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Inventory and Costing Methods

The document provides an overview of inventory management and costing methods, highlighting the importance of accurate inventory recognition and measurement for financial reporting. It outlines various inventory costing methods such as FIFO, LIFO, and WAC, along with the implications of each method on financial statements. Additionally, it discusses inventory valuation adjustments, systems, internal controls, and presentation in financial statements to ensure compliance and profitability.

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CASAMAYOR JOVELYN B.
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46 views4 pages

Inventory and Costing Methods

The document provides an overview of inventory management and costing methods, highlighting the importance of accurate inventory recognition and measurement for financial reporting. It outlines various inventory costing methods such as FIFO, LIFO, and WAC, along with the implications of each method on financial statements. Additionally, it discusses inventory valuation adjustments, systems, internal controls, and presentation in financial statements to ensure compliance and profitability.

Uploaded by

CASAMAYOR JOVELYN B.
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd

Inventory and Costing Methods

I. Introduction

Inventory is a critical component of financial accounting, representing goods held for sale or
production. Proper inventory management and costing methods ensure accurate financial
reporting and profitability analysis.

II. Definition of Inventory

Inventory refers to assets held by a business for sale in the normal course of operations or for
use in production. It includes:

1. Raw Materials – Items used in the manufacturing process.


2. Work-in-Process (WIP) – Partially completed goods.
3. Finished Goods – Completed products ready for sale.
4. Merchandise Inventory – Goods purchased for resale (for trading businesses).

III. Inventory Recognition and Measurement

A. Initial Recognition

● Inventory is recognized when control of goods is obtained.


● Cost includes purchase price, import duties, transport costs, and handling
expenses.

B. Subsequent Measurement

● Inventory is reported at the lower of cost or net realizable value (NRV):


○ Cost: The amount paid to acquire the inventory.
○ NRV: Estimated selling price minus costs to sell.

IV. Inventory Costing Methods

Companies use different costing methods to value inventory and calculate the cost of goods
sold (COGS).

A. Specific Identification Method

● Used for unique or high-value items (e.g., cars, jewelry).


● Tracks each item individually.
B. First-In, First-Out (FIFO)

● Assumes oldest inventory is sold first.


● Ending inventory consists of the most recent purchases.
● Effects:
○ Higher net income when prices are rising.
○ Lower cost of goods sold (COGS) in an inflationary environment.
○ Higher tax expenses due to increased profits.

C. Last-In, First-Out (LIFO) (Not allowed under IFRS)

● Assumes newest inventory is sold first.


● Ending inventory consists of older purchases.
● Effects:
○ Lower net income when prices are rising.
○ Higher COGS in an inflationary environment.
○ Lower tax expenses due to reduced profits.

D. Weighted Average Cost (WAC)

● Calculates an average cost per unit after each purchase.


● Formula:
Average Cost per Unit = Total Cost of Inventory / Total Units Available
● Effects:
○ Smooths out price fluctuations.
○ Used frequently in manufacturing and bulk inventory businesses.

E. Retail Inventory Method

● Uses the cost-to-retail ratio to estimate ending inventory.


● Commonly used in retail businesses.

V. Inventory Valuation Adjustments

A. Inventory Write-Downs

● If NRV < Cost, inventory is written down to NRV.

Example journal entry:


Loss on Inventory Write-Down XXX

● Inventory XXX

B. Inventory Obsolescence

● Obsolete or damaged inventory must be removed from accounting records.

C. Reversal of Write-Downs
● Allowed under IFRS but not under GAAP.
● If NRV increases, the write-down can be reversed.

VI. Inventory Systems

A. Perpetual Inventory System

● Updates inventory records in real-time after each transaction.


● Used with barcode scanning and inventory software.
● Provides continuous tracking of inventory levels.

B. Periodic Inventory System

● Updates inventory at the end of an accounting period.


● COGS is calculated as:
COGS = Beginning Inventory + Purchases - Ending Inventory
● Suitable for small businesses with low inventory turnover.

VII. Internal Controls for Inventory

1. Physical Inventory Counts – Regular stocktaking to verify records.


2. Segregation of Duties – Different employees handle purchasing, receiving, and
recording.
3. Inventory Monitoring Systems – Use of RFID, barcodes, and software.
4. Security Measures – Restricted access to inventory storage areas.
5. Audit Procedures – Regular internal and external audits.

VIII. Presentation in Financial Statements

● Inventory is classified as a current asset on the Balance Sheet.


● COGS is reported in the Income Statement.
● Notes to Financial Statements provide details on inventory policies and methods used.

IX. Conclusion

Inventory valuation and costing methods are crucial for accurate financial reporting. Companies
must select appropriate methods based on industry practices, taxation, and financial objectives
to ensure profitability and compliance.

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