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