ICAI Notes 4 - Inventories (Part - 3) CA Foundation Notes | EduRev

5. INVENTORY RECORD SYSTEMS

There are two principal systems of determining the physical quantities and monetary value of inventories sold and in hand. One system is known as ‘Periodic Inventory System’ and the other as the ‘Perpetual Inventory System’. The periodic system is less expensive to use than the perpetual method. But the useful information obtained from perpetual system eclipses the cost consideration. These systems are distinguished on the basis of the actual records kept to ascertain the cost of goods sold and the closing inventory valuations.

5.1 PERIODIC INVENTORY SYSTEM

Periodic inventory system is a method of ascertaining inventory by taking an actual physical count (or measure or weight) of all the inventory items on hand at a particular date on which inventory is required. It is because of actual physical count that the system is also called physical inventory system. The cost of goods sold is determined as shown below:

Opening inventory (known) + Purchases (known) - closing inventory (physically counted) = Cost of goods sold.

Periodic inventory system is simple and less expensive than the perpetual system. In this system, inventory account is adjusted at the end of the accounting period to determine cost of goods sold. This system suffers from various limitations:

(i) Physical inventory taking is required more than once a year for preparation of quarterly or half yearly financial statements thereby making this system more expensive.
(ii) Physical count of goods requires closure of normal operations of business.
(iii) As cost of goods sold is taken as residual figure, it includes loss of goods during the year.
(iv) Inventory control is not possible under this system. 

5.2 PERPETUAL INVENTORY SYSTEM

Perpetual inventory system is a system of recording inventory balances after each receipt and issue. In order to ensure accuracy of perpetuar inventory records, physical inventory should be checked and compared with recorded balances. Under this system, cost of goods issued is directly determined and inventory of goods is taken as residual figure with the help of inventory ledger in which flow of goods is recorded on continuous basis. The basic feature of this system is the maintenance of inventory ledger to have records of goods on continuous basis.

Perpetual inventory system helps to overcome the limitations of periodic system. As inventory is taken as residual figure, it includes loss of goods. However, the main limiting factor is the cost of using this system. 

5.3 DISTINCTION BETWEEN PERIODIC INVENTORY SYSTEM AND PERPETUAL INVENTORY SYSTEM

Both the systems - Periodic Inventory System and Perpetual Inventory System are not mutually exclusive and complementary in nature. Distinction between both the systems can be explained as follows:

6. INVENTORIES TAKING

Normally all operations are suspended for one or two days during the financial year and physical inventory is taken for everything in the godown or the store periodically. For the yearend inventory valuation, physical inventory taking is done during the last week of the financial year. If inventory taking is finished on 26th March, whereas accounting year ends on 31st March purchases and sales subsequent to 26th March are then separately adjusted. Later, a value is put on each item. The principle of cost or market price, whichever is lower, is applied either for the inventory as a whole or item by item.

Often, inventory taking cannot be carried out on the closing day. It is carried out a few days later or some times even a few days earlier. In such a case, the actual value of the inventory must be so adjusted as to relate it to the end of the year concerned. For doing so, it will be necessary to take into account the goods that have come in (purchases and sales returns) and those that have gone out (sales and purchase returns) during the interval between the close of the year and the date of actual inventory taking. Further, the adjustment of all goods must be on the basis of cost. Suppose, a firm that closes its books on 31st December, carried out the inventory taking on the 7th January next year and actual inventory was of the cost of Rs 78,500, during the period January 1 to 7 purchases were Rs 15,300 and sales Rs 25,000, the mark up being 25% on cost. The inventory on 31st December would be Rs 83,200 as shown below:

illustration 6 

From the following particulars ascertain the value of Inventories as on 31st March, 2011:

At the time of valuing inventory as on 31st March, 2010, a sum of Rs 1,750 was written off on a particular item, which was originally purchased for Rs 5,000 and was sold during the year for Rs 4,500. Barring the transaction relating to this item, the gross profit earned during the year was 20 percent on sales.

Solution

Statement of inventory in trade as on 31st march, 2011

illustration 7

A trader prepared his accounts on 31st March, each year. Due to some unavoidable reasons, no inventory taking could be possible till 15th April, 2011 on which date the total cost of goods in his godown came to Rs 50,000. The following facts were established between 31st March and 15th April, 2011.

(i) Sales Rs 41,000 (including cash sales Rs 10,000)
(ii) Purchases Rs 5,034 (including cash purchases Rs 1,990)
(iii) Sales Return Rs 1,000.
Goods are sold by the trader at a profit of 20% on sales.
You are required to ascertain the value of inventory as on 31st March, 2011.

Solution

Statement of valuation of inventory on 31st march, 2011

illustration 8

Inventory taking for the year ended 30th September, 2011 was completed by 10th October 2011, the valuation of which showed a inventory figure of Rs1,67,500 at cost as on the completion date. After the end of the accounting year and till the date of completion of inventory taking, sales for the next year were made for Rs6,875, profit margin being 33.33 percent on cost. Purchases for the next year included in the inventory amounted to Rs9,000 at cost less trade discount 10 percent. During this period, goods were added to inventory at the mark up price of Rs300 in respect of sales returns. After inventory taking it was found that there were certain very old slow moving items costing Rs1,125, which should be taken at Rs525 to ensure disposal to an interested customer. Due to heavy flood, certain goods costing Rs1,550 were received from the supplier beyond the delivery date of customer. As a result, the customer refused to take delivery and net realisable value of the goods was estimated to be Rs1,250 on 30th September. Compute the value of inventory for inclusion in the final accounts for the year ended 30th September, 2011.

Solution

Statement showing the valuation of inventory as on 30th September, 2011

illustration 9

The following are the details of a spare part of Sriram mills:

Find out the value of Inventory as on 31-3-2011 if the company follows First in first out basis. 

Therefore, the value of Inventory as on 31-3-2011: 50 units @ Rs 40 = Rs 2,000

illustration 10

The following are the details of a spare part of Sriram mills:

Find out the value of Inventory as on 31-3-2011 if the company follows Weighted Average basis.

Solution 

Weighted average basis

Sriram mills

Calculation of the value of inventory as on 31-3-2011

Therefore, the value of Inventory as on 31-3-2011 = 50 units @ Rs 38 =  Rs1,900