Basics of Inventories

IAS 2:Inventory Processing Systems
Inventory-processing systems relate to the timing of the assessment of stock. They can be valued on a continuous basis (physical count of stock will be completed after each sale) or periodically (physical count of stock will be completed at the finish of each period). For most businesses, continuous revaluation of their stock is pricey & generates tiny value. As a result, most companies evaluate their stock periodically.

The inventory-costing methods used relate to the way management has decided to evaluate the cost of their stock, for example, specific identification, average cost, first in first out (FIFO), or last in first out (LIFO). The costing process will have an impact on the estimated value of the stock on hand & the estimated cost of goods sold (CGS) reported on the income statement.

The valuation system is the method by which the stock is valued. GAAP requires stock to be valued at the lower of cost to market (LCM) valuation. Market valuation is defined as replacement cost. The choices made by management with the inventory- processing systems, the inventory-costing system & the valuation system used will affect what is reported on a company's balance sheet, net income statement (profits) & money flow statement. All these choices ought to be driven by the application of the matching principle.  these choices are sometimes driven by the owner/management tax implications (usually among private companies), or by the purpose to artificially increase a company's profitability (usually among public companies).  

Inventory Cost:

Stock cost is the net bill cost (less discounts) and any freight & transit insurance and taxes & tariffs. Stock includes not only stock on hand but also stock in transit. Furthermore, stock does not must be a done product to the included.

The cost of stock can be calculated based on:

1.  The specific identification system,
2.  The average-cost system,
3.  First in, first out (FIFO), &
4.  Last in, first out (LIFO)

GAP allows management to make use of methods to assess stock. They will use the following example to illustrate each of these methods.

Example: Company ABC bought these things in May, & sold item 102 & 103 for a total of $300:                   

                                                  

•  The Specific-identification Stock Method:

Under this stock method each unit bought for resale is identified & accounted for by its bill. Companies that use this method carryover a tiny number of units.

Cost of goods sold: $75 (ID: 102 & 103)
Ending stock: $55 (ID: 101 & 104)
Gross profit: $300-$75 = $2252 

•   Average-cost Method;

Under this stock method the units in stock are regarded as a whole & their cost is averaged out. Companies that use this method carryover a immense number of units.

•  First-in, First-out (FIFO):

Under this stock process the units that were first bought are assumed to be sold first.

Total cost: $130
Average cost: $33 per unit (total cost / total number of units)
Cost of goods sold: $66 ($33*2 units sold)
Ending stock: $66 ($33*2 units left)
Gross profit: $300-$66 = $234

• Last-in, First-out (LIFO):

Under this stock process the units that were last bought are assumed to be sold first.

Cost of goods sold: $65 (ID: 101 & 102)
Ending stock: $65 (ID: 103 & 104)
Gross profit: $300-$65= $235

Cost of goods sold: $65 (ID: 103 & 104)
Ending stock: $65 (ID: 101 & 102)
Gross profit: $300-$65 = $235

Introduction of Adjusting Entries

Introduction:

In accounting adjusting entries are journal entries usually made at the finish of an accounting period to allocate income and expenditure to the period in which they actually occurred. The revenue recognition principle is the basis of making adjusting entries that pertain to unearned and accrued revenues under accrual-basis accounting. They are sometimes called Balance Day adjustments because they are made on balance day.

Based on the matching principle of accrual accounting, revenues and associated costs are recognized in the same accounting period. However the actual funds may be received or paid at a different time.

TYPES OF ADJUSTING ENTRIES

Most adjusting entries could be classified this way:

	Prepayments (Deferral - cash paid or received before consumption)	Accrual - cash paid or received after consumption
Expenses	Prepaid expenses: for expenses paid in cash and recorded as assets before they are used	Accrued expenses: for expenses incurred but not yet paid in cash or recorded
Revenues	Unearned revenue: for revenues received in cash and recorded as liabilities before they are earned	Accrued revenues: for revenues earned but not yet recorded or received in cash

Prepayments:

Adjusting entries for prepayments are necessary to account for funds that has been received prior to delivery of goods or completion of services. When this funds is paid, it is first recorded in a prepaid expense asset account; the account is to be expended either with the passage of time (e.g. rent, insurance) or through use and consumption (e.g. supplies).

