Cambrige AS and A Level Accounting Notes (9706)/ ZIMSEC  Advanced Accounting Level Notes: Inventory valuation: Introduction

  • It has already been pointed out elsewhere that there are several types of entities:
    1. Manufacturing entities that make goods and sell them
    2. Merchandising entities that purchase goods and sell them for a profit for example supermarkets
    3. Entities that provide services for example accounting and law firms
  • Whatever their nature most entities have some form of inventory (sometimes called stock) as part of their assets
  • Manufacturing entities have:
    1. Stockpiles of raw materials (direct materials) that will be used in the manufacturing process even those that adhere to the Just In Time philosophy (JIT) still have to keep some stock
    2. Inventories of partially finished products known as work in progress
    3. Inventories of finished products ready for sale
  • Merchandising entities have:
    1. Stockpiles of products bought for resale
  • Whatever the reason for holding them, inventories form a material part of most entities’ assets
  • For decision making purposes and reporting purposes inventories have to be valued properly
  • Inventory valuation is important for:
  • for inclusion in the Financial statements of a business and
  • to calculate how much to charge for a product based on the amount of inventory consumed as well as a host of other decisions such as whether to make a product or purchase it, which product to make etc
  • The valuation of inventories is governed by the International Accounting Standard 2 (IAS 2 here)
  • Please note IAS 2 does not apply to Work in Progress,  some non-tangible assets and assets of a biological nature even if they are considered inventories
  • While as already pointed out in the introduction to Cost and Management Accounting, management accountants don’t have to adhere to these International Financial Reporting Standards as they prepare records for internal consumption in the organisation
  • It is conventionally considered good accounting practice to adhere to these standards unless there is a compelling reason not to
  • You can read notes on IAS 2 here

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