1

Financial Accounting
prof. Adriana Tiron Tudor- course
assist. Szilveszter Fekete- practice
att
Agenda course 4
1. Objectives
2. Assets definition and recognition
3. Inventories definition and classification
4. Recording system, costing and valuation
5. Recording transactions with inventories
That inventories
play an important role in the operating cycle of a business
entity
may represent a significant part of an entitys assets
are classified in different categories ( such as finished goods,
components, materials, merchandise)
1. Objectives
After studying this chapter, you will understand:
How to
record movements in inventory
inventory policies are disclosed
establish the cost of goods withdrawn from inventory
1. Objectives
What are
- the difference between permanent and intermittent
inventory system
- the costing methods
- the valuation methods
2
An asset represents
a source controlled by the entity
as a result of past events
which is expected to generate future economic benefits for the
entity
with a cost that can be credibly evaluated;
An asset is recorded in the balance sheet when:
Future economic benefits are likely to be realized as a result of
keeping (storing), using, selling that certain asset;
That certain asset has a cost or a value that can be evaluated
credibly.
2. Assets definition and recognision
The recognition of the assets in the balance sheet
usually takes place along with the recognition of a
debt or an income in the profit and loss account (the
principle of the connection between the expenses
and incomes).
Acquisition Asset = Supplier (2=4)
Internally constructed Asset = Capitalized costs (2=7)
2. Assets definition and recognision
In most counties of the Western Europe, the
patrimonial assets are presented in the reverse
order of liquidity, as follows:
Non-current assets
intangible assets
tangible assets
financial assets
Current assets
inventory
receivable
short term investments
cash
Regulation assets
pre-payments
2. Assets definition and recognision
Current assets
contain all the exploitation assets and the
treasury ones the liquidation period of which is
below one year.
Are characterized by the following:
dont last in a patrimonial entity, their rotation period is
usually shorter than one year;
are in continuous movement, changing their material
form and utility inside the estates economic circuit (raw
material, finished good, receivable, cash).
2. Assets definition and recognision
3
IAS 1 states that an asset must be
classified as a current asset when:
It is expected to be realized or its held for sale or
consume during the normal exploitation cycle of the
enterprise;
Its held, mainly, to be commercialized or on short term
and it is expected to be realized in 12 months from the date
of the balance sheet;
Represents cash or an equivalent of cash whichs
utilization is unrestricted.
2. Assets definition and recognision
The current assets
Current assets
depending on their concrete form and destination
inside the exploitation cycle, are divided in:
B.1. Inventory and production in progress;
B.2. Receivables or values in process of
reimbursement (settlement);
B.3. The short term financial investments (the
placements);
B.4. Cash.
2. Assets definition and recognision
IAS 2 the inventory are material goods
(assets):
Held for sale in the ordinary course of the activity;
In the process of production for such sale or;
In the form of materials, or suppliers to be consumed in the
production process or service providing.
3. Inventories definition and classification
Depending by the enterprises activity the
inventory is formed of:
Manufacturing /servicing activity
raw materials, consumables, parts, components
finished products, semi-finished products,
works and services in process;
Commercial activity (retail, wholesale or
merchandising)
commodities (goods purchased for resale)
3. Inventories definition and classification
4
In the category of the inventories are
included: (RO)
raw materials and consumables
work in progress
products
held by third parties
animals
commodities
packaging
3. Inventories definition and classification
1. The raw materials constitute the main substance of
the finished good, participate directly in the fabrication
of the goods and are found integrally or partially in the
finished good, in their initial formof transformed.
3. Inventories definition and classification
2. The consumables participate in the fabrication or
exploitation process without usually finding themselves
in the finished good.
The main consumables are:
Auxiliary materials
Fuel
Packaging materials
Spare parts
Seeds and sapling
Fodder
Other consumables
3. Inventories definition and classification
The auxiliary materials:
Are added to the raw materials in order to transform them;
Contribute to the fabrication of the finished goods;
Are used to ensure the necessary conditions for the normal
course of the activity.
The fuel:
Fuel takes direct or indirect part in the processes that take
place in a patrimonial unit.
Depending on their role and destination, we distinguish
between:
Technologic fuel;
Energetic fuel;
Household fuel.
3. Inventories definition and classification
5
The spare parts:
Spare parts serve for the replacement of machines and plant
components in order to repair them.
