Accounting for Inventories
Accounting, the business process of recording and managing accurate and organized
documentation of financially related records, is one of the pinnacle aspects of ensuring a business's present strength and capacity for future growth. Retailing firms need accurate accounts of financial accounts to remain competitive in their respective industries. Proper analysis of inventory is equally vital towards a business's financial health.
The importance of inventory upkeep cannot be understated. A business owner must have the proper information regarding inventory in order to make efficient and cost-effective decisions. Inventory accounting for a retail company includes several initial processes including the determining of inventory items, as well as determining inventory costs through cost flow assumptions or inventory techniques.
The first action taken to account for inventory is determining which items will be entered into inventory. While conducting a count of items in an inventory, the exact location of the goods to be included is not relevant provided the company or firm has ownership of the goods. In some cases the purchaser is responsible for freight charges and ownership is passed from the supplier to the purchaser at the time the goods are loaded. This method is known as FOB shipping point where FOB is an abbreviation for "freight on board". FOB destination means that the supplier is charged with the shipping fees and ownership of the goods would pass from supplier to purchaser when the shipment arrives at the purchaser's place of business. Damaged goods, defective goods, and other unsalable items are not included into the count of inventory items. However, damaged items that can be sold at a lessened sale price can be included under a value of the items estimated worth.
After the inventory items are identified, the cost of these items must be identified. These costs include direct and indirect costs and various other costs that are incurred to get an item ready and in good condition to sell. Four techniques for inventory costing are often taught in basic accounting textbooks and among these techniques are standardized procedures to maintain an accurate count of each item and to ensure that there are no excluded goods or when preparing the necessary financial statements. Although most accounting rules are standardized to eliminate confusion, cost flow management decisions within a particular business can be prepared through a number of different methods. Depending on a business's industry and managerial preference a different method can be applied, although consistency from one accounting period to another is very important. This consistency concept, as it were named, insists that by applying the same method over stretches of accounting periods, the resulting data is easily comparable to previous statements. This concept also explains that different methods can be utilized towards different components of a firm's inventory. The four most common techniques or cost flow assumptions are weighted average, first in-first out, last in-first out, and specific identification. These inventory techniques all address the importance of calculating the per-unit cost associated with each inventory item.
The weighted average technique, sometimes referred to as the average cost, is performed by taking the total cost of inventory goods available and dividing that value by the total number of goods available for sale. The resulting value is from this weighted average cost is the cost per-unit and this value is used at the time of each sale. This method is logical in its approach and is easily applied to large inventories.
Last in-first out, commonly known as LIFO, is performed by using the cost of the most recently purchased goods as the cost of goods sold and older items are assigned or remain in inventory. This technique takes the last cost entered because in most instances the cost will increase over time with inflation and represents the most updated portrayal of market price. This technique can help reduce taxes in the short term through diminished short term profits.
First in-first out, or FIFO, uses the cost of the oldest remaining inventory items to construct a cost of goods sold equation. The most recently entered items remain in inventory. This methods is used under the assumption that the first items entered into inventory will be the first sold.
The final method of cost flow assumptions is known as specific identification or specific invoice inventory pricing. Specific identification is typically used for more expensive purchases such as real property or purchases that are easily linked to a specific invoice. This cost method uses the exact price the item was purchased for and assigns to costs of goods sold.
These four techniques used to calculate inventory costs can have slightly different effects on the financial statements constructed. The underlying factor that determines the extent of the differing figures in the financial statements is directly related to the intensity in change of an items price during a given accounting period. The figures projected in the income statements and balance sheets over longer spans of time can be significantly different under different cost assumptions.
Accounting for Inventories
By: Matthew
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