Important Insights for Effectively Accounting Inventories
Inventories are considered an important asset for a business. It plays several roles in a business, it maintains the cash flow, provides a consistent supply of goods as per the demand, and maximizes the profits. As accounting is very important for ascertaining the sales of a business, similarly it is important for inventories also. All goods or inventories stocked have their shelf value and the total cost of such stocks may be more than the anticipated amount in the bank.
What are the basics of inventory accounting?
Just as another liquid asset like cash held by the business or the amounts receivable from the customers, the inventory is also a valuable asset for the business as discussed earlier. Assets are presented in the balance sheet of the business which indicates the net worth of the business by reflecting the total value of the inventory. While purchasing goods from vendors it has a dual impact on the business, as it increases the assets equal to the invoiced value and increases the liabilities also equal to the amount which the business owes to the vendor.
Sometimes the cost of some goods may fluctuate regularly such as oil etc. which may indicate the different values to evaluate the inventory. During such circumstances, the inventory is valued at its net cost price.
So, it is important to keep track of the inventories to ascertain the actual values of the inventories and the anticipated profits.
Key points of highlight
- The accurate value of inventories can be ascertained with the help of inventory accounting.
- Helps the business to reach proper conclusions
- Leads to maximization of profits
Why is inventory accounting important?
Firstly, it provides a clear representation of the inventories held by the business along with that, there is some other importance also. It keeps track of the inventories throughout all stages (raw materials-work in progress-finished goods). It provides the business with opportunities where it can increase its profits on a particular product in a particular market.
This can be predominantly seen in the cases of medicines and pharmaceuticals, technology, machinery, etc., as these products incur huge costs at their initial stages like designing, etc. With the help of inventory accounting, the business can analyze the value of a product at a certain stage, such as performing clinical trials or product transportation, where the business can alter the variables to maintain the high value of the product inventory by decreasing the expenses.
Inventory management is given ultimate importance by various accounting standards as it avoids the overestimation of profits by underestimation of the inventory which may result in inflation in the company's valuation. As we are well aware that profit is revenue minus costs, and the revenue is received on selling the inventory.
Various inventory valuation methods
There are many ways which a business can use for inventory accounting process which have different names in different places, some of these are explained below:
- The periodic inventory accounting method
Under this method, the accounting of the inventories isn't done when the sale happens, a sale includes the revenue and the tax of the business and it may represent the 100 % profit in the income statement of the business. At the end of every year or month, the value of inventory is ascertained and it is compared against the value of the previous or preceding year or month. The organization may physically count the inventory to ascertain the value at the end of each period. The closing and opening stock are entered into the accounts representing the sales and purchases made during the period which will give you the cost and the revenue earned that can be used to calculate the gross profit.
- Cost of sales inventory accounting method
Under this method entry regarding every sale containing the inventory is made in the income or profit/loss statement. The asset value in the balance sheet will decrease, and the sale cost in P&L will be increased based on the actual value of the inventories that is been shipped. The purchase of the inventory will be added to the assets on the balance sheet.
- First In First Out method
It is an effective method that is used in the valuation of the unsold inventory of the business. Under this method the first purchased stock is to be considered as the first sold one, hence the oldest stock will be used to meet the order of the customer. This method is more suitable for the business dealing with perishable goods such as beverages and food items. As they can protect the goods from getting spoiled. It also helps in maintaining a continuous supply of inventories. The stock received and sold must be recorded individually while using this method.
Role of CDA
Inventory accounting may seem simple but it may be complicated for small enterprises and retailers. In that scenario, it is the best course to outsource accounting services to accounting firms like CDA Dubai. Appointing the accounting firms may be more cost-effective and the firms can acquire professional services. CDA has a team of professionals who are always ready to lend their hands to the clients to assist them and solve their issues. To know more about services offered by CDA contact us now.