At the end of the accounting period all companies need to determine inventory quantities for effectively performing the business activities. A merchandising company may use periodic or perpetual inventory system, but in every inventory system the inventory need to be valued at the end of particular accounting period. These both inventory systems must take a physical inventory of products to measure the inventory. When using a perpetual inventory system, companies take a physical inventory for two purposes:
- The first purpose is to verify the accurateness of the perpetual inventory records and
- second is to determine that amount of inventory which could be lost for various purposes like wasted raw materials.
In periodic inventory system the company takes a physical inventory also for two purposes:
- In the balance sheet of that company determine the inventory on hand and
- To determine the cost of goods sold for that accounting period.
Determining inventory quantities consists of two steps:
- Taking a physical inventory of goods on hand and
- Determining the ownership of goods.
Taking a Physical Inventory:
Merchandising companies usually take physical inventory at end of their operating cycle. Counting, weighing, or measuring of each and every inventory on hand refers taking a physical inventory. When goods are not being sold or received during the counting then a physical inventory count could be more accurate. Sometimes the physical inventory has taken during the worst condition or deliberate position of business.
Determining Ownership of Goods:
Determine the ownership of goods is the most important and delicate task for measuring the inventory. Basically two criteria are related with this measuring step. The total amount of inventory held by the company and the other amount of inventory owned by the company beside the counting if there any.
Goods in Transit: Sometimes the company purchased goods but may not receive yet, or the company sold goods but does not yet delivered the goods. This occurrence could mislead the inventory counting. In order to count the inventory in more accurate way the company must determine ownership of these goods sometimes difficulties arise while determining ownership of goods in transit (like good in ship or plane or train or truck or any other vehicle) at the end of accounting period. Goods that are in transit and in which company has full legal rights, should be included in inventory. There are some terms of sale which determined the legal title. The terms are FOB (free-on-board) destination and FOB (free-on-board) shipping point.
If the shipping cost is paid by the seller then the procedure is identified with the term FOB (free-on-board) destination this term gives the authorization to the seller to own the merchandise until it is delivered to the buyer. If the shipping cost is paid by the buyer then the procedure is identified with the term FOB (free-on-board) shipping point and the buyer owns the goods during shipment.
The accurate amount of merchandise available in the transit and the terms that is being used with shipment process of merchandise should be recorded by the company in order to determine which items should be counted and included in the inventory balance for a accounting period. For goods in transit according to the term the inventory should be recorded to that owner who paid the shipping cost.
Goods on Consignment: Some companies take fee to sell the goods of other companies and hold the goods until it is sold. But those companies could not take the ownership of those goods. These goods are referred as consigned goods. In order to reduce the cost of inventory and to avoid the risk of purchasing an item many cars, boat, and antique dealers sell goods on Consignment. Some manufacturers also make consignment agreements with their suppliers to reduce their inventory cost.
Products under goods on consignment cannot be included in inventory since that company does not hold any legal ownership on those products. At the same time, the main owner or supplier of those products should include those products as inventory items because of their ownership although they don™t have those physically.
For example: XYZ is an automobile company hires ABC company to sell their products in exchange of fees. Here XYZ is the legal owner of the car and ABC is only the third party whose duty is to sell their cars. All unsold cars are the inventory product of XYZ not ABC.
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