Lecture notes week 8 - THE UNIVERSITY OF NEW SOUTH WALES...

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THE UNIVERSITY OF NEW SOUTH WALES Australian School of Business School of Accounting ACCT 1501: Accounting and Financial Management 1A Week 8 Accounting for Inventory Student Handout Contents: 1. Introduction 2. Tutorial questions – Week 9 3. Appendix 1 - Lecture example 4. Lecture slides Lecturer: Claudia Gormly School of Accounting UNSW c.gormly@unsw.edu.au Course website: http://www.webct.unsw.edu.au/
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1. Introduction One of the most important assets that a company has is its inventory – those goods purchased or manufactured for sale, resale or further use in operations. This week, we consider how to account for inventory by examining the different types of inventory systems and the different cost flow assumptions that underpin inventory valuation. There are two amounts you need to consider when reporting the balance of inventory: the cost of the inventory (How much did it cost?) the market value of that inventory (What’s it worth?) Why does market value matter? The only reason that market value matters is because of the conservatism principle. Usually market value is bigger than cost, and so we don’t need to worry about it. We record inventory at cost, effectively saying that we will get back at least the amount recorded – and hopefully a profit as well. However, if market value is less than cost, we may not be able to recover our cost of inventory. It means that our inventory is either damaged, obsolete, or worth less for some reason. Conservatism requires recognition of a loss as soon as it’s likely (i.e., we know), so we write inventory down (i.e., record a loss) if market value < cost. On the other hand, if market value > cost, then we do nothing now, and record a normal profit when we sell the inventory (since Sales Revenue will be greater than COGS). If that’s all there were to it, life would be easy. However, working out cost is only straight forward if you track items individually. Tracking items individually is only worth it if they are big or expensive, like cars or jewellery. Individual tracking is known as the specific identification approach. If it’s not worth tracking individual items, then you have to make a cost flow assumption. For instance, when selling tennis balls, you don’t know whether the pack you just sold was the pack you bought today, or the pack you bought a while ago. So you have to make an assumption about the flow. Assumptions you might make are first-in first-out (FIFO), last-in first-out (LIFO) or average cost (AVGE). AFM1A 2
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You’ve also got one other choice: do you keep track of every sale (the perpetual approach), or do you just keep track of purchases, then count your ending inventory, then deduce what you must have sold (the periodic approach)? So, if you also make cost flow assumptions, then you’ve six ways of coming up with
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This note was uploaded on 01/22/2011 for the course ACCT 1501 taught by Professor Helen during the Three '09 term at University of New South Wales.

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Lecture notes week 8 - THE UNIVERSITY OF NEW SOUTH WALES...

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