When you’re dealing with long term shipments which take about more than 2-3 days, it’s always the question of when the risks and rewards have been delivered from the supplier to you as the buyer. The reason it’s important is the pure fact of when you should recognize the goods as in transit and on your balance sheet.
If you’re not dealing with long term shipments as often, the easiest thing to do is just right when you make the order and if applicable, also sign the agreement, just make sure that at that time you already know the terms of shipment and delivery. If you’re obliged to take care of the shipment itself, pay for it and say even insure the goods, its definite the risks have already transferred, so they are your goods.
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You have inventory for your business on your balance sheet and every now and then you need to purchase extra to keep the business going obviously. As it happens, the goods are never recognized in bulks, but in single units with their own unit price. Why? Because when you sell them, you mostly sell single units. Keeping that in mind, you have a unit selling price, so you must have the cost price for this single unit as well.
Regardless of this, you need to make sure the unit price is always right. It’s not just getting the right amount from the invoice, but also making sure you’ve added all the extra costs, like duties, transport fees etc. to the unit price. Normally those expenses are just spread across units the expense was made for (i.e. transport invoice is for a larger shipment, which includes like 1,000 units – the invoice amount is divided with the units and the result is added to a single unit price), or in case of bigger differences in unit own prices, you just take the proportion and then spread across units (i.e. 50% of the shipment was just 1 unit whereas the other 50% is like 500 units – the cost needs to be proportioned).
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Every now and then it may happen that you may get let’s say extra goods that you really did not order – either the shipment comprising of all wrong goods, some missing or some extra, doesn’t really matter – but it happens. When this does occur, depending on the goods and the situation really (i.e. excess of goods or wrong items sent) you have quite a few opportunities to deal with it.
One option is to always to send the excess goods back and account on the balance sheet for the goods that you did order. It essentially means that you are not accepting part of the invoice and as such are also requesting for the vendor to make a credit note on the wrong invoice. However, if the invoice itself is correct, but just the goods don’t match with what is on the paper, they simply need to be reshipped and sorted out with the vendor.
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It happens in many companies that deal with inventory – they get the goods with a note, but no invoice. Usually an invoice is sent separately and a bit later on. However, during normal course of business and in most companies, you would expect to start selling the goods as soon as possible. But how can you do it with goods that the supplier has not yet sent the invoice for? You need a source document for every entry on your balance sheet and in this case for proper entry it’s missing.
Essentially you cannot leave those goods out of the balance sheet, because they are your company’s assets. So, to overcome this problem, you will recognize those items as goods held for sale (or materials etc) and on the other side of the balance sheet you take up a liability on a separate line called ‘Payables to suppliers (invoice not yet received)’. The entry looks something like this:
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Most companies thrive on advertisement and need it every now and then to fuel their business. Promotions are needed either for new products, new services or just to keep people reminded about current ones. When simply buying a webpage slot or space on a newspaper or a magazine and putting up your advertisement there isn’t a long term project, television commercials usually need a bit more work. Do note here that similar approach may be used for all sorts of advertisement campaign preparation costs and essentially, if promoting your product let’s say on a magazine also has a longer and more expensive preparation period, the same approach should be used.
To fire off for an example a television campaign, you need actors, scenes with text etc. As all of them require quite a lot of money, your company is bearing significant costs just on preparation of the advertisement. Although those expenses incur in the period you seemingly receive the service, think a bit further. What is the actual service you’re buying? Essentially all those costs are done with one aim in mind, to get an advertisement campaign out to the public. This is the end result and eventually the service you are really buying.
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Imagine a scenario (maybe a real situation for your company already or may be just happening ahead) – you are required to do an advance payment for some goods that you will be holding for sale when they arrive. They will essentially form a part of your inventory.
One part of the accounting entry is obviously Cr Cash as you give away money, but in return you get the right to retrieve assets. You have made a prepayment for it and as such it should be recognized as a part of assets on the balance sheet.
When you make prepayments for future expenses, they are recognized as prepaid expenses on a separate line under current assets on the balance sheet. However, when you make an advance payments for inventory, those payments done are recognized as a separate financial statement line item, but as a part of inventory (the entry is as follows: Dr Prepaid for inventory, Cr Cash). This way you will clearly show how much inventory your company in reality possesses.
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Buying, producing and storing inventory during the normal course of business means that you also have to initially price it and know what is and what is not included in the price. It would make sense to add all costs incurred while making or buying the product to the unit price, however it is not always so.
On initial recognition when goods held for sale are bought, the unit price should include all the following costs:
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Buying and storing inventory during the normal course of business means that you also have to initially price it and find means also to measure it in the future. When we talk about the value of inventory, we talk about two phases – initial recognition and subsequent measurement. They both have unique characteristics when it comes to policies.
On initial recognition when goods held for sale are bought, the unit price should include all the following costs:
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A company that is in production or selling of goods, almost definitely has some inventory. It’s an asset that the company is able to use for making sales and thus earning money. This inventory is held for certain product lines, certain markets or for certain companies and people. If something in the course of business of the company or on the market changes, this inventory is ‘under attack’. No, not literally, but the value of it through falling or non-existing sales, negative effect on selling prices or decrease in populations ability to buy those goods. All those conditions indicate that company’s inventory may be overvalued.
Essentially inventory is an asset and as such is recognized at fair value, which almost always is preferably its market value less cost needed to make the sale. If the selling prices are falling through demand-offer ratios, it may be that the company is earning losses through sales and as such the value of the inventory needs to be written down. In such case it’s written down to ‘net realizable value’ meaning market value less costs needed to make the sale. So watch out for those reducing selling prices. If your product is making losses, the first thing to do, is write-down the value, but for future purposes, think for alternatives – cease the production or sales in full, change the materials for cheaper ones or hope it’s just one-time thing and won’t happen again.
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