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
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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