Goods not sold at the period end are closing inventory: this is deducted from purchases in the income statement. The same figure appears on the balance sheet as a current asset.
Goods brought forward from the previous period are opening inventory. This is added to purchases in the cost of sales calculation in the income statement.
Grossprofit is thus:
Sales revenue X
Opening inventory X
Less: Closing inventory (X)
Cost of sales (X)
Gross profit X
Entries are only ever made to the inventory ledger account at the end of the accounting period when the openinginventory is transferred to the income statement and the closing inventory is entered into the inventory account.
1. Types of inventory
• goods purchased for resale
• consumable stores (such as oil)
• raw materials and components (used in the production process)
• partly-finished goods (usually called work in progress)• finished goods (which have been manufactured by the enterprise).
2. Valuing inventory
The matching concept justifies the carrying forward of purchases not sold by the end of the accounting period, to leave the remaining purchases to be ‘matched’ with sales.
The prudence concept requires the application of a degree of caution in making estimates under conditionsof uncertainty.
The amount at which inventory should be stated in the balance sheet is the lower of cost and net realisable value (NRV). The comparison between cost and net realisable value must be made item by item, not on the total inventory value. It may be acceptable to consider groups of items together if all are worth less than cost.
Cost includes all the expenditureincurred in bringing the product or service to its present location and condition. This includes:
• Cost of purchase – material costs, import duties, freight
• Cost of conversion – direct costs e.g. of materials and production overheads e.g. factory light and heat.
Net realisable value (NRV) is the revenue (sales proceeds) expected to be earned in the future when thegoods are sold, less any selling costs incurred.
Goods purchased for resale and raw materials: cost of purchase includes import duties, other taxes (unless recoverable) and transport costs; trade discounts to be deducted.
Manufactured goods or work in progress: cost includes direct labour and an allocation of production overheads.
3. Methods of arriving at cost:
•Unit cost is the actual cost of purchasing identifiable units of inventory. This method is used where inventory items are of high value and individually distinguishable.
• FIFO (first in first out) assumes that the first items of inventory received are the first items to be sold.
• LIFO (last in first out) assumes that the last items of inventory received are the first itemsto be sold.
• Average cost (or weighted average cost) assumes the cost of each item is determined from the weighted average of the cost of similar items at the beginning of the period and the cost of similar items purchased or produced during the period.
• Selling price less gross margin may be convenient for retailers for whom the selling price is more accessible than thecost price. The inventory is taken at selling price and then reduced to cost by deducting the appropriate percentage gross margin.
3.0 NON-CURRENT ASSETS AND DEPRECIATION
Non-current assets are assets of material value, and a relatively long life, which are expected to contribute to income generation over a number of years.
3.1 Classification of non-current assets