The statement of comprehensive income depicts the changes in equity over the given time frame. In other words, it explains why the net assets have changed over a given period of time. There are mainly two components for the statement of comprehensive income: Net income and other comprehensive income (OCI).
Net income is the difference between revenues and expenses and is obtained from the income statement. On the other hand, OCI includes all other items that are excluded from the purview of the income statement.
The amounts of OCI are not included in the entity’s net income or retained earnings but just on the OCI component of the statement of comprehensive income.
Condensed Statement of Comprehensive Income:
Condensed means being short. That would mean condensed statement of comprehensive income summarizes all the portions of income statement and OCI into few captions and amounts.
Generally, condensed statement of comprehensive income would show only the headings excluding the details that were being shown its more lucid form i.e. statement of comprehensive income.
The users of the condensed income statements would find it easier to go through this statement glancing directly at what the company has been doing.
Let’s take an example of a trading company.
The condensed income statement of trading company would summarize different categories of sales into one amount with description of net sales. The details regarding purchases and other changes in inventory are presented under cost of goods sold heading directly.
The numbers of operating expenses like selling expenses, administrative expenses, etc. would be presented under Operating expenses.
Breaking down Condensed Statement of Comprehensive Income
The most important part of the condensed statement of comprehensive income is the income statement. The income statement provides details on revenues and expenses, including payable taxes and interest charges. The main purpose of an income statement is to present net income.
However net income only serves the purpose of earned income and expenses. Certain gains and losses regularly occur from fluctuations in the value of their assets. They are to be recognized in other comprehensive income. It consists of items such as:
Unrealized gains or losses from debt securities
Adjustments made to foreign currency transactions
Unrealized gains or losses from available-for-sale securities
Gains (losses) from pension programs
Gains (losses) from derivative instrument
Format of Condensed Statement of Comprehensive income
A basic format for condensed statement of comprehensive income is given below:
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
Cost of goods sold
Income from operations
Income before taxes
Other comprehensive income for the year, net of income tax
Total comprehensive income
Net income (loss) attributable to Shareholders
Total comprehensive income (loss) attributable to shareholders
Basic Earnings per share
Uses of a Condensed Statement of Comprehensive Income
The Condensed Statement of Comprehensive Income entails the summary of the income statements and other comprehensive income.
It shows the eagle-eye view of all the operating and non-operating income and expenses in one statement. Here are some of the uses of the Condensed Statement of Comprehensive Income:
1. Summary of revenue and expenses information
The Condensed Statement of Comprehensive Income provides the figures of the sales revenue and cost of goods sold. Further it can provide category of operating expenses such as selling expenses and administration expenses.
2. Simple Analytics tool for investors
The components as income statement and statement of comprehensive income are financial reports. Investors are very much interested in these financial reports for decision making in evaluation of investment.
The higher the condensed statement shows about earnings, the more profitable it would be for investors to make a suitable investment.
Limitations of a Statement of Comprehensive Income
A condensed statement of comprehensive income is a summary of the income statement and other comprehensive income. It does not break the headings into various accounts. Hence, the statement falls short in some manner.
The statement is based on the accrual system of accounting meaning that all the expenses that need to be incurred during the year would be recorded although the cash flows are not necessary. This has to be checked from the statement of cash flows to give a rear view of the company.
2. Difficulties in making predictions
Condensed statement of comprehensive income does not provide details on whether the firm will succeed. It is based on historical data to compute earnings per share and other past financial records.
Hence, investors make certain assumptions to forecast the earnings of the company for investment purposes although it’s difficult in making such assumptions.
Cost Of Goods Sold (COGS) represents all the direct costs of the products manufactured and sold by a business. For most manufacturing businesses, the COGS will consist of material and labour costs that contribute directly to the value of a product.
COGS will, however, exclude any indirect costs. Indirect costs are costs that don’t directly contribute to the value of a product. These may include costs such as research and development, selling and distribution, etc.
The Cost Of Goods Sold of business is straightforward to calculate. First of all, the business must establish the cost of its products. It helps the business in determining the costs of its inventory, which is a required part of the COGS calculation.
COGS calculation mainly includes calculating the exact cost of the goods which the business sells. It is important because of the matching concept of accounting, which requires expenses to match with the related revenues.
