U3, AOS 1 - KK10-12 - Accounting for Inventory

Question 1

Perpetual Inventory System of recordiing inventory

Answer 1

Recording inventory transactions in inventory cards, then conducting a physical inventory count at the end of the Period to verify the balance of those inventory cards, in the process detecting any inventory losses or gains.

Benefits:

• -Reordering of inventory is assisted, as the inventory card can identify when levels of inventory are low and need to be reordered.
• Inventory losses and gains can be detected by comparing business records with inventory count results, this means that reasons can be investigated and corrective action taken if required.
• Fast and slow moving lines of inventory can be identified, this allows businesses to ensure they order enough of the fast moving lines of inventory so they do not run out and miss out on sales. And discount the slow moving lines of inventory so they do not get stuck with old inventory on hand.

Costs:

• -Staffing are required to set up and maintain the inventory cards
• Training is required so that staff know what they are doing and mistakes are not made.
• Technology (set-up and maintenance)

Question 2

Narration for an transaction involving inventory

Answer 2

When writing in narrations for inventory you must include the line of inventory, number of units (and if a purchase or sales return, the reason for the return) along with the source documents in brackets, e,g,, (Cr. Note 34)

Question 3

Cost Assignment Method

Answer 3

Cost assignment methods are used in order to determine the unit cost that should be applied to inventory as it moves in and out of the business.

Question 4

Identified Cost

Answer 4

A method of valuing inventory by physically marking each item in some way so that its individual price can be identified.

Question 5

First In, First Out (FIFO)

Answer 5

A method of valuing inventory that assumes that, unless otherwise indicated, the first items purchased are the first sold, and therefore values inventory sold using the earliest cost price on hand.

Question 6

Inventory loss

Answer 6

Inventory loss: an expense incurred when the inventory count shows a figure for inventory on hand that is less than the balance shown in the inventory card.

Reasons:

1. theft
2. Damage / spoilage / breakage
3. Undersupply from a supplier
4. Over supply to a customer.
5. Recording error

Question 7

Inventory Gain

Answer 7

Inventory gain: a revenue earned when the inventory count shows a figure for inventory on hand that is more than the balance shown in the inventory card.

Reasons:

1. Oversupply from supplier
2. Undersupply to customer
3. Recording error

Question 8

Internal control procedures relating to Inventory

Answer 8

1. Check Order Form (issued by business) and Delivery Docket match (issued by supplier) to prevent under supply from supplier.
2. Complete a physical count on arrival to ensure number matches Order Form and Delivery Docket) to prevent under supply from supplier.
3. Complete physical count of inventory leaving the business to prevent over delivery to client, ensure matches order form from client if one exists.
4. Hire an Inventory Manager and make it their responsibility to ensure correct processes are followed.
5. CCTV in storeroom to discourage theft.Preventative measures such as locks to prevent theft.

Question 9

First in First Out - which unit cost is used?

Answer 9

Sales, Stock Loss, Advertising, Drawings all FIFO

Sales Return - LOFI - the cost of each inventory item will be calculated by using the latest cost prices shown in the OUT column of the inventory card (reversing the last out)

Inventory gains - are to be determined by using the latest cost recorded in the IN column of the inventory card. This follows the qualitative characteristic of faithful representation.

Question 10

When to use Identified Cost?

Benefits and Costs

Answer 10

Identified Cost is used when it is practical (both cost and time wise) and possible (i.e., individual units of inventory can be easily identified)

Benefit: With every single unit of inventory being marked in order to identify it when it leaves the business, Identified Cost is accurate and neutral providing a Faithful representation of the value of inventory.

Costs:

Not always possible to mark individual items of inventory – e.g. if they’re sold in weight or volume such as petrol.

Administration costs – marking each individual unit of inventory requires time, resource and staff which all incurs added expense.

Question 11

When to use FIFO?

Benefits and Costs

Answer 11

First In First out is used when it is impractical (both cost and time wise) and impossible (i.e., individual units of inventory cannot be easily identified, such as petrol)

Benefits:

It can be applied to all types of inventory

Lower administration costs than identified cost.

Unit costs are still verifiable by a source document; therefore, FIFO also provides a faithful representation of the value of inventory.

Costs:

No way of knowing if the cost prices allocated at the time of the sale are in fact those which applied to those individual items of inventory at the time of their purchase, which can negatively impact accuracy of information.

Question 12

The effect of alternative inventory valuation methods and cost assignment methods on the accounting equation.

Answer 12

FIFO over IC, in an environment of rising prices

Lower cost of sales and Higher Net Profit (Owner’s Equity)

Higher inventory valuation in the Balance Sheet

Because, it is assumed that the cheaper inventory is sold first, IC would identify that more expensive inventory was sold first.

FIFO over IC, in an environment of falling prices

Higher cost of sales and Lower Net Profit (Owner’s Equity)

Lower inventory valuation in the Balance Sheet

Because, it is assumed that the more expensive inventory is sold first, IC would identify that less expensive inventory was sold first.

Question 13

Period Cost / Costing

Answer 13

a cost incurred in getting inventory into a condition and location ready for sale that _cannot_ be allocated to individual units of inventory on a logical basis.

Question 14

Product Cost / Costing

Answer 14

a cost incurred in getting inventory into a condition and location ready for sale that _can_ be allocated to individual units of inventory on a logical basis.

Question 15

Lower of Cost and Net Realisable Value rule

(inventory valuation)

Answer 15

Inventory should be value at either its original unit Cost**, or its **Net Realisable Value (NRV), using whichever is lower.

Question 16

Net Realisable Value

Answer 16

Estimated selling price minus estimated direct selling expenses (e.g. advertising etc).

Question 17

Reasons that the NRV might fall below the cost

Answer 17

• Damage or physical deterioration
• A purposeful decrease in selling price
• A decrease in demand
• Obsolescence.

Question 18

Inventory Turnover

Answer 18

The average number of days it takes for a business to sell its inventory or convert its inventory into sales.

Question 19

Inventory management strategies

Answer 19

Maintain an appropriate inventory mix – change from season to season as tastes and preferences change, so business must stay up to date.

Promote the sale of complementary goods – this represents an add on sale that is generated from the original sale.

Ensure inventory is up to date – must stop current version, moving older versions.

Rotate inventory – positioning of inventory in the store can impact sales.

Determine an appropriate level of inventory on hand – too low, leads to loss of sales as customers go elsewhere, too high can result in inventory loss or write-down.

Market strategically and effectively / ethically – in the right way to the right customers should ensure sales.

Appoint an inventory manager – has responsibility for record keeping including checking the documents to ensure goods ordered and charged for are delivered, conducting inventory counts and ensuring relevant inventory handling procedures are followed and effective.

Question 20

Net Sales Revenue or Sales Revenue

Answer 20

Sales (Revenue) - Sales Return