Introduction to Inventories, Inventory Record Systems and Inventory Valuation
Objectives After going through this lesson, you shall be able to understand the following concepts.
• Meaning of Inventory
• Inventory Record SystemPeriodic Inventory System Perpetual Inventory System
• Valuation of Inventory Introduction We all must have heard the term ‘inventory’. Up till now, to simplify things, we have regarded the term ‘inventory’ synonymous to the term ‘stock’. However, there exists a hairline difference between the two terms. In this lesson, our main focus will be to explore this difference. Besides this, we will be going through the meaning and the basic objectives of the inventories. In the later part of this lesson, we will be shifting our focus towards the methods of recording inventories and its valuation. So, let us head towards the concept of inventory.
Meaning of Inventory The basic meaning and definition of inventory have been presented in the note below.
Types of Inventories On the basis of our understanding of the above note, we can enlist the items that are included in inventories. The various types of inventories are listed below.
a. Finished Goods: These include goods that are in saleable form and are readily sold.
b. Raw Material: These are primarily used in the production process of the final product.
c. Work-in-Progress (WIP): These include goods that are partially completed and further value addition is to be done to transform them into the final goods.
d. Other Items: These include items such as stores, spares, packaging materials, etc.
The types of inventories vary from one business to another on the basis of the nature of the concerned business. For instance, the types of inventories of a manufacturing business are not the same as that of a trading business. This is because a manufacturing business considers finished goods, raw material, WIP and other items (such as stores and spares), whereas a trading business regards finished goods as the only type of inventory. This difference has been highlighted in the diagram given below.
Example 1: Which of the following is not included in the inventory?
(a) Stores and spares
(b) Raw material
(c) Repair of machinery
Solution Inventory includes finished goods, work-in-progress, raw material and stores and spares and the related expenses. However, it does not include the expenses that are related to the fixed asset such as machinery, land & building etc. Hence, the correct answer is option (c).
Inventory System It refers to the system through which the value of the inventory is ascertained at the end of the year. The two commonly adopted inventory systems are as follows.
1. Periodic Inventory System
2. Perpetual Inventory System
Periodic Inventory System Under this system, no records of inventory are maintained and inventory is ascertained on the basis of the actual physical counts. It is also known as Physical Inventory System due to the ascertainment of inventory on the basis of physical counts. Thus, Cost of Goods Sold is ascertained by using the formula presented below.
Advantages and Disadvantages of Periodic Inventory SystemAdvantages Disadvantages 1. Suitable for small organisations 1. Continuous stock checking is not possible 2. Simple and commonly used 2. Requires closure of other works while counting inventory 3. Inventory Control is not possible
Perpetual Inventory System Under this system, inventory is recorded through a stock ledger, which records each and every receipt and issue of inventory. Accuracy of the inventory records can be ascertained by comparing the physical record with the recorded balances. Closing inventory can be …
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