800
Cost of Conversion
Include costs/expenses directly related to the production units of the product.
* Direct Labour
* Direct Material
* Direct Expenses
For the product:
(1) Cost of Purchase
(2) Direct Labour
= 10,000+ 3,000 => 13,000 rupees
Other cost may include:
Administrative overheads incurred in bringing inventory to its present location and condition.
However, costs specifically linked to inventory should not be included in the cost of inventory, such as interest and borrowing cost.
In some cases when production requires a long period, borrowing cost may be capitalized if it may be directly attributed to the acquisition, construction, or production of the asset.
For example:
Unloading charges 1,000 rupees for putting the goods in the storage place in the factory in case of inventory.
We can simplified above concept through chart as follows :
Exclusions from cost of inventory: inventory costs exclude the following expenses:
(a) abnormal amount of waste materials, labor, or other manufacturing overheads: (b) Storage expenses, unless essential for production;
(c) Administrative overheads not related to inventory location and condition;
(d) Selling and distribution costs.
Net realizable value:
This is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale
Inventory record system
There are two methods of valuation of physical stock available at business premises (like Godown, warehouse). There are lots of explanation available in books and blog articles.
Periodic inventory system/ physical inventory system
In This system a person physically count inventory One by one, because of this is less expensive method.
Perpetual inventory system
As per the system determination of inventory value in monetary term through the books of accounts and this is done by the professional .
In this post is we understand the theory portion of inventory, this is the summaries view so getting more knowledge about inventory topic, you may visit below site:
BOS_ICAI
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