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InventoryInventory is the one of the largest current asset of a retail store or of a whole business merchandise. The sale of this inventory is the main source of revenue.
Inventory contains materials/Products in three forms of conditions
Raw MaterialsThe materials needed to make anything are called raw materials.The initial condition of any material is its raw form.Some work is needed to make a raw material into something useful
Consider we were making something using steel
Steel in raw form
WIP (Work in process)The process of making raw materials into some useful things
Steel is melted to reshape it into something useful
Finished GoodThe finished product formed after doing some work on raw material.The price of finished product is considerably high from raw material
We can make numerous useful products using same raw material
LIFO Last in First out
In LIFO the last formed products were sold earlier then first products
Products
Sold
Advantages of LIFOIn times of rising prices LIFO is beneficial because in LIFO the last purchased products (which were expensive than older) were sold Earlier. So the first products will be sell at greater profit.
Purchased
Selling Price = 100
80
80
80
Profit2020 20
Selling Price = 150
130130
Selling Price = 200
180
70 120
To overcome it the products last purchased were sold with lower profit The advantage of lower profit is that you don’t have to pay more income-taxes
But in this way income-taxes increasesThe more the profit the more the income-tax has to pay
You can also sell first products at same profit and lower price. So in this way you can variate your price. It also happies customers.
Sold at 110
20 20
Sold at 60
LIFO is also beneficial in (Non-Expiring) products.
For example
The price of Rice increases as it gets older
Also in Non-Muslim countries the price of Wine increases as it gets older.
So if we’re using LIFO the cost of old rice and wine keeps rising until we sold them.
FIFO First in First out
In FIFO the first formed products were sold earlier than last formed products
Products
Sold
Advantages of FIFOThe main advantage of FIFO is that the products were less likely to expire. Because in FIFO the oldest product is sold earlier
When you’re using FIFO your inventory is showing latest prices of the products because the old products were already sold.
If Inflation (Increase in market prices) occurs. FIFO decreases the impact of inflation on the company
Purchased
200030005000
Market Price = 2000Market Price = 3000Market Price = 5000
Profit3000
Market Price = 6000
6000
30001000Instead of Market Price = 7000
Purchased Sold BalanceDate Unit
sUnit Cost
Total Cost Unit
sUnits
Unit Cost
Unit Cost
Total CostTotal Cost
5 Feb 2 1000 2000
2 1000 2000
7 Feb 7 1200 8400
27
10001200 10400
10 Feb 1 1000 1000 17
10001200 9400
12 Feb 1 1000 1000 07
10001200 8400
FIFO
Purchased Sold BalanceDate Unit
sUnit Cost
Total Cost Unit
sUnits
Unit Cost
Unit Cost
Total CostTotal Cost
5 Feb 2 1000 2000
2 1000 2000
7 Feb 7 1200 8400
27
10001200 10400
10 Feb 1 1200 1200 26
10001200 9200
12 Feb 2 1200 2400 24
10001200 6800
LIFO
Purchased Sold BalanceDate Unit
sUnit Cost
Total Cost Unit
sUnits
Unit Cost
Unit Cost
Total CostTotal Cost
5 Feb 2 1000 2000
2 1000 2000
7 Feb 3 1200 3600
5 1120 5600
10 Feb 1 1120 1120 4 1120 4480
Average
2000+3600=5600
2+3=5 5600/5=11
20