Chapter 9 - Inventory

 Inventory - every companies need inventory be it a manufacturing or trading one😊. A Service company may need inventory but inventory costs will not be a high porportion of its total costs, a hair saloon may have shampoo or clips but its main costs will still be the hairdressers wages.👩

When a business purchase inventory, the double entry are as such: -

Dr Inventory                                                           XX

Cr Cash at bank/ Trade payable                                                         XX

When a business returns inventory 

Dr Cash at bank/trade payable                       XX 

Cr Inventory                                                                          XX

☝Question: - 

☝ Question - When a customer returns goods why isn't the Cost of sales and inventory account affected? 

Ans: Its because the business like the prev example above has purchases of 200 squids and also sale pf 200 squids which has already take place and cannot be reversed/adjusted.

 Instead we Debit Sales returns when a customer returns goods as, it will reflect a reduction to the business sales as such in the income statement: -

 

☝Question - When do we adjust the inventory account?

Ans: when we return goods back to Suppliers, the double entry is as follow:- 

Dr Trade Creditor/Supplier     $XX

Cr Inventory                                           $XX 

💨Which brings us to the next point, what are the items inside inventory account other than the cost of the product?

1. Freight/transport costs of bringing the good to the company 

2. Import duties or custom duties 

3. Insurance 

4. Packing materials 

5. Salaries paid to workers to process the goods to finished product

💨FIFO - First In First Out    

What is FIFO, it means First In First Out - it is a method to calculate the cost/product as part of the cost of sales. A business say for example that buys & sell Squid -- I like squid lah haha, the purchase price cannot always be the same right? Henceforth how do we determine the cost of the squid everytime we sell? The FIFO method assumes that the cost of the squid that is sold will be based on the earliest purchase  batch of the squid, until the earliest batch of  purchase is finish, then it will move to the 2nd batch of earliest purchase as its cost price.

☝Question - 

The total inventory at month end is $300.

Impairment/loss/Fire

💨Whenver we are asked to value stock, people always say "Lower of cost or Net book value lor, so easy"

But exactly whats that huh?

Let me explain - Cost refers to the initial/historical purchase price that is the price that was sold by supplier to you ;

Net book value would refers to Selling price less additional costs to bring the stock to its current condition. The selling price could be a market price, i.e.  the price that the stock can fetch at current market condition less selling cost.

See if either the costs is lower or the Net Book Value is lower then we will apply the lower of the 2 values.

For e.g. our stock costs is $500 current however its net book value( Selling price - selling costs) is $450, we will have to choose $450.

Henceforth impairment has occured because our stock in our balance sheet current asset is still $500 while the net book value is $450 , a reduction of $50.

we will need to pass our impairment journals : -

Dr  Impairment loss( Income Statement)                  $50 

Cr  Inventory/Stock( Balance sheet)                                        $50

☝Why is impairment needed?

Ans: it is because we need to fulfil the prudence accounting principle in that we should not overstate assets and undervalue our liabilities as this will present a wrong balance sheet information to user of our financial statements. 

☝Ok, what happens when we don't pass impairment losses above? 

Ans: Our profit and inventory values will be overstated by $50.

Test your understanding - try doing this question

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