Question

• What are the different types of inventories?
• What is the difference in bookkeeping that takes place between the periodic and perpetual approaches?
• What are the complicating situations for determining which items should be counted as part of inventory?
• What are the three primary cost flow assumptions, and how would management choose among them?
• How do different cost flow assumptions impact what is reflected on the balance sheet and income statement?
• Why do we need to discuss LIFO liquidations in the notes to F/S? What do they tell F/S readers?

Answer 1

1. What are the different Type of Inventories?

A. Inventories are basically classified into two categories.

• Direct Inventories
• Indirect Inventories

Direct Inventories

Direct inventories includes such items which are directly used for the production/manufactures and are a part of goods/services produced or provided. Direct inventories are further classified into following types.

1. Production Inventory - Items such as raw materials, components and sub-assemblies used to produce the final product.
2. Work in progress Inventory - The components which are in process, neither raw material nor finished goods but semi-finished goods lying in the machine awaiting for completionis called WIP.
3. Finished goods Inventories - This includes the final products ready for dispatch to the users.
4. MRO Inventories - Maintenace, repair and operating item such as spare parts and consumable stores that do not go into final product but are consumed during the production process.
5. Miscellaneous Inventories - All other items such as scrap, unsaleable products, stationary and other items in office, factory and sales departments etc.

Indirect Inventories

Indirect inventories includes items which are required for the production of goods and services and are not a part of FG such as fuels, lubricants, spare parts, tools etc. in the inventory of every production enterprise but these does not become a part of the goods pfroduced. Indirect inventories are of following type.

1. Transportation Inventories - These are also called transit, pipeline or movement inventories. It contains items that are currently in transportation.
2. Seasonal Inventories - Some inventories have to be maintained to meet seasonal demands. for eg. the demand for AC is before summer season, demand for crackers before Diwali etc. When the demands are going to increase, it is possible to stock inventories to meet such seasonal demand.
3. Anticipation Inventories - These inventories are stocked in anticipation of an event.
4. Lot- size Inventories - These are maintained to take advantages of discounts which are usually available for purchase of large quantities. Lot- size are held for makingpurchases in lots rather than for numbers which are exactly required.

2. What is the difference in bookkeeping that takes place between the periodic and perpetual approaches?

A. The periodic and perpetual inventory systems are different methods used to track the quantity of goods on hand.The periodic system relies upon an occasional physical count of the inventory to determine the ending inventory balance and the cost of goods sold, while the perpetual system keeps continual track of inventory balances.

In preparing the financial statements, the calculation of what is in closing inventory can be a major exercise for a business. The business may need to count its inventory at the statement of financial position date. A formal title for the sheets recording the inventory count is under periodic approaches. They are cheaper in most situations than the costs of maintaining continuous inventory records.Even if there is a continuous inventory record, there will still be a need to check the accuracy of the information recorded by having a physical check of some of the inventory lines.

An alternative would be to have records which show the amount ofinventory at any date, i.e. continuous/ Perpetual inventory records. Here record of each item ofinventory would be maintained showing all the receipts and issues for that item. some of the merits are as follows;

• There is better information for inventory control.
• Excessive build up of certain lines of inventory whilst having insufficient inventory of other lines is avoided.
• Less work is needed to calculate inventory at the end of the accounting period.

3.What are the three primary cost flow assumptions, and how would management choose among them?

A. Companies make certain assumptions about which goods are sold and which goods remain in inventory. The major cost flow assumptions are given below.

1. First in First out [FIFO] - This cost flow assumption closely follows the actual flow of goods. In other words, the items purchased first are assumed to have been sold first. Goods purchased at the end of the accounting period remain in closing inventory.  
2. Last in First out [LIFO] - This cost flow assumption was developed for tax purposes.Under LIFO the goods in inventory at the beginning of the period is assumed to remain in the ending inventory.
3. Average cost -  Under the average cost flow assumption all costs are added and divided by the total number of units purchased. At the end of the accounting period, the number of units sold (left in inventory) is then multiplied by the average price per unit to determine cost of goods sold and ending inventory.