Question

This discussion thread test the Learning Objective of 8-2, Explain which physical units of goods should be included in inventory.

Determining the physical quantity that should be included in a simple matter because that amount consists of items in the possession of the company. The cost of inventory includes all necessary expenditures to acquire the inventory and bring it to its desired condition and location for sale or for use in the manufacture process.

Required:

1. Identify describe the situations in which physical quantity included in inventory is more difficult than simply determining items in the possession of the company.

2. In addition to the direct acquisition costs such as the price paid and transportation costs to obtain inventory, what other expenditures might be necessary to bring the inventory to its desired condition and location?

Answer 1

1. Components of Inventory

Businesses purchase inventory to sell to their customers at prices greater its purchase price. Most of the time inventory only includes what is physically in the store or warehouse. The following items should be considered in the valuation of inventory.

Goods in Transit

The last day of the period is the inventory cutoff date. Establishing an inventory cutoff date is important when there are goods in transit between the business and its customers, or between the company and its suppliers. For example, a business ordered inventory on Dec. 28 and received it on Jan 3. If the inventory cutoff date is Dec. 30, the inventory in transit should be included in the company's financial statements.

Shipment Terms

When goods are in transit, it is important to note the terms of the shipping agreement. If the inventory is shipped free on board shipping point, the business is the legal owner of the inventory as soon as the supplier ships it. The business should include the shipment in its inventory count if it is shipped by the inventory cutoff date. If the inventory is shipped free on board destination, the business is not the legal owner of the inventory until it actually reaches the business. It should include the shipment in its inventory count only if it receives the shipment by the inventory cutoff date.

Consignment

When a business arranges for another business to sell its products while still retaining ownership, it is selling under consignment. The consignor transfers the inventory to the business (the consignee), but the consignor retains legal title. If the consignee can't sell the products, it returns them to the consignor. If it sells them, it remits the selling price to the consignor and takes a commission. Products held on consignment are included in the consignor's inventory, not the consignee's, even though they are not in the consignor's physical possession.

Sales Returns

Most buyers have the right to return merchandise. It can be difficult to accurately count sales returns and include them in inventory. In these situations, the sellers must estimate how many returns will be made. The sellers have to do this before they can record revenue. The sellers must also assign value to the returns that it estimates will be made. Businesses include the cost of merchandise that it anticipates will be returned by the inventory cutoff date in its inventory count.

2. Expenditures necessary to bring the inventory to its desired condition and location

AS 2 – Valuation of Inventories deals with the expenditures necessary to bring the inventory to its desired condition and location, ie the cost of purchase of inventory.

Cost of Purchase of Inventory

While determining the purchase cost of inventory, the following items should be considered:

a) Purchase price of the inventory

b) Duties and taxes (except those which are subsequently recoverable from the taxing authorities)

c) Freight inwards

d) Insurance during transport

e) Handling costs

f) . Trade discounts, rebates, duty drawbacks and other similar items are deducted in determining the costs of purchase