When should inventories recognize in financial statements?

What is inventory

Inventories are items or assets that are held for selling to customers but not for internal use in business. Inventories are the entity’s assets that report in the financial statements are current assets on the balance sheet.

The recognition of inventories in the financial statements of the entity is similar to the recognition of other assets.

In order words, the inventories should be recognized in the financial statements when the inventories meet the definition of assets in the financial frameworks.

Accounting treatment of inventories

Under IAS 2, Inventories shall be measured at lower costs and net realizable value.

What costs should be capitalized as inventories?

The cost that can be capitalized as inventories such as:

  1. Costs of purchase (direct cost of that items)
  2. Costs that bring inventory for ready to be used such as customs duty, transportations costs, direct material that used and other overhead costs to bring that assets/items as finish goods)
  3. Other costs such as storage costs, waste, and other overhead costs

For example, Retail company XYZ has a business selling sports products in the supermarket. What are the inventories of this company? What should be the cost of the inventory shall XYZ record?

Answer: The inventories of this company are the sports products that they sell in the market. The costs that should be recorded in the inventory include the direct cost of sports products that XYZ purchased from its suppliers, the transportation charge from the supplier factory to its warehouse and to the supermarket for sale, the customs clearance fee at the port (while shipment), the cost of testing product … etc.

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Example 2: Factory ABC has a business for producing lady dresses. What are the inventories of this company? What should be the cost of the inventory shall ABC record?

Answer: The inventories of this company are the complete lady dress that this factory finishes sewing. The costs that ABC shall record in the inventories include the cost of purchase of fabric, zip, and other material costs to produce the dress. This call direct material cost. More than direct material costs, the ABC shall consider direct labor costs which are the costs of labor that cutting, sewing that fabric to make a dress, and also direct overhead costs such as utilities, admin costs, and marketing expenses. All the cost from the beginning until making the product (Lady dress) to be ready for use or can say as ready for wear and can be sold).

What are the double entries of inventory when purchase and sale?

When the company purchases the inventory

Dr. Inventory                                       xxxx

      Cr. Bank/ Account payables                     xxxx

When the company sale the inventory

Dr. Cost of goods sold                        xxxx

      Cr. Inventory                                             xxxx

Where to record inventory in the financial statements?

Inventories are recorded in the statement of financial position under current assets.

What are the assertion risk and its procedures of inventory?

  1. Existence: to ensure the inventories that recorded in the statement of financial position is really exist. The procedure is to do an inventory count at the financial year-end.
  2. Completes: to ensure all transactions of inventories recorded in the statement of financial position really occurred. Procedures are a sight to the supplier invoices and paid.
  3. Rights and obligation: to ensure the inventories recorded is really belong to the company and it is not just a consignment of inventory from another company. Procedures are a sight to the supplier invoices and paid.
  4. Valuation: to ensure the value that is recorded is the real value of the inventory as of the financial period. If there is any slow-moving or obsolete or broken inventory haven’t been written off and does it still record in inventory?
  5. Presentation and disclosure: according to IAS 2, inventory need to disclose in the notes to financial statements.
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Recognition of inventory

There are two types of recognized inventory:

  1. First In First Out (FIFO) which inventories purchase first need to sale first.
  2. Weighted average costing which means the costing of inventories need

The recognition of inventories in the financial statements of the entity is similar to the recognition of other assets.

In order words, the inventories should be recognized in the financial statements when they inventories meet the definition of assets in the financial frameworks.

Based on the financial frameworks, assets are the resources that control by an entity as the result of past transactions, and the future economy of those assets is expected to into an entity and the value of those assets could measure reliably.

Therefore, the entity could recognize inventories in the financial statements if those inventories are under the control of the entity.

An entity will gain economic inflow as the result of the use or trade of those inventories. The value of inventories should be measured reliably.

For example, if the entity purchases goods for trading, the entity should recognize inventories in its financial statements at the time the entity has full control over those entities.

In other words, the risks and rewards of inventories are transferred to the entity.

Goods received normally play as the main documents for recording inventories. However, for international transactions, there are certain conditions, for example, FOB and CIF of contracts.