In the category of the consumables are also included: the
packaging materials the seeds and sapling, the fodder used in the
agricultural units activity, as well as other consumables.
3. Inventories definition and classification
3. The materials in form of inventory items
The materials in form of inventory items represent
the goods which either have a smaller value than
the limit settled to be considered tangible assets,
regardless of their utilization period, or have a
utilization period smaller than one year, regardless of
their value.
3. Inventories definition and classification
4. Production in process
(Work in process, unfinished
production)
goods in process of
transformation, which occupy an
intermediary position, either
between the raw material and
semi-finished good, or between
semi-finished good and finished
good.
3. Inventories definition and classification
5. The semi-finished goods
are the goods that:
Went through a number of technologic phases, suffered a
certain level of handling and
Were received, are supposed to be handled further in the
unit or sold to the third parties.
can be obtained from own production or acquisitioned from
outside and destined to the internal consume or to the resale.
6. The residual products
are rejections, recoverable materials and waste products.
3. Inventories definition and classification
6
goods which:
- went through al the phases of
the technological process,
- match the quality standards,
- were receipted and
- documents of delivery to the
warehouses were made.
Manufactured items that are
complete and ready for sale.
7. Finished goods
3. Inventories definition and classification
8. The commodities (merchandise)
goods purchased from the third parties in order to be resold as they are
or fabricated in the unit and passed in their own retail shops.
Ex. computers, cars, books, telephones, food,
9. The packaging
goods used to protect other goods, during the transportation, handling or
storage.
The packaging are classified in:
Circulation packaging: sacs, boxes, containers, recipients, bottles,
Production packaging: cans, tubes for the toothpaste, vials for
medicines, perfumes etc.
3. Inventories definition and classification
10. The animals and birds
born or acquisitioned and the young ones of any kind
(calves, lambs, sucking pigs, colts etc.) bred and used
for reproduction, wool, milk, meet, furs, animals and
birds for fattening, bees colonies.
There are not included in this category the working
animals, contained in the category of the tangible
assets.
3. Inventories definition and classification
Questions/Discussion Concerning
Ownership
Do all the goods included in
the count belong to the
company?
Does the company own any
goods not included in the
count?
.
3. Inventories definition and classification
7
In the category of the inventory are also included (11) the
goods held in custody, for handling or in consignation at
the third parties.
These are recorded differently in accounting, on inventory
categories.
Consigned Goods
Goods of others you hold that you dont pay for until
they are sold The company does not have the
ownership.
3. Inventories definition and classification
Expenses represent value consumed
consumption of value the firm incurred
Revenues represent value created
creation of value during the period
3. Inventories definition and classification
8
3. Inventories definition and classification
Specific
identification
Special
costing
methods
Specific
identification
Special
costing
methods
Recording system Costing methods
Valuation methods
Permanent
inventory
system
Periodic
inventory
system
Cost based
Market based
4.Recording system, costing and valuation
Class 3: Groups of accounts for inventories
and for production in progress
30 - Inventory of raw materials and consumables
33 - Work in progress
34 Products
35 Inventories held by third parties
36 Animals
37 Commodities
38 Packaging
39 Adjustment for impairment of inventories and work in
progress
30-38 - Asset accounts
- inventories accounts
- price differences accounts: A 308,348, 368,388 and L 378
39 Adjustments: Liability accounts( with inverse accounting function)
acc
Group 30. Inventory of raw materials and consumables
301 Raw materials
302 Consumables
3021 Auxiliary materials 3022 Fuel
3023 Packaging materials 3024 Spare parts
3025 Seeds and sapling 3026 Fodder
3028 Other consumables
303 Materials in the form of inventory items
308 Price differences on raw materials and consumables
Group 33. Work in progress
331 Goods in progress 332 Works and services in progress
Group 34. Products
341 Semi-finished products 345 Finished products
346 Residual products 348 Price differences on products
4.1. Accounts
9
Group 35. Inventories held by third parties
351 Raw materials and consumables at third parties
354 Products at third parties 356 Animals at third parties
357 Commodities at third parties 358 Packaging at third parties
Group 36. Animals
361 Animals and birds 368 Price differences on animals and birds
Group 37. Commodities
371 Commodities 378 Price differences on commodities
Group 38. Packaging
381 Packaging 388 Price differences on packaging
Group 39. Adjustment for impairment of inventories and work in
progress
4.1. Accounts
General functioning rules for
asset accounts
present only debit closing
balance and represent the
existences of assets at a
certain time;
debit - the initial existences
of asset, undertaken from the
initial balance sheets asset;
debit - the asset increases
determined by the economic
operations, inscribed in the
supporting documents;
credit - the asset decreases
determined by the economic
operations, inscribed in the
supporting documents;
D Inventories Asset C
General functioning rules for
adjustment of asset
present only credit closing
balance and represent the
existences at a certain time;
credit - the initial existences
undertaken from the initial
balance sheets asset;
credit - the increases
determined by the economic
operations, inscribed in the
supporting documents;
debit - the decreases
determined by the economic
operations, inscribed in the
supporting documents;
D Adjustment C
4.2.Costing methods
IAS 2 states: the cost of inventories shall comprise all costs of
purchase, and other costs incurred in bringing the inventories to their
present condition and location ( I.e. historical cost of acquisition)
Cost of goods manufactured ( production cost) is the sum of the
acquisition cost of raw materials, components and supplied
consumed, labor cost , and a reasonable proportion of production
support and infrastructure costs ( overheads).
