Inventory is the idle but valuable group of raw materials and raw material based derivatives held in the ordinary course of business. It is important to note that it is not yet actively available for sale (or external consumption), i.e. it is idle, but it is not without value, i.e. realisable worth can be attributed to it; it is not waste or scrap. Essentially, it is a buffer, or better still, a decoupling component of materials as a resource in the business. that decouples "demand" and "supply". Business houses produce their product range to satisfy customers' demands; and procure the materials needed as inputs for the production activity from suppliers. In case both supply and demand are uniform, instantaneous and well-matched, the demand can be directly matChed by supply in both time and quantity. Since this is an absolutely rare possibility. inventories have to be held. Accordingly, inventory is the aggregate of those items which are held for sale in the ordinary course of business (finished goods), or are in the process of production for such sales (work-in- process or work-in-progress) or are to be currently (or soon) consumed in the production of goods and services (raw materials) to be (eventually) available for sale. It is the least liquid current asset, but yet is inevitable as a decouple as said above. Too much of it locks up funds; too little of it tends to disrupt production and sales activity, besides other ill-effects on the business in several other counts both when overstocked or under stocked. Inventory is reported in the BS at cost or market value whichever is lower. Inventory
affects the total profits. Hence, its valuation is an important necessity for business.
Depreciation as has been brought out in the previous units, has a role in ascertaining the true profit, in correctly stating the financial position and in accumulating funds to replace the asset at the end of its useful life.
One may also incidentally note that whereas inventory is essentially a current asset. depreciation refers almost exclusively to the context of fixed assets. Whereas market value is relevant in inventory valuation, market value is rarely quoted in case of fixed assets. Scrap value is relevant for fixed asset but assigning scrap value to inventory as a policy is reflective of ineptitude of the management. But both affect the profits and in major ways too.
Objectives
After studying this unit, you should be able to
- distinguish inventory valuation from inventory management,
- understand the purpose of inventory valuation and its role in defining the profits correctly,
- reason out the assumptions involved in the different approaches to inventory valuation and value inventory accordingly,
- apprise the importance of depreciation provisions and on how they affect profits, replacement, cost of production, etc.,
- learn the different methods of computing depreciation and the effect on taxes thereby,
- choose an appropriate depreciation policy for an organisation,
appreciate the occurrence and role of switch point in depreciation, and
evaluate the relative effects of expensing or capitalising for repairing costs.
No comments:
Post a Comment