Module 4

Special Areas in Accounting

1. Inventory
2. Receivables
3. Fixed assets
Inventory
• Inventory classification
• Classification based on degree of completeness
• Merchandise inventory
• Manufacturing inventory
• Raw material
• Work in process
• Finished goods
• Determination of inventory Quantities – costing, accounting, and
presentation
• Taking physical inventory
• Determining ownership of goods
Determination of inventory Quantities
Taking physical inventory
• Periodic inventory system - at the end of the accounting period
• Perpetual inventory system – before each sale
• Involves actual counting, weighing or measuring each kind of inventory on hand
• Required to check the accuracy of inventory records and to determine the amount
of inventory lost due to wastage, theft etc.

Determining ownership of goods

• Do all goods included in the count belong to the company?
• Does the company own any goods that are not included in the count?
• Goods in transit
• Consigned goods
Goods in Transit

• FOB (Free On Board) shipping point

• Ownership passes to buyer when the public carrier accepts the goods from the seller
• FOB (Free On Board) destination
• Ownership remains with the seller until goods reach the buyer

Eg. Hargrove co. has 20,000 units of inventory on hand on Dec 31. it also has the following
goods in transit.(a) sales of 1500 units shipped on Dec 31 FOB destination and (b)
purchase of 2500 units shipped FOB shipping point on Dec 31

What is the quantity of inventory on the hand of Hargrove co.?

Consigned Goods

• Holding the goods of other parties and try to sell the goods for them
for a fee, but with out taking the ownership of the goods
• Eg. Used car to sell
Determination of inventory cost – costing
methods(inventory cost flow methods)
First-in, First-out (FIFO)
• Goods purchased first are to be sold first
• Closing stock is based on the price of the most recent units purchased
Last-in, First-out (LIFO)
• Latest goods purchased are the first to be sold
• Closing stock is based on the price of the oldest units purchased
Average cost
• Assumes goods are similar
• Allocates cost of goods available for sale on the basis of weighted average unit cost
• Weighted average unit cost = cost of goods available for sale /Total units available for
sale
• Cost of goods sold= (opening Inventory + purchase)- closing inventory

• Cost of goods available for sale = cost of goods sold + cost of closing
inventory
Financial statement effects of Costing methods
Income statement effects
• During inflation, FIFO produces higher NI - because lower unit costs
of first units purchased are matched against revenue (produces paper
profit – earnings that do not really exist)
• During inflation, LIFO produces lower NI - because higher unit costs
of last units purchased are matched against revenue
• If prices are falling – effects will reverse
• Irrespective of whether prices are rising or falling, average cost
produces NI between FIFO and LIFO
Financial statement effects of Costing
methods
Balance sheet effects
• FIFO – Higher value of closing stock
• LIFO – Lower value of closing stock
Tax effects of Costing methods
• FIFO – higher NI- higher income tax
• LIFO - Lower NI- Lower income tax
• Consistency approach
Inventory computation
• Periodic inventory system – calculate the value of closing inventory
and cost of goods sold at the end of the period
• Cost of goods available for sale
• Cost of closing inventory and COGS
• Perpetual inventory system - calculate the value of closing inventory
and cost of goods sold prior to each sale
Periodic inventory system
Date Particulars Unit cost Total Cost
Perpetual inventory system
Date Purchase Cost of goods sold Balance
• A company has reported the following inventory, purchases and sales
data for the month of January. The physical inventory count on
January 31 shows 450 units on hand. Under periodic and perpetual
inventory systems, determine, the cost of inventory on hand on
March 31 and the cost of goods sold for March under (a) FIFO (b) LIFO
and (c ) Average cost
Beginning Inventory Jan 1 100units@Rs.10 Rs.1,000
Purchases Jan 10 200units @Rs.11 Rs.2,200
Purchases Jan 20 300units @Rs.12 Rs. 3,600
Sales Jan 25 550units  
Purchase Jan 30 400units @13 Rs.5,200
   
Inventory estimation methods
Inventory estimation is done when physical counting is not possible –
Eg. Inventory destroyed by fire or theft
• Gross profit method
• Step 1
Estimated COGS(ECOGS) = Net sales – Estimated GP
• Step 2
Estimated cost of closing inventory = COG available for sale - ECOGS
Inventory estimation methods
• Retail inventory method
• Step 1
Closing inventory at retail = goods available for sale at retail - Net sales
• Step 2
Cost-to-retail ratio = Goods available for sale at cost/ goods available for
sale at retail
• Step 3
Estimated cost of closing inventory = closing inventory at retail x cost-to-
retail ratio
Accounting Standards on Inventory
• AS2 and
• IAS 2