Inflows historical cost of acquisition
standard cost (RO)
invoice cost (RO)
Outflows non fungible goods: specific identification
- fungible goods: special costing methods:
FIFO
LIFO
WAC
10
4.2.Costing methods
standard cost (RO) acquisitions production
Ex: standard cost 100, real cost 90 ( invoice) standard cost 100, real cost 90
% = suppliers 90 % = Revenue 90
materials 100 products 100
differences 10 differences 10
Ex: standard cost 100, real cost 105 (invoice)
% = suppliers 105
materials 100
differences 5
invoice cost (RO)
Ex: invoice cost 100, transport 10
% = suppliers 110
materials 100
differences 10
4.2.Costing methods
The price differences
Correct through sum or subtraction the value
of the current assets, respectively of the
inventory.
Appear due to the use for the recording of the
inventory of other values called recording
(registration) values, other than the real ones
(the acquisition cost or the production cost).
4.2.Costing methods
The price differences
For instance, the standard cost, the preset
production cost, the retail price are used.
The distribution of the price differences over
the value of the output goods and over the
inventory is realized with the aid of a certain
coefficient which is calculated as follows:
4.2.Costing methods
The price differences
The initial balance of + the price differences related to
The distribution the price differences the entries during the period
coefficient = _______________________________________________________ x 100
The initial balance of the + the value of the entries during
inventory at registration price the period at registration price
11
Example
A SC uses standard cost, has an inventory of auxiliary materials of 200 kg with
an acquisition cost of 20 lei/kg, price differences 200 lei. Later it buys 500 kg at
an invoice price of 21 lei/kg+ VAT. It consumes 600 kg.
Acquisition of auxiliary materials 500 kg
% = 401 12495
3021 10000
308 500 (21-20)*500
4426 1995
Consumption of auxiliary materials
6021 = 3021 12000
Coefficient of price difference
K= (IB308+CDA308)/(IB3021+CDA3021)=0.05
Price differences for the consume 12000*0.05
6021 = 3021 600
42
Specific Identification
An actual physical flow costing method in which items still in
inventory are specifically costed to arrive at the total cost of
ending inventory.
Cost of goods sold = $700 + $800
43 45
What Is Wrong with Specific
Identification?
COST BENEFIT -
EXPENSIVE TO SET-UP AND
MAINTAIN
4.2.Costing methods
44 45
What Is a Cost Flow Assumption ??
To presume the order in which goods are sold.
4.2.Costing methods
What Makes Cost Flow Assumptions Necessary ?
Changing Prices
12
45
44
4.2.Costing methods
Cost Flow Assumptions
FIFO- First-in, First-Out- earliest goods purchased
are the first to be sold
LIFO- Last-in,First-Out- latest goods purchased
are the first to be sold
Average Cost Method- costs are charged on the
basis of weighted average unit cost
46
The FIFO method assumes the earliest
goods purchased are the first to be sold.
47
The LIFO method assumes the latest goods
purchased are the first to be sold.
SC, VAT payer, it has an initial inventory of 200 kg with the acquisition cost
of 8 lei/kg, later it buys 600 kg with 10 lei/kg VAT 19%, expenses with
transport 600 lei + VAT 19%.It consumes 700 kg and it uses LIFO method.
