Inventory and Depreciation

Inventory and Depreciation - Transcript

Inventory and Depreciation

Inventories Three Types


Material Inventory Items of material that are to become a part of the ultimately salable goods that result from the manufacturing process Work in Process inventory Goods that have started through the manufacturing process but have not been finished Finished Goods Inventory Goods that have been manufactured but have not yet been shipped to customers





Material Inventory Balance as on 1st Apr 07 Purchases Raw material Balance as on 30th Apr 07 154 273 163 Work in Progress Inventory 19 264 330 43 Finished Goods inventory 69 570 264 154 273 163

Balance as on 1st Apr 07 Material Used Conversion Cost Balance as on 30th Apr 07

570 19 264 330 43

Balance as on 1st Apr 07 Goods Manufactured

573 69 570 66

Balance as on 30th Apr 07

66 Cost of Goods Sold 573

Periodic inventory
A physical count is made of merchandise in the ending inventory and the cost of this inventory is determined

Perpetual Inventory
A record is maintained of each item carried in the inventory Advantages of perpetual inventory 1 Detailed record is prepared for each item 2 It has built in check for inventory 3 Income statement can be prepared without taking physical

Effect of inventory Error
An error in the inventory will misrepresent the cost of sale gross profit net profit current asset and equity

Determining the physical inventory
Physical counting of all the items related to the inventory Goods in transit In case of FOB destination goods are treated as goods in transit till it reaches to the buyer Goods on consignment Goods out on consignment are part of consigner s inventory

Different Methods




Specific Identification Method First in First Out FIFO Method Weighted Average Method Last in First Out LIFO Method not allowed in India Standard Cost Method Adjusted Selling Price Method Retail Method

Specific Identification Method Units Inventory as on 1st April 07 Purchased on 1st June 07 Purchased on 1st Oct 07 Goods available for sale Goods sold during the year Ending inventory 100 60 80 240 150 90 Unit Cost Total Cost 8 9 10 12 800 540 800 2140 1800 790

If sold item is 50 unit of opening 50 units from 1st june purchase and 50 units from 1st Oct purchase Inventory Cost will be Inventory as on 1st April 07 Purchased on 1st June 07 Purchased on 1st Oct 07 Total

50 10 30 90

8 9 10

400 90 300 790

Average Cost method Units Inventory as on 1st April 07 Purchased on 1st June 07 Purchased on 1st Oct 07 Goods available for sale Goods sold during the year Ending inventory Cost per unit Inventory Cost will be 100 60 80 240 150 90 Unit Cost Total Cost 8 9 10 12 800 540 800 2140 1800 802 5

8 916667 2140 240 802 5

First In First Out Units Inventory as on 1st April 07 Purchased on 1st June 07 Purchased on 1st Oct 07 Goods available for sale Goods sold during the year Ending inventory Inventory Cost will be Purchased on 1st June 07 Purchased on 1st Oct 07 Total Inventory Cost will be 10 80 90 890 9 10 90 800 890 100 60 80 240 150 90 Unit Cost Total Cost 8 9 10 12 800 540 800 2140 1800 890

Last In First Out Units Inventory as on 1st April 07 Purchased on 1st June 07 Purchased on 1st Oct 07 Goods available for sale Goods sold during the year Ending inventory Inventory Cost will be Inventory as on 1st April 07 Total Inventory Cost will be 100 60 80 240 150 90 Unit Cost Total Cost 8 9 10 12 800 540 800 2140 1800 720

90 90 720

8

720 720

EFFECT OF INVENTORY METHOD ON PROFIT Specific Identificat Average ion Cost Method method Sales Inventory as on 1st April 07 Purchases Cost of goods available for sale Less ending Inventory Cost of goods sold Gross profit 1800 800 1340 2140 790 1350 450 1800 800 1340 2140 802 5 1337 5 462 5

First In Last In First Out First Out 1800 800 1340 2140 890 1250 550 1800 800 1340 2140 720 1420 380

Fixed assets
A fixed assets is an assets that is held with the intention of being used for the purpose of producing or providing goods or services and not held for sale 1 Tangible assets 2 Intangible assets 3 Natural assets

Cost of assets includes the following
Stamp duty Lawyer s fee Commission and brokerage Cost of site Freight transit insurance initial delivery cost Installation charges Professional fee

Capitalisation of Borrowing cost
Borrowing costs are interest and other costs such as commitment charges incurred by an enterprises in connection with the borrowing of funds There are following rules for capitalisation a Capitalise borrowing costs that are directly attributable to a qualifying asset b suspend capitalisation of borrowing costs during extended period c Stop capitalisation of borrowing costs when the construction of asset complete

Basket Purchases
An Enterprises may buy a group of fixed assets for a composite sum In such cases the total purchase price to the various assets on the basis of their relative fair market value

Donated Assets should be recorded at a nominal value Self constructed assets should be capitalised on costs directly can be identified as direct material cost and direct labour cost

Accounting for depreciation
Depreciation is a allocation of the cost of asset to the periods that are expected to benefit from its use It is the gradual conversion of the cost of an asset into expenses The depreciation accounting process involves the following steps 1 Establishing the depreciable base 2 Estimating the useful service life 3 Choosing an appropriate cost allocation method

Depreciation Method
The following depreciation methods are commonly used a Straight line method b Accelerated method written down method sum of the year s digit method c production units method

Straight Line Method
Cost Residual Value Useful Life Cost of plant 8 00 000 Residual value 80 000 Life of plant 6years Depriciation 8 00 000 80 000 1 20 000 6 Depreciation

Written Down Value
Depreciation rate 1 6 80 000 8 00 000 1 0 6813 0 3187 or 31 87

Sum of the years digit method
cost Residual value year Sum of the digit 1 6 Ist yr 8 00 000 80 000 Rs 2 05 714 6 1 2 3 4 5 6

Production units method
The depreciable amount of an asset is divided by the total estimated out put

COMPARING THE DEPRECIATION Method Straight line method Advantage Esay to apply suitable for assets that depreciate with time Higher in early years when asset is more productive Suitable for asset that have high obsolescene Matches expenses related with out put Disadvantage Undercharge in early years Smoothens Income Produces volatility in profit

Accelarated Method

Production unit method

High record keeping cost not acceptable in Govt

Special Accounting Treatment
Computing depreciation for partial accounting period Revising estimated useful life Accounting for assets of low unit cost Changing the depreciation method Applying group depreciation Accounting for fully depreciated assets

Capital and Revenue expenditure
Capital Expenditure are expenditure for the acquisition of fixed assets and are recorded in the asset accounts Revenue Expenditure are expenditure for ordinary repairs maintenance fuel insurance etc

Disposal of depreciable assets
A Discarded B Sold for cash C Exchanged for another assets

Revaluation of assets
Selective revaluation of assets can lead to unrepresentative amounts being reported in financial statement When a firm revalues a fixed asset it should either revalue an entire class of assets or select assets for revaluation on asystematic basis and disclose this basis

Intangible assets
An Intangible asset is an identifiable non monetary asset without physical substance held for use in the production or supply of goods or services Brand names trademarks copyrights softwares licenses patents goodwill

Impairment of assets
If the value recoverable from future use of an asset is less than its carrying amount there is an impairment loss The impairment loss is recognised by writing down the book value of the impaired asset