A business can use the following formula to calculate its COGS:
Cost Of Goods Sold = Opening Inventory + Purchases – Closing Inventory
Is Cost Of Goods Sold The Same As Expenses?
While the Cost Of Goods Sold is technically an expense that business bears on goods it produces, it is different from other types of expenses. From an accounting point of view, COGS is an expense for a business.
However, businesses don’t usually calculate their COGS until the end of an accounting period when they are preparing the Statement of Profit or Loss. The Statement of Profit or Loss is also where a business presents its COGS separate from other expenses.
COGS and other expenses appear separate in the statement to differentiate between the COGS, which is the main cost for any business that deals in inventory, and other costs, which may also apply to all businesses.
The COGS also represents all the costs that business bears directly on producing a product for sale. On the other hand, other costs are those which a business must bear to keep it running but may not directly add to the cost of a single product.
There’s also a difference between expenses and costs, that businesses must understand. While these differences are minor, they are still worth considering.
Cost vs Expense:
The main difference between cost and expense is that cost refers to the amount a business spends on the acquisition or production of an asset. On the other hand, expense refers to the amount that it spends for its operations to ensure it can generate revenues in the short and long run.
While this is the general difference between cost and expense, there are also many more differences.
The term cost refers to the investment of a business in the purchase or production of an asset. It doesn’t matter whether it is for a fixed asset or inventory.
A business bears costs with the expectation of benefiting from it in the future. Expenses, on the other hand, are not investments, but rather a tool for a business to help in its objective of revenue generation.
Businesses also bear costs once and add them to the value of the asset for which it bears the cost. On the other hand, expenses are more regular. Similarly, costs relate more to the Statement of Financial Position or balances.
However, costs may sometimes also relate to the Statement of Profit or Loss but must follow the matching principle of accounting. Expenses, on the other hand, only relate to the Statement of Profit or Loss and are transactions rather than balances.
Similarities of COGS with expenses
As mentioned above, the Cost Of Goods Sold is an expense in the Statement of Profit or Loss. Therefore, it is similar to other expenses of the business. However, in the statement, the COGS is presented separately from other expenses. There are many reasons why they are separated.
The first reason is that it is necessary for the calculation of Gross Profit and needs to be separated. The second reason is that COGS is fully tax-deductible as opposed to other expenses. However, in essence, COGS is an expense the same as other types of expenses.
Differences of COGS with expenses
While COGS may be similar to expenses, there is still a difference. The difference is due to the source of costs and expenses. With costs, the money of a business goes towards the manufacturing of products of a business.
As mentioned above, costs are more of an investment rather than an expense. On the other expenses go towards keeping the business operational and not towards any product. In summary, COGS and expenses are different because COGS shows the direct expenses of business while other expenses are indirect.
The Cost Of Goods Sold represents all the direct expenses of a business in the Statement of Profit or Loss. Businesses calculate COGS following the matching principle of accounting. There are some differences between the COGS of a business and other expenses.
A business must first consider the difference between costs and expenses generally, to understand the difference between COGS and other expenses. The similarity of COGS with other expenses is that they are all expenses in the Statement of Profit or Loss. The difference is that COGS represents direct costs, while expenses represent indirect costs.
Companies commonly arrange a condensed financial statement along with the customary financial statements. The core groundwork on these documents function to serve various legal commitments and usually associates with an episodic audit.
Nevertheless, except for substituting comprehensive financial statements, condensed financial statements turn out to be the additional documents or precise supplementary papers essential during the auditing procedure.
What Are Condensed Financial Statements?
Condensed financial statements are defined to be the brief version of a business’s income statement, cash flow statement, and balance sheet, all collectively put into a particular financial document.
These brief reports are made to deliver a rapid outline of the business’s financial position with appropriate detail, and usually for internal procedures.
Purpose of A Condensed Financial Statement
A condensed financial statement is made to deliver quick and accurate information about a business’s financial position and a brief look on where the business’s finances stand during that period. The condensed statement also mentions all the variations in the financial position of the business.
Usually, businesses aim on arranging condensed statements all around the year along with the annual financial statements.
Moreover, businesses also require condensed financial statements at times to assist the calculated demonstration of concise data to business associates or likely through the introductory periods of conciliation.
Understanding Condensed Financial Statement
Businesses arrange condensed financial statements during the year in expectancy of their monthly or yearly reports. These are often envisioned to be useful for internal as well as external auditing, except a shareholder or predictor use.
