Question

Describe the importance of control over inventory, & Describe three inventory cost flow assumptions and how they impact the income statement and balance sheet.

Answer 1

IIMPORTANCE

Inventory is one the most important asset for any enterprise. Revenue if any enterprise is highly dependent upon the stock of the enterprise, so it becomes evident that any enterprise should have proper controls over the inventory system in order to serve customers effectively and efficiently. If the enterprise do not have adequate controls on the stock, it may end up loosing all the customers by not serving them well and won't be able to compete in the market in this competitive era.

Having adequate stock would help the enterprise to minimise losses, and serving the needs of potential customers.

Whereas if the enterprise has overstocking in its warehouse, it will unnecessarily block the working capital of the enterprise and inadequate stocks wouldn't be able to serve the customers and thus leading to loss of revenue.

IINVENTORY COST FLOW ASSUMPTIONS

FIFO- First in First Out method is the one where the inventory which is purchased first is sold first. Cost of the inventory is also taken into the consideration of the inventory pertaining to the purchase price.

Example: Inventory 100 units purchased on 1 jan $10/- per unit. On 2 jan 10 units purchased at $12 /- per unit.

Now on 3 jan 10 units were sold.

For valuing10 units cost would be $10per unit as they are sold from the unit purchased on jan 1.

Impact: Valuation of inventory would be nearly on the current prices prevailing in the industry and also there would less chances of loss because dead stock would be valued at lower price as per this method.( Assuming inflation is prevalent)

LIFO- Last in first out - means the inventory which is purchased later are sold first. And the valuation of stock sold is done on recent purchases made.

Example: Considering the example taken above , now the goods sold on Jan 3 would be considered by taking cost at $12 per unit.

Impact: The impact if such valuation is that inventory will be undervalued in case of inflationary economy. And cost of goods sold will be increased thereby reflecting less profits.

Average- As per this method inventory is valued by taking the average of the purchases and thereby calculating the Cost of goods sold as per the units sold.

It can be of two types: Simple Average and Weighted Average

In simple Average, average of prices is done and thus accordingly price is calculated.

In case of weighted average, units× price (i.e units are taken as weights) and price is calculated.

Impact: In this case valuation of inventory is basically the average of LIFO FIFO and in case of fluctuating prices economy, helps to value the inventory in better manner.

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