A company receiving the funds for benefits yet to be delivered will must record the amount in an unearned revenue liability account. Then, an adjusting entry to recognize the revenue is used as necessary.

 Example

Assume a journal publishing company charges an annual subscription fee of £12. The funds is paid up-front at the beginning of the subscription. The income, based on sales basis technique, is recognized on delivery. Therefore the preliminary reporting of the receipt of annual subscription fee is indicated as:

                        Debit  |  Credit
                        ----------------
Cash                     £12   |         
  Unearned Revenue             |   £12
                               |         

The adjusting entry reporting each month after the delivery is:

                        Debit  |  Credit
                        ----------------
Unearned Revenue           £1  |   
  Revenue                      |    £1   
                               |

The unearned revenue after the first month is therefore £11 and revenue reported in the income statement is £1.

Accrued revenues are revenues that have been recognized (that is, services have been performed or goods have been delivered), but their money payment have not yet been recorded or received. When the revenue is recognized, it is recorded as a receivable.

Accruals

A third classification of adjusting entry occurs where the exact amount of an expense cannot basically be determined. The depreciation of fixed assets, for example, is an expense which has to be estimated.

Accrued expenses have not yet been paid for, so they are recorded in a payable account. Expenses for interest, taxes, rent, & salaries are often accrued for reporting purposes.

Estimates

The entry for bad debt expense may even be classified as an estimate.

HOW TO PREPARE CASH FLOW STATEMENT

The balance sheet, income statement, and cash flow statement are the three generally accepted financial statements used by most businesses for financial reporting.The purpose of the cash flow statement is to report the sources and uses of cash during the reporting period. 

       Structure of the Cash Flow Statement

The most commonly used format for the cash flow statement is broken down into three sections:

1. Cash flows from operating activities 
2. Cash flows from investing activities 
3. Cash flows from financing activities.

Cash flows from operating activities are related to your principal line of business and include the following:

• Cash receipts from sales
• Payroll and other payments to employees
• Payments to suppliers and contractors
• Rent payments
• Payments for utilities
• Tax payments

Investing activities include capital expenditures .  Investing activities also include investments (other than cash equivalents as indicated below) that are not part of your normal line of business.  These cash flows could include:

• Purchases of property, plant and equipment
• Proceeds from the sale of property, plant and equipment
• Purchases of stock or other securities (other than cash equivalents)
• Proceeds from the sale or redemption of investments

Financing activities include cash flows relating to the business’s debt or equity financing:

• Proceeds from loans, notes, and other debt instruments
• Installment payments on loans or other repayment of debts
• Cash received from the issuance of stock or equity in the business
• Dividend payments, purchases of treasury stock, or returns of capital

the cash flow statement normally includes cash and cash equivalents.  Cash equivalents are short-term, temporary investments that can be readily converted into cash, such as marketable securities, short-term certificates of deposit, treasury bills, and commercial paper.  The cash flow statement shows the opening balance in cash and cash equivalents for the reporting period, the net cash provided by or used in each one of the categories (operating, investing, and financing activities), the net increase or decrease in cash and cash equivalents for the period, and the ending balance.

There are two methods for preparing the cash flow statement –

• Direct method.
• Indirect method.

  Both methods yield the same result, but different procedures are used to arrive at the cash flows.

                                                Direct Method

Under the direct method, you are basically analyzing your cash and bank accounts to identify cash flows during the period.  You could use a detailed general ledger report showing all the entries to the cash and bank accounts. You would then determine the offsetting entry for each cash entry in order to determine where each cash movement should be reported on the cash flow statement.