Condensed financial statements show a similar general financial image of the business as any regular financial statements, but in a much concise manner; each item condensed to only one line for briefness.
For example, the condensed financial statement offers only one line for the “total revenue,” while the full financial account will have the revenue by products, services, operating division, interest, and various other sources of revenue.
When inspecting condensed elements of financials, it is important to be more careful while observing each item line. The lesser the data, the simpler the analysis.
However, that same lack of detail can bring in bigger essential complications to the firm. To cross-check the condensed version, a full set of financial statements can be very helpful.
So while reviewing, the full statements will comprise of releases and line items that might have been exempted from the condensed form of the financial statement.
Preparing a Condensed Financial Statement
Financial data with usually several dedicated lines in a full financial statement, only receives a single line to represent that data in the condensed form. Therefore, a representative condensed financial statement normally comprise of one line for expenses, financing income, revenues, cost of goods sold, and net income.
While preparing a condensed financial statement, only relevant pieces of financial data are included. It forms a summary version of the information presented on a complete financial statement with detail.
Condensed financial statements document and calculate assets and liabilities for temporary recording using the financial data available on a year-to-date basis.
Due to practical reasons, the formation of condensed financial accounts usually makes more profit on approximation approaches as related to comprehensive or full financial statements.
A regular set of condensed financial statements would generally include statement of comprehensive income, changes in equity, cash flows, financial position, and particular descriptive notes.
What Is The Use Of Condensed Financial Statements?
Condensed financial statements are an exceedingly accumulated form of the financial statements, with various line items being concise into just a few lines. Using this method, the demonstration of financial data can be simplified, often consolidating all three of the financial statements into a single page.
Example Of Condensed Financial Statement
Below is a condensed financial statement version, presenting a single line dedicated for each item: revenue, expenses, etc.
Overall, the condensed financial statement is used to outline the financial reporting using the least possible content. The aim is to deliver a rapid and brief summary of a business’s financial standing.
Alongside a set of reports, it displays the present “interim” time period and relative “interim” previous period’s financial data (even without being a whole long statement).
Interim periods typically possess particular financial accounts with a comprehensive or condensed form of financial statements dated for less than a fiscal year.
The statement of changes in equity is one of the four main financial statements that prepared by the entity for the end of the specific accounting period along with other statements such as balance sheet, income statement, and statement of cash flow.
This statement normally presents the entity’s capital, accumulated losses, or retained earning pending on the performance of the entity and the reserves. In others, the ending balance of equity in this statement is the difference between total assets and total equity.
Definition of Statement of Change in Equity
Equity can be defined as the values of a corporation’s stakeholders that is used up for the business. It holds a share of the total in cash or in kind dedicated for a business. Moreover, the total money signifies tenure of a company.
The statement of changes in equity allows a business to contemplate its gain or loss for a specific period.
Along with that, it keeps a record of other inclusive income during the period or during the year, the outcomes of variations in accounting strategies and alterations of substantial errors identified within that time, and the sum of savings by, and bonuses and other supplies to, equity stockholders throughout the time span.
What Does Statement Of Change In Equity Include?
Statement of change in equity points out the modification in owners’ equity for an accounting time period through representation of the association in assets including the stockholders’ equity. It highlights the variations in equity starting from the initiation till the completion of the accounting time.
They may occur from businesses with new monetary investment, the bonus compensations, holder’s withdrawal, net gain or loss, and revision of fixed assets, etc.
Changes in equity for an accounting time period contains the basic features mentioned below:
Net gain or loss for the particular accounting span
Extra expenses to investors
Increase or decrease identified straight in equity
Outcome of fluctuations in accounting strategies
Gain or loss in share monetary investments
Consequence of alteration of inaccuracy in previous time period
A statement of change in equityis therefore created to report with variations in equity for business sorts, whether it is aimed at partnerships, corporations, or sole proprietorships. The ultimate aim of the statement remains to provide a brief movement for all the equity accounts within a specific time period.
Why Is The Statement Of Change In Equity Required?
A simple calculation of subtracting the assets and liabilities of two accounting periods will result in a movement in equity.
Even though this calculation can be seen on a balance sheet of a particular business, yet it does not list the details of the variations occurring in the equity during that period. A statement of changes in equity is required for this purpose.
