Stock in Trade

Inventories are assets that are held in ordinary course of business for sale or use in the production of items for sale.

Types of Inventory

• Raw material (items which are used in the production process e.g. limestone for cement production, vehicle parts for vehicle manufacturing, etc.)
• Work in process (items which are in the production process at a particular point in time)
• Finished Goods (items which are ready for sale)

Cost of Inventory

The cost of inventories includes all purchase costs, conversion costs, non-refundable duties and taxes, and other costs incurred in bringing the inventories to their present location and condition.

At the balance sheet date, stock in trade instated at lower of cost and net realizable value (NRV).

Example:

A company imported a batch of raw material. The costs are as follows:

Purchase cost              $ 100,000
Freight                         $ 15,000
Custom duty               $ 40,000

The company incurred conversion cost (labor and overheads) amounting to $50,000 during the manufacturing process. None of the finished goods have been sold at reporting date. The estimated revenue from the sale of finished goods is $. 230,000

As discussed earlier cost of inventory includes all costs incurred to bring it to its present location and condition. So the cost of raw material inventory will include its purchase cost, cost of freight (i.e. cost of moving it to the company’s warehouse), and customs duty (ie. Cost that was paid to clear it from custom authorities without which it couldn’t have reached company premises). The Entry will be recorded as:

When the raw material is used in a production process its cost is shifted to a “Work in process” account through the following entry.

All cost incurred in the manufacturing process is also charged to the Work in Process Account. In our example, labor and overheads worth $ 50,000 were used. So the entry would be

On completion of the manufacturing process the total cost of finished goods is transferred to the Finished Goods Inventory account.

                                                                               155,000 + 50,000 = 205,000

Now if the finished goods are sold during the period the amount will be transferred from the Finished Goods Account to the Cost of Goods Sold Account.

If on the other hand, finished goods inventory is not sold during the period and is held at the period end then management should perform NRV testing to assess if there is a need to recognize a provision for diminution in value of inventory.

Scenario 1: NRV is $ 230,000 which is above cost.

No adjustment entry required.

Scenario 2: NRV is $ 200,000 which is below cost.

Management needs to reduce the carrying value of its finished goods inventory to Rs. 200,000 by recognizing a provision of Rs. 5,000.

Finished goods inventory will be carried in the balance sheet as per below: