Accounting for Inventory By Sandhya Ghosh ( Pal ).

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Presentation transcript:

Accounting for Inventory By Sandhya Ghosh ( Pal )

Definition Accounting Standard 2: Inventories are assets that are i ) held for sale in normal course of business ii) in the process of production for such sales iii) in the form of materials or supplies to be consumed in production or in rendering services.

Importance of Inventory valuation I ) for income statement : Due to fluctuation in inventory price, the income statement is influenced by the method of valuation used for determining the value of closing inventory. Any error in inventory valuation will affect cost of goods sold, gross profit and ultimately the net profit figure. 2) For balance sheet : Any error in the valuation of inventory may prevent a balance sheet from showing a true and fair view of the affairs of the business.

3) For liquidity of business: The liquidity of a business is primarily judged by a current ratio i.e. current assets : current liability. If the inventory valuation is wrongly done the current assets value shall be greatly erroneous and as a result the current ratio worked out shall not the reliable

Valuation of Inventory Accounting Standard -2 issued by the Chartered Accountants of India requires that – inventories should be valued at the lower of cost and net realizable value.

Definitions as per Accounting Standard – 2 Cost of inventories : Purchase price including duties and taxes, freight inward and other expenses directly attributable to business. Trade discount, rebates, duty drawbacks etc. are deductible from price Cost of conversion : It includes cost directly related to the units produced that is direct labor, fixed and variable factory overhead systematically allocated according to some rational principle.

Other Costs : It includes the costs incurred in bringing the inventories to their present location and condition. These costs are overheads other than factory overhead as attributable to the inventories for bringing them to present location and condition. Interest and other borrowing costs are not to be considered.

Different methods of valuation LIFO ( last in First out ) method FIFO ( first in first out ) method Weighted Average method Standard Cost method Retail method

Advantages of LIFO method Cost of goods represent current price The method is simple in theory and practice In conditions of rising prices replacement of stock will not require additional money It shows lower value in condition of rising prices. Hence there will be no unrealized profits in financial Accounting.

Disadvantages of LIFO method Clerical errors may crop up if there is large number of receipts. Two sales of same dimensions may show different cost of sales. In case of falling prices the cost of sales will show lower figure and the inventory will show higher figure. In Conditions of rising prices the value of inventory will have no relation with the current market price.

The End