To summarize the points mentioned earlier, it can be seen that statement of change in equity is created to fulfill the following items:
Settlement of the starting and ending balances of equity, stating the variations in detail
Specification of inclusive revenue for the accounting time period
Particulars of variations and the effect after constituents of equity are reaffirmed or used all together
Statement of changes in equity delivers the consumers with financial data for three main elements of equity, comprising:
A settlement among the amount during the start and the closing of the period of a respective factor of equity, like retained earnings, share capital, and revision
Variations in accounting strategy that involves the alteration in the equity account because of the outcomes of the retrospective use of accounting strategies
Inaccuracy adjustment in the previous period that necessitates the alteration in the equity version because of the outcome of the retrospective reassertion of preceding period miscalculations
Basic Demonstration Of Statement Of Change In Equity
The statement of change in equity displays a connection amongst the income statement and balance sheet of the business. Moreover, even the transactions like dividend paid or owner’s withdrawal, that are not shown on the income statement or balance sheet are visible in the statement of change in equity.
Movement of equity along with accrued incomes and losses are presented through a statement of change in equity in order to make it simpler for the readers to illustrate the sources and understand the origins and channels of equity (where the equity goes).
Statement of Changes in Equity is divided into three sections:
Retrospective use of variations in accounting strategies to the preceding period
Retrospective reaffirmation of previous period miscalculations
Settlement of the variations of respective elements of equity for the existing period
Data To Include In a Statement Of Change In Equity
To make a statement of change in equity, the following can be included:
Aggregate inclusive profit for the time period, presenting the sum of attributable to holders of the parent and to non-controlling benefits distinctly
For respective elements of equity, the outcomes of retrospective use or retrospective reaffirmation documented ascending from variations in accounting strategies or factual miscalculations
Every section of equity to have a understanding among the carrying sum during the start and the conclusion of the time period, distinctly releasing alterations due to: gain or loss
Additional inclusive earnings (consisting sub-analysis through detail for each element of equity with both on the appearance of the account and in the records)
The total money through, and extras and other allocations to, possessors, displaying \ concerns of dividends distinctly, consumption of own share dealings, and variations in possession benefits in businesses that do not produce a loss of regulation
Understanding Statement Of Change In Equity
The initial point is to be familiar with the opening balance of the account as that indicates the sum of stockholder’s equity investments at the beginning of the recording time. It is essential to note that the opening balance is unadjusted as it is taken from the previous time period of the report of financial position.
Any required or recommended alterations will be accessible individually in the statement of changes in equity; variations in accounting strategy and alteration of previous period miscalculations.
Further, it is vital to monitor for any modifications in accounting plan. The outcomes of any variations will be stated in the sorting.
Any previous period faults that have impacted the equity must be noted as an alteration to the primary investments, not the initial balance. This will permit the existing period sums to be resolved, and outlined to former period financial accounts.
With that, you can see the reaffirmed balance, which is the sum of the shareholder’s equity with alterations because of the sorts of variations and alterations.
Detailed Components Of Statement Of Change In Equity
Below mentioned are the key components of statement of change in equity:
It represents the stability of stockholders’ equity assets from the beginning of the relative recording period as redirected in the previous period’s declaration of financial situation.
The opening balance is unadjusted with respect to the alteration of previous period mistakes resolved in the existing period and the result of variations in accounting policy executed throughout the time as these are accessible distinctly in the statement of changes in equity.
Result of Variations in Accounting Policies
When variations in accounting strategies are used in retrospect, an alteration is essential in shareholders’ investments by the beginning of the relative recording period to reaffirm the primary equity to the sum that would be attained if a different accounting strategy is in function.
Effect of Correction of Previous Period Faults
The effect of correction of previous period faults must be obtainable distinctly in the statement of changes in equity as an alteration to the initial investments.
The outcome of the modifications may not be taken off in contrast to the initial balance of the equity investments so that the sum existing in existing period report can be simply resolved and outlined from previous period financial accounts.
It signifies the equity that is characteristic towards shareholders at the beginning of the relative period after the changes with respect to variations in accounting strategies and alteration of previous period miscalculations as described above.
Variations In Share Capital
Subject of additional share capital throughout the period can be supplemented in the statement of change in equity while restoration of shares can be subtracted therefrom. The outcome of subject and restoration of shares can be accessible distinctly for share premium reserve and share capital reserve.
Dividend payments dispensed or declared throughout the time period can be subtracted from stockholder equity as they signify the delivery of capital characterized with the shareholders.
Loss/ Gain for the period
It signifies the gain or loss characterized with stockholders throughout the time period as stated in the income statement.
Changes in Revision Reserve
Revision profit and loss documented throughout the time period can be offered in the statement of change in equity to the degree that they are accepted apart from the income statement as well.
Revision profits documented in the income statement because of the setback of earlier diminishing losses though shall not be accessible distinctly in the statement of change in equity due to their compensation in the gain or loss during that time period.
Additional Profits & Losses
Any other profits and losses not mentioned in the income statement can be accessible through the statement of change in equity. For example: actuarial profit and losses.
It signifies the stability of stockholders’ equity investments by the conclusion of the recording time period as revealed in the statement of financial position.
Purpose Of The Statement Of Change In Equity
Statement of change in equity is required for the consumers who aim to identify the issues in a financial statement that are a source of alteration in the owners’ equity throughout the accounting time periods.
While the change in stockholder investments can be witnessed from the balance sheet, the statement of change in equity reveals noteworthy data about equity assets that is not accessible distinctly anywhere else in the financial reports. This is valuable for comprehending the nature of variation in equity investments.
The information only available in the statement of change in equity may include share capital matter and restoration throughout the period, the outcomes of variations in accounting strategies and improvement of previous period inaccuracies, profit, and loss documented apart from the income statement, dividends stated, and additional shares delivered throughout the period.
Format Of Statement Of Change In Equity
The statement of change in equity is usually obtainable as a distinct statement. However, it can be supplementary to an alternative financial statement as well. Receiving a significantly extended version with all the added various elements of equity on the statement is also conceivable.
For example, par value of the common stock can be distinctly recognized, capital stock, extra paid-in investment, and retained earnings, with all of these components then progressing up into the concluding equity total.
The format of the statement includes the following steps:
Generate distinct financial records in the general ledger reserved for each category of equity. This means, there would be a diverse range of financial records for the retained earnings, the balance cost of stock, and extra paid-in investment. A separate column in the statement embodies respective accounts.
Handover each contract surrounded by individual equity account on a spreadsheet, and classify it there.
Combine the similar type transactions on the spreadsheet, and handover them to distinct line articles in the statement of change in equity.
Finish the statement, and validate that the opening and concluding balances in it go along with the general ledger and that the combined line articles surrounded by it combine with the concluding balances for all columns.
Partnerships and sole proprietorships extend a related approach on formatting their statements of change in equity. However, the statement of changes in equity for a corporation uses a marginally altered format.
Formula Of Statement Of Change In Equity
Starting with the beginning equity balance and then plus or minus such items as gains and dividend payments to reach the ending balance. Generally, the calculation structure of the statement of change in equity is:
Beginning equity + Net income – Dividends +/- Other changes = Ending equity
The dealings usually apparent on this statement are mentioned below:
Profits from the sale of stock
Capital stock acquisitions
Net profit or loss
Outcome of variations due to faults in previous periods
Effects of fluctuations in fair cost for some assets
Profit and loss documented directly in equity
Example of Statement of Change in Equity
Below is a momentary example of statement of change in equity. There are many other possible sort of elements that could be in a statement of change in equity.
However, it demonstrates the most customary one for a business. It can be referred to as a consolidated statement as it shows non-controlling interest.
How To Prepare A Statement Of Change In Equity
Prepare the statement of shareholders’ equity template. Starting with the title of the corporation name, the financial statement heading and the time period being reported. As seen, the first left column is usually empty. After that each of the next columns will have the titles of each equity account from the general ledger. Make a Total Equity column on the extreme-right.
Note down the beginning balances. Label the next row in the extreme left as Beginning Balance, (or just write the first date of the period). Put the beginning balance of each account in the suitable account. After the addition of balances, go to the extreme-right column and fill in the total.
Categorize equity transactions during the year. The transactions may contain mainly the delivering stock, repurchasing stock, compensating bonuses or tracking net income. Assess respective equity account for any variations. Each alteration would denote an equity transaction.
Record every business deal amount on the financial account. Modify the particular columns of equity account for the dollar variations of respective transaction. Review related transactions, including numerous cash dividend expenses or various stock issues. Add the total transaction amount of each transaction in the extreme-right column.