Acquisition of raw materials 600kg
% = 401 7140
301 6000
4426 1140
Expenses with transport
% = 401 714
301 600
4426 114
Acq. Cost/unit= 6600/600=11
Consumption of raw materials
601 = 301 7400
600*11+100*8
13
49
The average cost method assumes that
goods available for sale are the same.
The allocation of the cost of goods available
for sale is made on the basis of the weighted
average unit cost incurred.
50
The average cost method assumes that
goods available for sale are homogeneous.
Illustration 6-10
The average cost method assumes that
goods available for sale are similar in
nature.
51
Factors Used in Selecting an Inventory
Cost Method
Income statement effects
Balance sheet effects
Tax effects
pag. 310-313
4.2.Costing methods
52
Income Statement Effects
In periods of increasing prices
FIFO reports the highest net income
LIFO the lowest
average cost falls in the middle.
In periods of decreasing prices
FIFO will report the lowest net income
LIFO the highest
average cost falls in the middle.
4.2.Costing methods
14
53
53
Balance Sheet Effects
In a period of increasing prices costs allocated
to ending inventory using:
FIFO will approximate current costs
LIFO will be understated
4.2.Costing methods
54
Tax Effects
Why do companies use LIFO?
Lower Income Taxes
Higher cost of goods sold
Lower net income
4.2.Costing methods
55
54
Consistency
Whatever cost flow method a company
chooses, it must use it consistently
OR
Disclose the change and its effects on net
income in the financial statement.
4.2.Costing methods
56
55
The Lower of Cost or Market Basis of
Accounting for Inventories
When the value of inventory is lower than its cost, the
inventory is written down to its market value by valuing the
inventory at the lower of cost or market (LCM) in the period in
which the price decline occurs.
4.3.Valuation methods
15
57
56
Lower of Cost or Market (LCM)
departure from cost principle
follows conservatism concept
can be used only after one of the cost flow
methods ( Specific Identification FIFO,
LIFO, or Average Cost)
4.3.Valuation methods
58
57
Market Is...
CURRENT REPLACEMENT
COST
4.3.Valuation methods
59
58
How Much Inventory Should a
Company Have?
Only enough for sales needs
Excess inventory costs:
storage costs
interest costs
obsolescence - technology, fashion
4.3.Valuation methods
4.4.Inventory recording system
A. Permanent inventory system
A continuous record of changes in inventory quantities and values
(entries and withdrawals) is maintained in the inventory account.
All movements are recorded in inventory account.
Purchases are recorded as increases of inventory assets
Withdrawals and consumption are reductions of the inventory assets
Provide a continuous record of the balances in both
the inventory account and in
the cost of goods sold account
Beginning inv. + Purchases or additions Withdrawals = Ending inv.
200 900 800 X
16
4.4.Inventory recording system
debit closing balance and
represent ending inventory
(the existences of assets at
a certain time);by deduction
SI beginning inventory
debit asset increase
purchases ( cost of good
purchased) or additions to
the inventory (cost of goods
manufacturated)
credit - asset decreases
determined by withdrawals
from inventory
-- cost of goods sold or
-- cost of good consumed in
the next step of production
process
D Permanent inventory account C
Example: Permanent inventory system
SC VAT payer, keeps the evidence of the inventories using PI. It buys 10
measurement devices with 800 lei/piece+ VAT 19%. 4 devices are given for
consume, which, after the utilisation period expires, it will be discharge.
Acquisition of materials in the form of inventory items
% = 401 9520
301 8000
4426 1520
Giving the devices into use
603 = 303 3200
Extra accounting evidence of the devices
\ D8039 Inventories in the form of inventory items 3200
C8039 Inventories in the form of inventory items 3200
4.4.Inventory recording system
B. Periodic inventory system (intermittent)
Follows the general requirement that at least once every period a
business physically counts and attest to what is really in inventory.
All beginning inv.and additions to inv.(through manufacturing of
purchase) are in a first step presumed consumed and recorded directly
as an expense in the income statement
In a second step, the presumed consumption cost is adjusted at the
end of the period by deducting the independently measured ending inv.
Beginning inv. + Purchased or additions Ending inv = Withdrawals
200 900 300 X
64
33
Take a Physical Inventory
Determine inventory quantities by counting, weighting or
measuring each type of inventory.
Determine ownership of goods, including goods in transit,
consigned goods.
