Topic 8 - Introduction to Inventory and Non-Current Assets

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This article is a topic within the subject Accounting 1A.

Contents

Required Reading

Trotman, K. & Gibbins, M., 2009 Financial Accounting: An Integrated Approach, 4th edition, Melbourne: Thomson Nelson ITP pp. 387-437.

Inventory

Inventory are assets;

  • Held for sale
  • In the process of production that will lead to a sale/product
  • In the form of raw materials or supplies to be consumed in the production process

Measurement

Inventory is measured at the lower of cost or net realisable value

Cost = Purchase price + Import Duties + Costs of Conversion + Inward Transport Costs - Trade Discounts

Perpetual Inventory Control Method

The perpetual control method shows how many items are on hand at any times. This is because when inventory is received, it is added to quantity on hand. When inventory is sold, it is deducted from quantity of hand

  • Opening Quantity + Purchased Quantity - Sold Quantity = Closing Quantity

At any time, a physical count should match records, if it is not an adjusting entry must be made

  • Shortage - DR Shortage Expense, CR Inventory
  • Overage - DR Inventory, CR Overage Revenue

The only disadvantages of this method in comparison to the periodic method is that it is more complicated and required more record keeping (costly)

This is an example from the prescribed textbook [1] that shows the perpetual inventory control method in action as well as accounts receivable (AR) control

Perpetual.jpg

Periodic Count Method

In the periodic method, no continuing records of inventory are kept on hand. This means accounts cannot be reconciled (with a physical count) causing less internal control, but it is cheaper and simpler.

  • Opening Inventory (Counted) + Purchases (Recorded) - COGS (Deduced) = Ending Inventory (Counted)

This may be suitable for high volume low cost inventory firms, e.g. Woolworths or Coles. However, with the rise of computer systems, more companies are switching to the perpetual method

Here is the same example[2] just with using the periodic method (please refer to the first picture for the required information under transaction totals (EXAMPLE) In this case the inventory shortage is not discovered and is just included in the cost of goods sold

  • COGS = 23,000 + 114,000 - 28,000 = 109,000 (management will not know that 9000 is due to an inventory shortage)

Periodic.jpg

Inventory Valuation And Cost of Goods Sold - Cost Flow Assumptions

Total Cost = Quantity x Unit Cost. Because it is costly (time and resources) firms do not track the cost of each individual item. Hence a cost flow must be assumed.

First in First Out (FIFO)

The first items acquired are the first ones sold. This means that ending inventory will consist of the most recently acquired goods and cost of goods sold is made up of the earliest acquired goods.

  • In times of inflation - cost of goods sold is lower (in comparison to the other cost flow assumptions), profit is higher and inventory valuation is higher
  • In times of deflation it is the exact opposite

Weighted Average Cost Method

Assumes that ending inventory and cost of goods sold are a mixture of old and new units

Last in First Out (LIFO)

The last items acquired are the first ones sold. This means that ending inventory is made up the earliest acquired goods and cost of goods sold is made up of the latest acquired goods.

  • In inflationary times - COGS are higher, profit is lower and inventory is valued lower
  • In times of deflation it is the exact opposite.

Summing up Measurement of Inventory

There are 6 ways inventory and cost of goods sold is valued. This is because a firm can choose between periodic and perpetual and then must choose between FIFO, Weighted Average or LIFO.

INVA.jpg

Inventory Valuation Textbook Example - All 6 Methods

This example is from page 398 of the textbook[3]. I have summarised the example and included all working. Please note that FIFO (whether periodic or perpetual) will give the same answer).

It is highly recommended that you use the inventory card methods taught in the lectures to ensure that you minimise the chances of making errors

Note: With perpetual the weighted average cost changes at each purchase. With LIFO the last goods purchase price changes with each purchase.

Minv.jpg

Minv1.jpg

Non Current Assets - Property, Plant And Equipment & Intangibles

Types of Non-Current Assets

  1. Property, Plant and Equipment (PPE)
  2. Intangibles
  3. Long Term Investments

Property, plant and equipment items are held for use in the production or supply of goods and services, for rental to others or for administrative purposes

  • They are tangible
  • Expected to be used during more than 1 period

Initial Recording And the Cost of an Asset

Under historical cost accounting, the asset at the lower of cost and net realisable value. Cost = Purchase Price + Any costs directly attributable to bringing the asset to the location and conditions necessary for it to be used as intended by management

  • Additional capital expenditure that improves or betters the asset may increase its recorded cost.

Depreciation

Depreciation is the allocation of the assets cost over the assets useful life (matches revenues with expenses to smooth out profit figures).

  • Depreciation - physical assets
  • Depletion - wasting assets (timber, ore bodies)
  • Amortisation - intangibles

To estimate depreciation we need some information:

  • Useful Life
  • Residual/Salvage Value - Depreciable Amount = Cost - Residual Value
  • Flow of Benefits over useful life

As we incur a depreciation expense it is added to the accumulated depreciation account (contra asset) which reduces the net value of the asset, representing its 'depreciation'

There are 3 methods of depreciation as shown in the image below

Dep.jpg

Gains/Losses on Asset Disposals

[4]

Perhaps beyond this course (more applicable to ACCT1511 - Accounting 1B), is the recording of asset disposals. The difference between book value (cost - accumulated depreciation) and the selling price. If the selling price is higher a gain is recorded, if it is lower a loss is recorded. This is how a disposal is recorded:

Disposal.jpg

Intangible Assets

[5]

Intangible assets are identifiable, non monetary assets that don't have a visible physical existence. If the intangible has a finite life is is 'amortised' (in the same was as a physical asset is depreciated). If it has an infinite life it is tested annually for impairment (loss of value)

Goodwill

Goodwill arises when a firm pays more than the book value of an asset. It is needed to balance assets with liabilities and equity (accounting equation). A firm may not record internally generated goodwill.

End

This is the end of this topic. Click Accounting 1A to go back to the main subject page for Accounting 1A

References

Textbook refers to Trotman, K. & Gibbins, M., 2009 Financial Accounting: An Integrated Approach, 4th edition, Melbourne: Thomson Nelson ITP

  1. Trotman, K. and M. Gibbins. Financial Accounting: An Integrated Approach, Thomas Nelson, Fourth Edition 2009
  2. Trotman, K. and M. Gibbins. Financial Accounting: An Integrated Approach, Thomas Nelson, Fourth Edition 2009
  3. Trotman, K. and M. Gibbins. Financial Accounting: An Integrated Approach, Thomas Nelson, Fourth Edition 2009
  4. Trotman, K. and M. Gibbins. Financial Accounting: An Integrated Approach, Thomas Nelson, Fourth Edition 2009
  5. Trotman, K. and M. Gibbins. Financial Accounting: An Integrated Approach, Thomas Nelson, Fourth Edition 2009
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