Compute the closing balances. Put a label of Ending Balance on the last row (or just include the last date of the period). Put the total amount of each column to conclude the closing balance. Equate these balances with the general ledger interpretation balances. Both the amounts should be same. On the account of difference between the two, go through the transactions again for each account that varies. Update the statement due to any transactions not registered correctly on the statement of change in equity.
The statement of changes in equity is significant for the predictors and critics of financial statements as it permits them to get insights on the issues that root a change in owner’s equity through a specific accounting period.
Moreover, it helps unlock the detailed financial information that is not usually found on a balance sheet, as the data specifying equity assets is not logged distinctly in the other financial statements.
As seen above, the statement of change in equity delivers thorough information regarding the changes in the equity share money through a specific accounting period that is not gained through any other financial statements. Due to these details, it is easier for the stockholders and investors to make learning choices for their reserves.
Businesses that deal with physical products will have inventory at some point during their operations if not always. Inventory is a term used to describe all tangible materials that businesses use to manufacture products for sale.
For businesses, it is one of the most important assets as it is the main reason for the revenues and profits that they generate, which also translates to an increase in the wealth of owners.
There are different methods to value inventory. The first method that businesses use is known as the First-In, First-Out (FIFO) method. In this method, they value inventory based on the cost of the earliest purchases.
Businesses can also value inventory using the weighted average method using the average cost of purchases. Finally, they can also use the Last-In, First-Out (LIFO) method of inventory valuation, where they value inventory based on the cost of the latest purchase. However, using the LIFO method may be prohibited under some accounting laws.
Types of Inventory
Businesses can categorize inventory into three main types. The first type is raw material. The raw material of a business consists of unprocessed material. These are materials that it further uses in the production process to make finished goods.
Examples of raw material include wood for furniture makers, crude oil for refineries, chemicals for pharmaceutical companies, etc.
The next categorization of inventory is work-in-progress. Work-in-progress is a term used to describe inventory that has entered the production process of business but has not left it.
In other words, work-in-progress is the inventory that is partially finished and still needs work to convert into finished goods. Examples of work-in-progress include molten aluminum for steel manufacturers, which still needs further work to become sellable.
The last categorization of inventory is finished goods. Finished goods consist of goods that are in their finished form and readily available for sale. These are goods obtained after raw materials go through the work-in-progress phase. Examples of finished goods include any products that consumers buy from a business.
The types of inventories that businesses use will depend on their nature. All businesses that deal with physical products will have finished goods but may not have raw materials or work-in-progress inventory. For instance, retailers purchase products and do not need to process them further to sell them.
Therefore, for them, raw material and work-in-progress inventory may not exist. Similarly, the type of inventory will also be different for different types of businesses. For example, the finished goods of one business may be raw materials for another.
A concept that applies to inventory is inventory profit. Inventory profit is the increase or appreciation in the value of an item classified in inventory for some time. Regardless of which type of inventory it is or the inventory valuation method used, inventory may be subject to an appreciation in value.
For example, a business holds inventory that cost $50, the market value of which has risen to $75. The $25 difference in the cost of the inventory and its market value is known as inventory profit.
Inventory profit can generate due to two main reasons. The first reason for it is inflation. Inflation occurs when the value of the currency in a country decreases, thus, decreasing the purchasing power of the currency.
When the purchasing power of currency declines, the prices of products in the country goes up. Inventory profit due to inflation mainly occurs when a business uses the FIFO valuation of inventory. In FIFO valuation, the cost of the oldest inventory will be the lowest and will encounter a higher profit due to inflation.
The second reason for inventory profit is appreciation in the value of inventory. Appreciation mainly occurs due to factors other than inflation, for example, market speculation. Businesses that hold a high amount of inventory commonly experience appreciation of inventory.
Some businesses base their operations around inventory profit due to appreciation in value, buying inventory when it is at a lower price, and selling it when its value appreciates.
For a well-managed inventory system, inventory profit is rare because inventory turnover should be fairly regular. When a business can regularly turn over its inventory, it will not experience any inventory profit. Inventory profit mostly occurs for businesses with lower inventory turnover.
However, as mentioned above, some businesses can still profit due to it. Similarly, for businesses that face the risk of obsolescence of inventory, inventory loss due to impairment will be more common, the longer they hold on to it. Overall, inventory profit is very rare, and only specific industries may experience it.
