Top Insights For Effectively Accounting For Inventories
Accounting for inventories is critical for companies in the retail sector. Many people often think of on-hand inventory simply as a stock that is yet to be sold. However, one should consider it as a business asset, and it should be treated the same legally. In this respect, inventory accounting is essentially the process of accurately valuing a business asset, so it can be properly documented in end-of-year financial records. And even VAT (Tax) laws also mandate every taxpayer to maintain books of accounts along with the inventory. Companies can consult with accounting firms in Dubai for accurately accounting inventories.
This article deals with the critical aspects of accounting for inventories in compliance with accepted accounting standards. Read ahead.
What is Inventory Accounting?
Inventory accounting can be defined as how a business would show the stock it holds in its financial records – balance sheets, profit & loss (P&L) reports, etc. In retail, it covers the following:
- Raw materials.
- In-progress items.
- Finished products ready for sale
Inventory accounting key terms
There are two key terms retailers need to be aware of when it comes to inventory accounting:
Cost of Goods Sold
Cost of goods sold (COGS) is a core element of measuring a retail business’s profitability and inventory value. As the name suggests, COGS refers to the amount it cost a business to produce the products it sold, including everything that went into it – materials, inward shipping cost, labour, tools used, etc, but without factoring in costs not directly tied to the production process – like outward shipping, advertising and sales force costs, etc.
Ending Inventory (EI)
Ending Inventory (EI) is the value of any unsold, on-hand inventory at the end of an accounting period. Likely, a business will not sell the entirety of its inventory at the end of each accounting period. It means that any on-hand, unsold stock becomes an asset that must be valued and included in financial statements.
Inventory valuation methods
Businesses need to adhere to a specific inventory valuation method as it is vital for preparing a consistent, accurate financial statement. Let’s talk about the two main valuation methods retail firms depend on for inventory accounting:
1. First in First Out
First in First Out (FIFO) is a commonly used inventory management method that helps companies effectively manage the stock in the warehouse. However, FIFO is also effective in valuing unsold inventory. In this method, we assume that the first purchased inventory is also the first to be sold. This means the oldest on-hand inventory will be used to meet an order.
The benefits of using the FIFO method are numerous. For instance, a company selling perishable goods such as food and beverages can minimise the risk of its products become spoiled or exceeding the best-before sale date. The FIFO method is useful in maintaining a smooth supply chain while making sure that the customers get the freshest item in the inventory. Every product that is received and sold should be recorded individually while using the FIFO method. Businesses must, however, take care not to overestimate or underestimate the value of inventory in the future due to potential market changes while using the FIFO system.
2. Average Cost
Average Cost or weighted-average is an inventory accounting method that applies to businesses that choose not to track cost per inventory unit for each separate purchase delivery. Instead, inventory value is based on the average cost of items throughout the relevant period. Companies can work out the average cost by simply dividing the overall cost of products for sale by the total number in the inventory.
3. Inventory Tracking
Every business should maintain its inventory with a unique tracker for its storing location, to identify the inventory easily.
4. Physical Stock Take
Every company should make periodic inventory verification to verify any shortages and to know that the inventory accounting is correctly maintained.
How Can Jitendra Chartered Accountants Help you?
Hopefully, this article has given the entrepreneurs a good insight into the best inventory accounting practices. That being said, this can still be a hugely complicated task for retailers. So we highly recommend employing the services of the best accounting firms in Dubai such as Jitendra Chartered Accountants (JCA) when it comes to compiling financial records and submitting tax returns.
JCA has a team of highly qualified accounting professionals who will ensure that your inventory accounting system is smooth, simple and robust. JCA will guide you through important requirements including budgeting and forecasting apart from ensuring that your financial records are maintained properly and in compliance with UAE laws. JCA will reduce your headaches about vital aspects such as VAT return filing, Economic Substance Requirements, and maintenance of real beneficiary registers. Avail JCA’s accounting services in Dubai to ensure success comes to you faster.