What Are the Rules of Inventory Accounting that You Need to Know?

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What Are the Rules of Inventory Accounting that You Need to Know?

Any small business owner knows how important inventory is. In fact, SMEs have inventory take up the bulk of their company’s financial statements.

Because of how important it is to a small business owner, there are inventory rules that need to be followed in order for it make sense for the layman (and of course, to the business owner himself/herself).

That being said, it is crucial that you have a basic understanding of the principles of inventory accounting. Examining the principles for which they are based can ensure that your inventory is properly accounted for.

If you do not want to go through the hassle, you might just want to get financial and accounting services in Malaysia.

Costs to Include

Companies who manufacture goods should know the rules of inventory to help them determine what costs to include and exclude. Product costs should always be included in the inventory, while period costs, should always be excluded.

This means that, in general, the costs that are associated with materials, labor, and factory overhead costs should be considered and should be placed in the company’s balance sheet inventory.

On the other hand, other costs such as selling, general and administrative costs are considered to be period costs and should be excluded from the balance sheet inventory.

Goods to Include

The rules of inventory accounting follow strict guidelines, especially the ones that pertain to physical goods and which ones are to be included in the inventory count.

One of the keys to these rules is to know who has the legal titles to the goods on the specified data that the financial reports are issued.

For instance, the organization may have goods that are on consignment with some retailers, share warehouse space with another company or that have goods that are still in transit.

If the legal title of those goods has been transferred to the company, it should immediately be reflected in the company’s inventory. Failure to do so would mean that they will have to be excluded from the list.

Cost Flow Assumption

Cost flow assumption will help the business owner determine the manner in which the goods enter and leave their company’s financial records.

For instance, the LIFO cost flow assumption states that the last item of the company’s inventory is to be recorded as the first one to be sold. The FIFO system will instantly assume the reverse in that the first item that was recorded in the inventory should be the first one to leave the storage facility.

Whatever system the company chooses to follow; it does not have to match how the goods naturally leave the company’s inventory or storage facility.

What do most owners typically use? Well, in general, most business owners would go for the FIFO system because it is just so much simpler to account for than the LIFO system, although you cannot go wrong with using either of them.

The cost flow assumption just makes it so that each item that leaves the company is tracked and is accounted for.

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