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Dear Professor,
“Review the aged inventory listing to identify items which need to be written down and compare with the inventory allowance made, if any.”
Professor i have never really heard of an inventory allowance, what is it? and isnt inventory impaired always directly?
Suppose inventory includes 3 products – A, B and C. They are counted – 10, 20 and 30 items, respectively – at the reporting date 31 December.
Inventory is measured initially at cost (IAS 2) – say $10, $20 and $5 each.
So the inventory valuation at cost is:
10 x $10 = $100
20 x $20 = $400
30 x $5 = $150
i.e. total $650The double entry to record closing inventory is:
Dr Inventory (asset SoFP) $650
Cr Inventory (SoPL) $650But suppose the aged inventory listing shows that C was purchased some months ago. If the inventory had simply been scrapped (no longer exists), closing inventory would have been $500. If it does still exist, management effectively writes it down (to net realisable value) by making an allowance. Suppose all of C was sold in the January sales @ $2 per item. The allowance then needs to be $60:
Dr Inventory (SoPL) $60
Cr Inventory (asset SoFP) $60It’s the same principle as an allowance for irrecoverable debts – i.e. the carrying amount of the asset as presented in SoFP is reduced to a recoverable amount. The difference between making an allowance and writing off an asset is that it stays “on the books” and, because it is just an accounting estimate, it can be revised at each reporting date (and “reversed” if necessary).
Ahhh so in your last paragraph you basically mean to say that difference between “writing down(akin to loss allowance)” and “writing off” is that former is an accounting estimate and can be reversed if need be, whereas latter is complete removal of an item which cannot be reversed no matter what, is my comprehension correct?
part 2 of my query:
just one more thing professor, won’t the loss allowance be this, immediately before sale or the date when we got to know NRV of inventory C(before sale of actual inventory):
DR. inventory(SPL) 90
Cr. inventory (SOFP) 90after sale:
Dr. cash and inventory(SPL) 60
cr. inventory(SOFP) 60Pretty much yes – once you’ve written off a debt you won’t be chasing it. If you happened to receive some amount at a later date of course you would recognise it (Dr Cash Cr Bad debt expense).
Allowances – depreciation/credit losses (for receivables)/obsolescence, etc are period-end (i.e. year-end for financial statements) adjustments made as at the reporting date. They are accounting estimates – they are not “corrected” retrospectively because they cannot be “correct” in the first place (they’re estimates!)
The general ledger does not record inventory movements in an inventory account – a sale is:
Dr Cash/Receivables and Cr Revenue – a purchase is Dr Purchases and Cr Cash/Payables.The only entries to the inventory account are the period-end adjustments – the “reversal” of the opening inventory and recognising the closing inventory – please refer back to FA/F3 if you need further reminder.
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