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Inventory and costing

FACTS Perpetual inventory management software helps in tracking inventory levels at the shop, order requests, delivery of items and sales processes.

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Inventory and costing

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  1. INVENTORY & COSTING

  2. INVENTORY & COSTING • What is Inventory? • What is COGS? • What are the Standard Costing methods? (Cost flow Assumptions) • Inventory calculation Systems/Methods • Periodic • Perpetual • Methods of Estimating Inventory • Gross Profit method • Retail Method

  3. WHAT IS INVENTORY? • A current asset whose ending balance should report the cost of a merchandiser's products awaiting to be sold. • The cost of inventory should include all costs necessary to acquire the items and to get them ready for sale. • Inventory is merchandise purchased by merchandisers (retailers, wholesalers, distributors) for the purpose of being sold to customers. The cost of the merchandise purchased but not yet sold is reported in the account Inventory • Inventory is reported as a current asset on the company's balance sheet. Inventory is a significant asset that needs to be monitored closely. Too much inventory can result in cash flow problems, additional expenses (e.g., storage, insurance), and losses if the items become obsolete. Too little inventory can result in lost sales and lost customers. • Because of the cost principle, inventory is reported on the balance sheet at the amount paid to obtain (purchase) the merchandise, not at its selling price. • Inventory is also a significant asset of manufacturers. The inventory of a manufacturer should report the cost of its raw materials, work-in-process, and finished goods.

  4. WHAT IS COGS (COST OF GOODS SOLD) • Cost of goods sold is the cost of the merchandise that was sold to customers. The cost of goods sold is reported on the income statement when the sales revenues of the goods sold are reported. • A retailer's cost of goods sold includes the cost from its supplier plus any additional costs necessary to get the merchandise into inventory and ready for sale. For example, let's assume that AAK purchases 1000 Carton Apple from a Supplier. If AAK cost from the Supplier is AED80 for the Apple Per Carton plus AED5000 in shipping costs, AAK reports AED85,000.00 in its Inventory account until the Apple is sold. When the Apple is sold, the AED85000 is removed from inventory and is reported as cost of goods sold on the income statement.

  5. WHAT IS THE DIFFERENCE BETWEEN INVENTORY AND THE COST OF GOODS SOLD? • Inventory for a retailer or distributor is the merchandise that was purchased and has not yet been sold to customers. For a manufacturer, inventory consists of raw materials, packaging materials, work-in-process, and the finished goods that are owned and on hand. Inventory is generally valued at its cost. If a business has inventory it is often a major component of its current assets. • The cost of goods sold is the cost of the merchandise or products that have been sold to customers during the period of the income statement. For a company that sells goods, the cost of goods sold is usually the largest expense on its income statement. As a result, care must be taken when computing and matching the cost of goods sold with the sales revenues.

  6. WHAT ARE THE COSTING METHODS? (COST FLOW ASSUMPTIONS) • Weighted Average Costing (WAC) • FIFO Costing • LIFO Costing (Banned by IFRS) • Specific Identification Method • FACTS Batch Costing (Container/Serial No/Batch/Piece/IMEI)

  7. IS THERE A DIFFERENCE BETWEEN THE ACCOUNTS PURCHASES AND INVENTORY? • The account Purchases is generally associated with the purchase of inventory items under the periodic inventory system. Under the periodic system the account Inventory is dormant until it is adjusted to the cost of the ending inventory at the end of an accounting period. Under the perpetual inventory system, the account Purchases won't exist. Rather, the cost of inventory items purchased will be recorded directly into the account Inventory. Under the periodic system, the cost in the account Purchases will be added to the cost of the beginning inventory to arrive at the cost of goods available. The cost of the ending inventory is computed through a physical count (or an estimate) and is subtracted from the cost of goods available. The resulting amount is the cost of goods sold. Under the perpetual system, the balance in the account Inventory should be the cost of the ending inventory. Under the perpetual system, the cost of goods sold will have been removed from the account Inventory when the items were sold and placed in the account Cost of Goods Sold.

