1 UNIVERSITY OF WEST INDIES OPEN CAMPUS Introduction to Cost & Management Accounting –ACCT 1003(MS 15B) INVENTORY VALUATION & CONTROL INVENTORY VALUATION At the end of an accounting period, inventory/stock must be counted and its value determined or verified. A company’s ending inventory must be reported accurately. An error in the ending inventory will affect the current year’s income statement, statement of owner’sequity and balance sheet. Closing inventory for one accounting period is the opening inventory for the next accounting period; hence the following year’s financials would also be affected. Observing and verifying ending inventory is an important aspect of the external auditors job The method used to value inventory is dependent upon the policy and conditions of the business and is determined by management. Types of Inventory Systems There are two types of inventory systems Perpetual Inventory System Periodic Inventory system The Perpetual Inventory System Merchandising transactions are recorded as they occur. Each time an addition to inventory is made by purchasing, or in some other way such as sales returns, the amount is added to inventory and each time a reduction is made through sale, purchase returns or any other reason the total amount of inventory is decreased. This means that COGS and inventory are continually updated each time merchandise is purchased/added or sold/subtracted - POS system. A running balance is maintained of inventory remaining after each receipt or issue of inventory. Used mainly by large businesses that is computerized e.g. large supermarkets and department stores. Almost all manufacturing companies also utilize a POS system, as these businesses need current information to coordinate their inventories of raw materials with their production schedule. The balance on COGS and inventory accounts are always current. Freight-in or carriage inwards is added to the cost of inventory. Stock taking is done at year end to verifythe balance of inventory on the books. Adjustment would be made to COGS and Inventory for any shortage or inventory shrinkage resulting from pilferage, spoilage or shoplifting. These systems are quite expensive however, which limits their use to very large businesses. Periodic Inventory system Used primarily in small businesses with manual accounting systems No effort is made to keep up-to-date records Unlike the perpetual system where stock taking is done to verifyending inventory, under the periodic system physical stock take is done at the end of an accounting period to valueending inventory and computeCOGS. Freight-in or carriage in is debited to a specific account and used in the calculation of COGS.