Understanding the Basics of Inventory Accounting
The entire concept of inventory accounting offers an insight into the inventory assets of an organization. Therefore, every business that concerns warehousing, logistics and storage need to abide by the guidelines of inventory accounting. While there are many accounting strategies associated with inventory management, it all comes down to proper record keeping and inventory valuation. Needless to say, inventory accounting, clubbed with inventory valuation, directly impacts industrial taxation and profits.
Inventory Accounting: Definition
It is important to evaluate inventory as an entrepreneurial asset before assigning valuation and accounting strategies to the same. However, in order to validate a portion of inventory as an asset, it is important to assign costs to the same. Be it the raw materials or an existing conglomerate of finished products; any kind of inventory is considered an asset, provided it’s valuated and accounted, accordingly. Placing a value on the inventory is termed as inventory accounting which directly impacts the overall costs of products.
Inventory Accounting: Modus Operandi
Although, inventory accounting is based on tedious calculations, the basic approach towards leveraging its functionality involves using the same for calculating the ending inventory costs. The ending costs when subtracted from the beginning inventory costs and purchases clearly reveal the actual costs of the products during a predefined period. Therefore, inventory accounting is a great business tool for retailers, wholesalers and manufacturers.
Businesses often face inventory assigning challenges as similar goods usually carry different price tags at different points in time. Therefore, it becomes difficult for businesses to have a fixed algorithm when it comes to calculating the ending inventory costs. Needless to say, every enterprise should look to embrace a particular approach towards inventory accounting during the initial days which can later be changed, according to the requirements. This brings us to the fact that there are multiple approaches to inventory accounting.
Inventory Accounting Guidelines
The process of inventory valuation requires a business to establish a sales-specific operating account. The next approach or rather guideline involves establishing a tracking system for the concerned inventory and then following it up by a physical control. Purchasing, receiving and recording product transactions are the subsequent inventory accounting processes which are followed by establishing a physical warehouse for inventory management. Lastly, inventory accounting or rather valuation requires businesses to adjust the ledger balances for fixing the product price points.
Different Types of Inventory Accounting
Accountants, specific to industries, should predefine the inventory accounting approaches, before moving ahead with the process of inventory management and logistics. At present, the existing strategies include the First in First Out process, Last in First Out process, specific inventory identification method and lastly, the weighted average method.
1. FIFO— This inventory accounting method works when the accountants realize that the first item entering the long list of inventories is the first one to be sold. The FIFO accounting technique, therefore, aligns itself with supply chain and lowers the overall cost of products. With the oldest lot moving out at first, this inventory accounting approach results in higher operational earnings and increased taxes.
2. LIFO— Here is an inventory approach where businesses move out or sell the product that’s purchased last. While this process is beneficial during inflation and sudden surges in prices, it has been officially banned by the IFRS or International Financial Reporting Standards. LIFO actually increases the trending costs of products, which in turn leads to lesser income taxes and lower operational earnings. As the older products are stagnated in this approach, LIFO often leads to obsolete inventory.
3. Specific Identification— Probably the most well-researched inventory accounting process, specific identification technique tracks the cost of each item and tallies the same with the one sold. This approach requires advanced levels of data tracking and works best with the pricier commodities.
4. Weighted Average— Here is a standalone inventory layer where the existing inventory costs are rolled along with the newer purchases and an average cost is determined. The average value can therefore be readjusted whenever newer products are added into the scheme of things.
Inventory accounting isn’t a straightforward process but can be simplified if the organizations hire functional and reliable accountants. Moreover, this approach works perfectly when it comes to assigning values to the existing inventory which actually helps categorize them as business assets. Lastly, it is important to select the best accounting technique based on the business requirements as having one in place can help maximize the revenue potential and simplify the entire process of taxation and record keeping.