  8. SPECIFIC IDENTIFICATION METHOD • Under this approach, you separately track the cost of each item in inventory, and charge the specific cost of an item to the cost of goods sold when you sell the specific item to which that cost has been assigned. This approach requires a massive amount of data tracking, so it is only usable for very high-cost, unique items, such as automobiles or works of art. It is not a viable method in most other situations.

  9. SPECIFIC/BATCH IDENTIFICATION METHOD (SAMPLE) Doc type Date Unit Qty Rate Amount Batch# COGS Cumm Qty Cumm Cost PI-150001 Jan-15 CTN 500.00 80.00 40,000.00 PI-150001 40,000.00 500.00 40,000.00 Sal-1001 Jan-15 CTN (400.00) 110.00 (44,000.00) PI-150001 (32,000.00) 100.00 8,000.00 PI-150002 Jun-15 CTN 550.00 75.00 41,250.00 PI-150002 41,250.00 650.00 49,250.00 Sal-1002 Jun-15 CTN (550.00) 108.00 (59,400.00) PI-150002 (41,250.00) 100.00 8,000.00 PI-150003 Jul-15 CTN 100.00 88.00 8,800.00 PI-150003 8,800.00 200.00 16,800.00 SAL-1003 Aug-15 CTN (50.00) 120.00 (6,000.00) PI-150003 (4,400.00) 150.00 12,400.00 PI-150004 Dec-15 CTN 150.00 99.00 14,850.00 PI-150004 14,850.00 300.00 27,250.00 27,250.00 27,250.00

  10. FIRST IN, FIRST OUT METHOD • Under the FIFO method, you are assuming that items bought first are also used or sold first, which also means that the items still in stock are the newest ones. This policy closely matches the actual movement of inventory in most companies, and so is preferable simply from a theoretical perspective. In periods of rising prices (which is most of the time in most economies), assuming that the earliest units bought are the first ones used also means that the least expensive units are charged to the cost of goods sold first. This means that the cost of goods sold tends to be lower, which therefore leads to a higher amount of operating earnings, and more income taxes paid. Also, it means that there tend to be fewer inventory layers than under the LIFO method (see next), since you will continually use up the oldest layers.

  11. FIRST IN, FIRST OUT METHOD (SAMPLE) Doctype Date Unit Qty Rate Amount Up Doc COGS Cumm Qty Cumm Cost PI-150001 Jan-15 CTN 500.00 80.00 40,000.00 PI-150001 40,000.00 500.00 40,000.00 Sal-1001 Jan-15 CTN (400.00) 110.00 (44,000.00) PI-150001 (32,000.00) 100.00 8,000.00 PI-150002 Jun-15 CTN 450.00 75.00 33,750.00 PI-150002 33,750.00 550.00 41,750.00 Sal-1002 Jun-15 CTN (550.00) 108.00 (59,400.00) PI-150001 (100)+ PI-150002 (450) (41,750.00) - - PI-150003 Jul-15 CTN 100.00 88.00 8,800.00 PI-150003 8,800.00 100.00 8,800.00 SAL-1003 Aug-15 CTN (50.00) 120.00 (6,000.00) PI-150003 (4,400.00) 50.00 4,400.00 PI-150004 Dec-15 CTN 150.00 99.00 14,850.00 PI-150004 14,850.00 200.00 19,250.00 19,250.00 19,250.00

  12. LAST IN, FIRST OUT METHOD • Under the LIFO method, you are assuming that items bought last are sold first, which also means that the items still in stock are the oldest ones. This policy does not follow the natural flow of inventory in most companies; in fact, the method is banned under International Financial Reporting Standards. In periods of rising prices, assuming that the last units bought are the first ones used also means that the cost of goods sold tends to be higher, which therefore leads to a lower amount of operating earnings, and fewer income taxes paid. There tend to be more inventory layers than under the FIFO method, since the oldest layers may not be flushed out for years.

