Question

Chapter 6 – Reporting and Analyzing Inventory

After reading Chapter 6, please answer the following questions:

• Discuss two ways in each inventory is classified and determined.
  
• Define the inventory cost methods
  
  
  Which financial statement is inventory presented on?

Answer 1

In a manufacturing company, inventory is usually classified into three categories: Finished goods, Work in process, and Raw materials. Raw materials inventory—the basic goods that will be used in production but have not yet been placed into production.

On the basis of functions, inventory may be classified into the following four types:

(i) Lot-size Inventories:

Some business firms prefer to purchase materials in bulk because they receive a discount on bulk purchases. Big business firms can afford to buy in large quantities. To produce the goods in exact amount of their demand is not generally possible and practical. Some inventories accumulate. The inventories accumulated as a result are known as lot-size inventories.

(ii) Fluctuation Inventories:

Because of the demand and supply factors, the market for certain commodities or raw materials generally fluctuates. This fluctuation is marked in respect of agro-based products.

When the availability of raw materials is seasonal, bulk stocks are purchased and stocked throughout the year in order to meet the high demand during the season. Since demand fluctuates over time and cannot be forecasted accurately, some reserve stocks are necessary. Those safety stocks are fluctuation inventories.

(iii) Transportation Inventories:

The inventory manager of the business firm favours low in­ventories to reduce inventory cost. However, this policy increases stock-outs, back orders, paper work, special production runs and high cost fast-freight transportation.

Raw materials are transported from its place of production to the business firm which needs it. Since the goods and raw materials in transit cannot serve those for whom these have been sent, these goods or resources in transit represent transportation inventories.

(iv) Anticipation Inventories:

When a business firm anticipates a price rise or introduces the business promotion tools, it will need to accumulate inventories. The raw materials may be stored in the form of semi-finished goods or stored in their original form. These inventories are known as anticipation inventories.

Ans B

The method a company uses to determine it cost of inventory (inventory valuation) directly impacts the financial statements. The three main methods for inventory costing are First-in, First-Out (FIFO), Last-in, Last-Out (LIFO) and Average cost.

Ans C

Reporting Inventory

Inventory: Inventory appears as an asset on the balance sheet. Depending on the format of the income statement it may show the calculation of Cost of Goods Sold as Beginning Inventory + Net Purchases = Goods Available – Ending Inventory.