.  Some examples for the operating activities section include:

Cash receipts from customers:

• Net sales per the income statement
• Plus beginning balance in accounts receivable
• Minus ending balance in accounts receivable
• Equals cash receipts from customers

Cash payments for inventory:

• Ending inventory
• Minus beginning inventory
• Plus beginning balance in accounts payable to vendors
• Minus ending balance in accounts payable to vendors
• Equals cash payments for inventory

Cash paid to employees:

• Salaries and wages per the income statement
• Plus increase  in salaries and wages payable
• Minus decrease in salaries and wages payable
• Equals cash paid to employees

Cash paid for operating expenses:

• Operating expenses per the income statement
• Minus depreciation expenses
• Plus increase or minus decrease in prepaid expenses
• Plus decrease or minus increase in accrued expenses
• Equals cash paid for operating expenses

Taxes paid:

• Tax expense per the income statement
• Plus increase  in taxes payable
• Minus decrease  in taxes payable
• Equals taxes paid

Interest paid:

• Interest expense per the income statement
• Plus increase  in interest payable
• Minus decrease  in interest payable
• Equals interest paid

Under the direct method, for this example, you would then report the following in the cash flows from operating activities section of the cash flow statement:

• Cash receipts from customers
• Cash payments for inventory
• Cash paid to employees
• Cash paid for operating expenses
• Taxes paid
• Interest paid
• Equals net cash provided by operating activities

Similar types of calculations can be made of the balance sheet accounts to eliminate the effects of accrual accounting and determine the cash flows to be reported in the investing activities and financing activities sections of the cash flow statement.

                                                  Indirect Method

In preparing the cash flows from operating activities section under the indirect method, you start with net income per the income statement, reverse out entries to income and expense accounts that do not involve a cash movement, and show the change in net working capital.  Entries that affect net income but do not represent cash flows could include income you have earned but not yet received, amortization of prepaid expenses, accrued expenses, and depreciation or amortization.  Under this method you are basically analyzing your income and expense accounts.  The following is an example of how the indirect method would be presented on the cash flow statement:

• Net income per the income statement
• Minus entries to income accounts that do not represent cash flows
• Plus entries to expense accounts that do not represent cash flows
• Equals cash flows before movements in working capital
• Plus or minus the change in working capital, as follows:

PROPERTY PLANT AND EQUIPMENT EXPLAINATION

IAS16 PROPERTY PLANT AND EQUIPMENT
This standard does apply to property, plant, and equipment is to prescribe the accounting treatment for property, plant, and equipment. The principal issues are the recognition of assets, the determination of their carrying amounts, and the depreciation charges and destruction losses to be recognized in relation to them.

Recognition

Items of property, plant, & equipment ought to be recognized as assets when it is probable that the future economic benefits associated with the asset will flow to the entity, the cost of the asset can be measured reliably. This recognition principle is applied to all property, plant, & equipment costs at the time they are incurred. These costs include costs incurred initially to acquire or construct an item of property, plant & equipment & costs incurred subsequently to add to, replace part of., IAS 16 does not prescribe the unit of measure for recognition what constitutes an item of property, plant, & equipment. Note, however, that if the cost model is used (see below) each part of an item of property, plant, & equipment with a cost that is significant in relation to the total cost of the item must be depreciated separately. , IAS 16 recognizes that parts of some items of property, plant, & equipment may need replacement at regular intervals. The carrying amount of an item of property, plant, & equipment will include the cost of replacing the part of such an item when that cost is incurred if the recognition criteria (future benefits & measurement reliability) are met., Also, continued operation of an item of property, plant, & equipment (for example, an aircraft) may need regular major inspections for faults irrespective of whether parts of the item are replaced.

Initial Measurement:

An item of property, plant and equipment ought to initially be recorded at cost. Cost includes all costs necessary to bring the asset to working condition for its anticipated use. This would include not only its original purchase cost but also costs of site preparation, delivery and handling, installation, related professional fees for architects and engineers, and the estimated cost of dismantling and removing the asset.

If payment for an item of property, plant, and equipment is overdue, interest at a market rate must be recognized or imputed.