  13. WEIGHTED AVERAGE METHOD • Under the weighted average method, there is only one inventory layer, since the cost of any new inventory purchases are rolled into the cost of any existing inventory to derive a new weighted average cost, which in turn is adjusted again as more inventory is purchased.

  14. WEIGHTED AVERAGE METHOD (SAMPLE) Doc type Date Unit Qty Rate Amount COGS Cumm Qty Cumm Cost Cost Rate PI-150001 Jan-15 CTN 500.00 80.00 40,000.00 40,000.00 500.00 40,000.00 80.00 Sal-1001 Jan-15 CTN (400.00) 110.00 (44,000.00) (32,000.00) 100.00 8,000.00 80.00 PI-150002 Jun-15 CTN 550.00 75.00 41,250.00 41,250.00 650.00 49,250.00 75.77 Sal-1002 Jun-15 CTN (550.00) 108.00 (59,400.00) (41,673.08) 100.00 7,576.92 75.77 PI-150003 Jul-15 CTN 100.00 88.00 8,800.00 8,800.00 200.00 16,376.92 81.88 SAL-1003 Aug-15 CTN (50.00) 120.00 (6,000.00) (4,094.23) 150.00 12,282.69 81.88 PI-150004 Dec-15 CTN 150.00 99.00 14,850.00 14,850.00 300.00 27,132.69 90.44 27,132.69 27,132.69

  15. PERIODIC - INVENTORY SYSTEMS/METHODS • Under this system the amount appearing in the Inventory account is not updated when purchases of merchandise are made from suppliers. Rather, the Inventory account is commonly updated or adjusted only once—at the end of the year. During the year the Inventory account will likely show only the cost of inventory at the end of the previous year. • Under the periodic inventory system, purchases of merchandise are recorded in one or more Purchases accounts. At the end of the year the Purchases account(s) are closed and the Inventory account is adjusted to equal the cost of the merchandise actually on hand at the end of the year. Under the periodic system there is no Cost of Goods Sold account to be updated when a sale of merchandise occurs. • In short, under the periodic inventory system there is no way to tell from the general ledger accounts the amount of inventory or the cost of goods sold.

  16. PERPETUAL - INVENTORY SYSTEMS/METHODS • Under this system the Inventory account is continuously updated. The Inventory account is increased with the cost of merchandise purchased from suppliers and it is reduced by the cost of merchandise that has been sold to customers. (The Purchases account(s) do not exist.) • Under the perpetual system there is a Cost of Goods Sold account that is debited at the time of each sale for the cost of the merchandise that was sold. Under the perpetual system a sale of merchandise will result in two journal entries: one to record the sale and the cash or accounts receivable, and one to reduce inventory and to increase cost of goods sold.

  17. WHAT IS THE DIFFERENCE BETWEEN PERIODIC AND PERPETUAL INVENTORY SYSTEMS? • The difference between the periodic and perpetual inventory systems involves the general ledger account Inventory. In a periodic system the account Inventory will: have a constant balance (the ending balance from the previous period) • not include the cost of purchases (they are recorded in a Purchases account) • be adjusted at the end of the accounting period (so the balance reports the costs actually in inventory) • require a physical inventory at least once per year (and estimates within the year) • require a cost flow assumption(FIFO, LIFO, average) • require a calculation of the cost of goods sold (to be used on the income statement)

  18. WHAT IS THE DIFFERENCE BETWEEN PERIODIC AND PERPETUAL INVENTORY SYSTEMS? (CONT.) • In a perpetual system the account Inventory will: be debited when there is a purchase of goods (there is no Purchases account) • be credited for the cost of the items sold (and the account Cost of Goods Sold will be debited) • have its balance continuously or perpetually changing because of the above entries • require a physical inventory to correct any errors in the Inventory account • require a cost flow assumption (FIFO, LIFO, average) • It is possible that a company will use the periodic system in its general ledger and use a different computer system outside of its general ledger to track the flow of goods in and out of inventory.

  19. THANKS

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