Cost of Inventory and Costing Methods Homework Answers
You must have heard of the word â€˜Inventoryâ€™ many times if you are an accounting student. But I wonder that if you exactly know what â€˜Inventoryâ€™ means? And adding further, about cost of inventory and costing methods? Determining cost of inventory for any business is foremost important because it affects the success rate of any business.
It is necessary to first get a basic insight into â€˜Inventoryâ€™ before proceeding to cost of inventory and costing methods. Inventory means a record of stock of unprocessed material, work in progress commodities and completed goods that are considered as a part of assets for any business, already available or will be available for selling purpose. For a detailed analysis in regards to this topic, you can surely check out manuals as cost of inventory and costing methods homework answers.
Inventory for any business is extremely important because the profit generation of that business directly depends on its inventory i.e. as fast as the business will sell its inventory the more will be the earnings.
What is meant by Cost of Inventory?
After knowing about the term Inventory precisely, let me illustrate some more interesting concepts related to inventory.Inventory, as you know, constitutes an important part of any business as it is directly related to income generation but to accommodate this inventory company usually beara certain amount of costs and this cost is referred as cost of inventory.
Cost of inventory is defined as the costs associated with warehousing and preserving its stock over a specific time frame.Cost of Inventory control has numerous features which include financing, appliances, work, defensive measures, management, insurance,loss due to burglary and opportunity cost of managing inventory. These components all put together make aggregate cost of inventory.
Figure out Inventory cost calculation with the help of an example
Calculating the cost of inventory is not that problematic, in fact, if you have appropriate information about all the factors that constitute cost of inventory then it is as simple as ABC.
Suppose your friend Steve is a store manager in a delivery plant. Steve has gained rich experience,and now he is specialist in regulating operations of inventory.
Steve tries to gather and monitor the cost of inventory at regular intervals as it is significantly important for any business.
Letâ€™s find out how Steve calculated cost of inventory if:
Equipment — $2000
Labor — $1000
Insurance — $500
Handling — $800
Obsolescence — $100
Burglary — $100
Adding all these components will provide cost of Inventory.
Cost of Inventory= $2500 + $1000 + $500 + $800 + $100 + $100= $5000
After getting cost of Inventory, Steve finds the ratio of cost of inventory to the total value of inventory:
Cost of inventory — $5000
Value of inventory — $50000
Ratio of Inventory cost = Cost of inventory/Value of inventory = $5000/$50000 = 10%
Hence,in this illustration, Steve successfully determined the cost of inventory and ratio of cost of inventory, and surely that will be useful for his business.
What is the importance of cost of inventory in a business?
Cash, no doubt is foremost thing required by any business to sustain. Lack of money can be considered as one of the prime reason for closing of any business.Keeping this in mind, companies always try to estimate the cost of inventory so that they can strategize the cash inflow and cash outflow for their business.
Cost of inventory for any business plays a vital role because proper planning of cash inflow and cash outflows can prevent the situation which can lead to closing of business. Henceforth, for any business in order to reduce their expenses and to do good in market should manage their inventory well.
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Costing methods — Explanation
FIFO (First-in, first-out)
FIFO is a technique of stock valuation depends on the presumption that the products are sold and utilized in the same sequence in which they are purchased. Consequently, the cost of products bought i.e. first-in is the cost of products sold i.e. first-out.
LIFO (Last-in, first-out)
LIFO is another technique of stock valuation depends on the presumption that the products bought most freshly i.e. last in are sold or utilized first i.e. first-out.
Specific Identification method
A technique of monitoring entire things in a stock. Specific identification stock valuation is usually used for bigger things like vehicles etc.
Average cost method
Average cost method or weighted average is a method of appointing cost to stock when it is sold. A few companies use this method of valuation rather than other techniques like FIFO or LIFO because the average cost method reduces the extreme impact of allotting the costs on the basis of purchase rate.
These four costing methods are used by companies so far to manage their cost of inventory.
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