Quantity of each kind of inventory is listed on inventory summary
sheets where unit costs are applied.
4.4.Inventory recording system
17
debit closing balance and
represent ending inventory
(the existences of assets at
a certain time, measured);
SI beginning inventory
credit beginning inv.
assumed consumed
D Intermitent inventory account C
4.4.Inventory recording system
Example: intermitent inventory
system
SC, VAT payer, keeps the evidence of the inventories using II and it has an initial
inventory of 200 kg with an acquisition cost of 8 lei/kg, later he buys 600 kg with
10 lei/kg VAT 19%, expenses with transport 600 lei+ Vat. At the final stocktaking
it has a surplus of 100 kg. (LIFO)
Including the initial inventory in the expenses 601 = 301 1600
Acquisition of raw materials 600 kg % = 401 7140
601 6000
4426 1140
Expenses with transport % = 401 714
601 600
4426 114
Acq. Cost/ unit=6600/600=11
Registering the final inventory 601=301or -800
301=601 800
Raw materials: beginning inv. 200, purchases 900,withdrawals 800,
ending inv 300
PIM IIM
1. Withdr. beg.inv expense = inventory 200
a.purchases inventory = supplier 900
b.withdrawals expense = inventory 800
2. Purchases/withdr. expense = inventory 900
3. Ending inv. Inventory = expense 300
Comparison PIM, IIM
4.4.Inventory recording system
68
Record Revenue and
Cost of Goods Sold
Compute Cost
of Goods Sold
Perpetual
Periodic
Perpetual
Item Sold
End of
Period
Comparing Periodic and
Perpetual Inventory Systems
Inventory Purchased
Record Purchase of Inventory
End of
Period
No Entry
Record Purchase of Inventory
Record Revenue Only
Inventory Purchased
Item Sold
18
Practical example
1. Acquisition of raw materials 200 units, 110 lei/unit, VAT 19%,
transport expenses 8.000 lei, VAT 19%.,the payment being
due later. A half is consumed.
- acquisition cost ?????
raw materials 200 x 110 = 22.000
transport 8.000
2. Purchase on commercial credit of commodities, 400 units, unit
price 200 lei,, commercial discount 2%, VAT 19%
- acquisition cost ?????
commodities 200 x 400 = 80.000
discount 2% 1.600
3. Selling merchandise, 300 units, (using FIFO), unit price 240,
VAT 19%. Beginning inv. 30 units x 210 lei/unit.
5. Recording the transactions
GENERAL JOURNAL
O
p
Explanation Corresponding Accounts SUMS
D C
1 1
Acquisition of raw
materials
% = 401 Suppliers
301 Raw materials ...
4426 Input VAT
30.000
5.700
35.700
1 2 Raw materials
consumptions
601 = 301
Expenses with raw mat Raw materials
15.000 15.000
2 3 Acquisition of
commodities
% = 401 Suppliers
371 Commodities
4426 Input VAT
78.400
14.896
93.296
3 4 Sale of commodities 4111 = %
Customers 707
Sales of commodities
4427 Output VAT
85.680
72.000
13.680
3 5 Evidence discharging 607 = 371
Commodities expenses Commodities
59.220 59.220
5. Recording the transactions
FIFO
Beginning inv. 30 units x 210 lei/unit. = 6.300
Purchase 400 units x 196 lei/unit. = 78.400
Sale 300 units 50.220
30 units x 210 lei/unit. = 6.300
270 units x 196 lei/unit. = 52.920
5. Recording the transactions
GENERAL JOURNAL
O
p
Explanation Corresponding Accounts SUMS
D C
4 6 Finished goods are
obtained
% = 711 Variation in inventory
345 Finished products
348Differences
25.000
1.000
24.000
5 7 Sale of finished
goods
4111 = %
Customers 701
Sales of finished goods
4427 Output WATT
9.996
8.400
1.596
7 8 Evidence
discharging
711 Variation in inventory = %
345 Finished products
348Differences
7.200
7.500
300
4. Obtaining finish goods 200 units, standard cost 125 lei/unit, real cost 120 lei
5. Selling finished goods 60 units, unit price 140 lei VAT 19%.
5. Recording the transactions
19
Key points
Valuation methods
Definition
recognition
Acquisition cost
Production cost
recording systems:
PRM, IRM
Costing methods
Inventories
assets