Businesses do not record inventory profit in their books of accounts when it occurs. That is because accounting rules do not permit businesses to record inventory profit. Instead, when a business sells its inventory, its gross profit increases due to inventory profit.
Therefore, businesses do not adjust the accounts at the time of profit. That is different from inventory loss due to impairment, where a business has to record it straight away.
Inventory consists of physical stock that a business holds and uses in its daily operations to generate revenues and profits. The business can use different valuation methods for its inventory and can also classify the inventory into different categories based on the completion level.
Sometimes, the value of inventory can increase when held in a business, known as inventory profit. Inventory profit can occur due to inflation or appreciation in value. There is no accounting treatment of inventory profit.
Inventory management is the efficient mechanism of ordering, storing, and use of the company’s inventory. The process includes the management of raw materials, components as well as finished goods. Further, the management of warehoused products and work in process items also fall under efficient inventory management.
Inventory management helps to know when to re-stock inventory, what amounts to purchase or produce, what price the products can be sold as well as the timing of sales to be made.
How to organize Inventory for small businesses?
Small businesses need to be cost-effective in the selection of various methods of inventory management. Here are the ways small businesses can use to organize their inventory:
1) Managing purchase orders
Small businesses shall start with creating and submitting accurate purchase orders. Purchase orders are used for the requisition of raw materials or goods to make resale. Managing purchase orders helps in tracking the movement of stock purchase efficiently to placement and payment of bills.
Purchase orders management helps the owners to estimate the cash flows of the business and also the need to re-stock the inventory levels. The stock re-order alerts can also tell which items are sold fast and slow and which needs refilling or restocking early.
2) Organizing vendor data
Small businesses need to set up stock and vendor information in their software or daily books. They can use excel sheets however they need to manually organize their spreadsheet. They need to organize data using point of sale mechanism.
They need to record each product’s information along with subsequent vendor details. The various details that need to depicted are product name, a short description of the product, product category, sizes, regular selling price, reorder quantities, details of the package, etc.
Using the Point of Sale mechanism helps to keep product details organized and in real-time. Further, it helps to track various post-sales aspects such as vendor billing information, payment terms, and contact of the vendor.
3) Tagging and Labelling inventory
This is the step when the inventory comes into the hands of small businesses. This means managing the products on your hand. Tagging means allocating the prices and affixing price tags while product label displays mean using bar code labels, tracking the inventory to speed checking out i.e. selling the product.
The use of good allocation of time to tag and labeling of inventory helps in making quick checkout of the product. The point of sale mechanism emphasizes the use of bar code scanners. These scanners also come with the function of effective labeling and scanning.
ted, labels can be affixed directly to product packaging or attached to hang tags. Some inventory might even arrive prelabeled with manufacturer’s bar codes, which you can also track in your POS. In that case, your job is easy. You can just add a price label.
4) Physically counting inventory levels
This is a very time-consuming task and excessively mundane. However, this process is a must for small businesses. All the irregularities and reconciliations can be easily solved through physical verification and counting of inventories. For tax purchases, annual counting is a must and done at the end of the fiscal year.
Doing physical counts helps to reduce shortages, displacement, and errors in receipt of stocks. To catch these mistakes, counts should be done in a smaller time period. This can include spot counts at the time of receipt of the product from the vendor.
While stock count should be started with inventory in hand, spot counts should be matched to invoice or purchase orders.
POS mechanism can be used by scanning the items and it can be nearly as useful as physical counting. However, when shortages are found, one should resort to physical counting.
5) Reconciliation of differences in inventory
After the physical counting of stocks, the differences if any shall be reconciled. This can be done by following the procedure of reconciliation. The first step would be to identify the discrepancy in counting. This can be due to inventory missing due to theft, damaged, and not reported and stock recorded as received but not actually received.
In a few cases, it can be just due to reasons owing to wrong labeling. If reasons cannot be known, the stock sheet needs to be adjusted to reflect physical balance in hand. After the adjustment in the books, the difference in any shall be accounted for loss in inventory as inventory shrinkage.
The small businesses shall carefully look if any human error has occurred intentionally or unintentionally. Further, small businesses can use various security features like access policy to stock and locking systems in order to reduce theft of stocks done intentionally.