If an asset is acquired in exchange for another asset, the cost will be measured at the fair value unless (a) the exchange transaction lacks commercial substance or (b) the fair value of neither the asset received nor the asset given up is reliably measurable.

·         Cost Model. The asset is carried at cost less accumulated depreciation and destruction.

·         Revaluation Model. The asset is carried at a revalued amount, being its fair value at the date of revaluation less subsequent depreciation and impairment, provided that fair value can be measured reliably. [IAS 16.31]

The Revaluation Model:

Under the revaluation model, revaluations ought to be carried out regularly, so that the carrying amount of an asset does not differ materially from its fair value at the balance sheet date. If an item is revalued, the whole class of assets to which that asset belongs ought to be revalued. If a revaluation leads to an increase in value, it ought to be credited to other comprehensive income and accumulated in equity under the heading "revaluation surplus" unless it represents the reversal of a revaluation decrease of the same asset historically in the past recognized as an expense, in which case it ought to be recognized as income.

 Depreciation (Cost and Revaluation Models)

The depreciable amount (cost less residual value) ought to be apportioned on a systematic basis over the asset's useful life. The residual value and the useful life of an asset ought to be reviewed at least at each financial year-end and, if expectations differ from earlier estimates. The depreciation system used ought to reflect the pattern in which the asset's economic benefits are consumed by the entity. The depreciation system ought to be reviewed at least yearly and, if the pattern of consumption of benefits has changed, the depreciation system ought to be changed prospectively. Depreciation ought to be charged to the income statement, unless it is included in the carrying amount of another asset. Depreciation begins when the asset is available for use and continues until the asset is derecognized, even if it is idle.

Recoverability of the Carrying Amount

IAS 36 requires destruction testing and, if necessary, recognition for property, plant, and equipment. An item of property, plant, or equipment shall not be carried at more than recoverable amount. Recoverable amount is the higher of an asset's fair value less costs to sell and its value in use.

Any claim for compensation from third parties for destruction is included in profit or loss when the claim becomes receivable.

Derecogniton (Retirements and Disposals)

An asset ought to be removed from the balance sheet on disposal or when it is withdrawn from use and no future economic benefits are expected from its disposal. The gain or loss on disposal is the difference between the proceeds and the carrying amount and ought to be recognized in the income statement.If an entity rents some assets and then ceases to rent them, the assets ought to be transferred to inventories at their carrying amounts as they become held on the market in the ordinary work of business.

Disclosure

For each class of property, plant, and equipment, disclose:

·         basis for measuring carrying amount

·         depreciation method(s) used

·         useful lives or depreciation rates

gross carrying amount and accumulated depreciation and impairment losses

·         reconciliation of the carrying amount at the beginning and the finish of the period

A Day In The Life Of An Accountant

While the work isn't exactly physical, accounting is one of the most demanding jobs in any industry. These employees perform on the frontline of an organization's financial engine. They are responsible for making sure the books are balanced, bills paid and that profit margins are not sagging. 


Most accountants get their work done on a routine 40 to 50 hour week schedule. Although there are many different types of accountants, most of them keep consistent track of payments, transfers of capital and financial positions for institutional clients or individuals. They must be efficient with numbers and most importantly, delivering unfavorable news to clients. An accountant is often put in the position where he/she must be the bearer of bad news. These, of course, are situations where they should expect to be greeted in a fashion that is less then friendly. Several people entering the field have admitted that this is the most unanticipated drawback to the profession. 



On average, an internal auditor spends a small amount of their time dealing with paperwork and standard accounting procedures. Most of their day consists of speaking with clients on the phone and traveling to meet with executives, representatives and other divisional auditors. The daily operations of a tax accountant are significantly different. Most are either self-employed or employed at a small firm, where they are responsible for tracking income for their clients and making sure they are squared away with state and federal agencies. The corporate tax accountant is more involved in the decision-making process, largely responsible for managing a company's tax issues and assets.