Measurement of Inventory

1 Introduction

The measurement of inventory can be extremely important for financial reporting, because the measurements affect both the cost of sales (and profit) and also total asset values in the statement of financial position. There are several aspects of inventory measurement to consider:

• Should the inventory be valued at cost, or might a different measurement be more appropriate?
• Which items of expense can be included in the cost of inventory?
• What measurement method should be used when it is not practicable to identify the actual cost of inventory?

IAS 2: gives guidance on each of these areas.

Inventory

1 Definition of inventory

The nature of inventories varies with the type of business. Inventories are:

• Assets held for sale. For a retailer, these are items that the business sells – its stock-in trade. For a manufacturer, assets held for sale are usually referred to as ‘finished goods’
• Assets in the process of production for sale (‘work-in-progress’ for a manufacturer)
• Assets in the form of materials or supplies to be used in the production process (‘raw materials’ in the case of a manufacturer).

IAS 2: Inventories sets out the requirements to be followed when accounting for inventory.

Correction of Errors

Errors in the double entry accounting system

Errors can occur in a book-keeping system, because individuals make mistakes.

The types of error that will appear in the accounting records can be classified into four broad categories:

•  Errors of transposition
•  Errors of omission
•  Errors of commission
•  Errors of principle

Bank RECONCILIATIONS

The cash book (bank account in the general ledger) and bank statements

The cash book is a book of prime entry used to record all receipts and payments of cash.

There are many different methods by which a business might make payment to suppliers and receive payment from customers.

Methods include

Control accounts and control account Reconciliations

The receivables control account

The receivables control account is an account for recording the value of transactions in total with credit customers. The balance on the receivables control account (debit balance) is the total amount currently owed by all customers.

The receivables control account will contain some or all of the totals to date for all

of the following postings to the account.

 Illustration:

receivables control account

Some other Issues of Inventory

• Valuation of inventory

Basic rule

The valuation of inventory can be extremely important for financial reporting, because the valuations affect both the cost of sales (and profit) and also total asset values in the statement of financial position.
Inventory must be measured in the financial statements at the lower of:

• cost, or

• net realisable value (NRV).

END-OF-YEAR ADJUSTMENTS for INVENTORY

Recording inventory

In order to prepare a statement of comprehensive income it is necessary to be able to calculate gross profit. This is done by comparing the sale proceeds from the sale of items of inventory to the cost of those items. This is an application of the accruals concept (matching principle).

In order to calculate gross profit it is necessary to record opening inventory, purchases and closing inventory.

There are two main methods of recording inventory.

•  Periodic inventory method (period end system)
•  Perpetual inventory system

UNEARNED Income and ACCRUED Income

Introduction

A business may have miscellaneous forms of income, for example, from renting out property.

When a business entity has income from sources where payments are made in advance or in arrears. The accruals basis of accounting applies, and the amount of income to include in profit and loss for a period is the amount of income that relates to that period. It may therefore be necessary to apportion income on a time basis and there may be unearned income or accrued income to account for.