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0:01
Welcome to easy accounting for all. In this video we are going to talk about general inventory concepts. And the concepts that we are going to talk about are: what is an inventory? The importance of inventory in businesses, type of inventory, inventory valuation methods, physical inventory, inventory systems, an inventory system versus general accounting records. So, let's see what is an inventory? Inventory is what the company owns
0:41
today, goods, material, parts, etc. in order to sell or use tomorrow. Also, the inventory is to sell. But depending on the type and size of the company, they can use some of those inventories to either way produce something or to be consumed in the same company. There is other type of inventory depending on the size or how organized the company is. There is type of inventory like an
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office supplies inventory or fix assets inventory, like machinery equipment, furniture etc. In our accounting cycle course exercise, we create inventory as part of the learning process. This inventory will serve as the basis to explain the inventory reconciliation. We create a fictitious company in a video number three. The company name is Auto Maintenance and Parts. AMP So, we are going to continuing use those transactions to find and to explain the
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inventory. The importance of inventory in businesses: Generate income or revenue. That's the main goal, you buy inventory just to resell, so when you sell, want to have a
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profit, increasing the price and so you get generate income. Ensure Smooth Operations. You buy inventory because you want to have that handy for your customers. So, you're supposed to have it at home. Support Customer Satisfaction. If you have everything handy, you can just response quickly to the customer. So that provides certain satisfactions to the customer and that's a good sign to move or to run the business. Control cost. We need to know as much as accurate possible how
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much cost whatever we sold, right, because in that way you know if you are making profit or
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gross profit. So that's very important to generate some information about the cost. Type of inventory. We have the raw material. This is the basic item used to create a product or service. So that means when you have a raw material is to create a new product. You don't have a final product. It could be that material that you purchase they are a final product for somebody else for your vendors but not for you. So that's most of the industries
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manufacturing companies have that type of inventory. Work in process (WIP). It is an unfinish pro or service. In our exercise, it will be a car in the repair process waiting for parts, that means the service is in progress or in process. Finished Goods. Okay. So, so these are parts that are ready for sale or use in our exercise. It will be tires, oil, auto parts and others. Obsolete or Dead Stok. Those are the items that are outdated or no longer in demand. Today is
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very difficult to manage sometime inventory because technology changed everything overnight. you buy certain number of items expecting to sell but tomorrow is too late because those items became obsolete, especially with the cell phones and many others. So that's why it's very important to have the right person managing the inventory with a good knowledge and with a good principle of inventory. So that person needs to know how to set up the maximums
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and minimum stock for those items, in order to avoid getting to the obsolete other dead stock. Inventory evaluation method. The reason to use inventory methods is to determinate the cost of sales. The most common inventory evaluation methods are: First In First Out also known as (FIFO), Last In First Out also known as (LIFO) and the average cost. I'm going to talk about these three. There are more but,
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these are the most common methods. Based on the EMP inventory activity created during our accounting cycle exercise video three. I'm going to use that to play with these three methods. The reason why I'm going to play is just to show you exactly what are the different; And I'm going to tell you that in terms of the balances, it should be the same balances from the inventory system and the accounting records, and we are going to discuss that one later.
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Physical inventory. A physical inventory is the process of counting, measuring or verifying all inventory items in a business to ensure that the recorded inventory in the books matches the actual stock on hands. Yeah, I said that is a counting. So, that means there are some items that is easy to count. So, there are other that are not easy to count. So, you have to measure them using a different
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measuring type of systems. So, you have to define exactly which one applies for your inventory. The purpose of physical inventory. Verify inventory records. Identify losses, death or damages. Identify obsolete or dead stoke. We already went through. Adjust the inventory system and the accounting system records according with the physical inventory. Implement new inventory controls, establishes some promotion specially
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for the low inventory rotations parts. If you have the physical inventory, all this information is going to help you to manage the inventory efficient, right? So, you can just avoid creating an obsolete or dead stock inventory. You can just find out the ways that the inventory is getting missing or damaged. You can create controls for these things to avoid that this happens again. And with this information, you have to adjust your inventory system and your accounting system. But
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the only way that you're going to know that things like this happened and measure it for
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every single situation, is just doing the physical inventory. Now there are a computerized inventory system that provides different reports to you, but not necessarily for damages, not necessarily to identify losses, but helps to identify the obsolete or dead stock, because the computer can provide you the list of the items that have not been moved in certain period of time. So, if you think, there is not necessary that you have to wait for the physical inventory. So, anyway
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inventory system. There are three basis systems: Perpetual inventory system: the inventory record of activity is updated continuously in a real time. Usually, this system uses barcodes, scanner through the inventory management software. Big companies use these ones. Uh, also if you go to the grocery store or the store by department most of the business todays' date, use the scanners. just to add the inventory or to remove the inventory and keep the update inventory. Purchases
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add or increase the inventory and sells reduce the inventory. So when you go to the grocery store, they scan or if you scan by yourself using the sell check out, the product, automatic that's going to reduce the inventory see the real time nothing is 100% possible but perpetual inventory system is one of the best one that today days is useful for big and medium companies, probably the small companies use the periodic inventory system. The inventory activity is updated
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at a specific interval of time like weekly, monthly or yearly based on physical counts. I really recommend doing if it's possible the physical inventory weekly but not later than monthly, because you need to make correction during the year. It's not going to be a good idea just to wait 360 days to find out that you're inventory has been damages or loss or to find out that you have an obsolete stock, right? or to find out that the inventory has missing records. No,
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it has to be as quickly as possible. So, my recommendation is if you don't do it weekly, at least do monthly and if you can do weekly just by certain locations, because by the way on inventory you have to have locations where the parts are storage. Yeah, like an excel row and columns, there supposed to be a location where you can find the inventory. So, it is good to have that one if it's possible weekly by batches or at least monthly as much as possible
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hopefully the whole inventory; because we need to find out as soon as possible, almost real time, what's going on with the inventory. So don't wait too much. I don't recommend just the yearly at all. Hybrid system. This is the combined perpetual and periodical system. Often taking high value items perpetually and low value items periodically. Yeah. If you have very expensive parts, it is better to have perpetually on the other one's like screws or something like
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that. Something very small probably you can use the periodically system. The Hybrid system is the combination between the perpetual system and periodical system. okay, Inventory system versus general ledger account reconciliations. in the ideal life. It should not be any discrepancies. If everybody was in a real time doing the real situation that happen in a daily basis, it should not be discrepancies. But
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that's in the ideal life. But in the real life, it's always discrepances. But the goal is just to find out why. That's the important things. Why we had these discrepancies and there are several reasons why the inventory balances value had these discrepancies compared with the accounting records and is specific with the inventory general ledger balance. So, remember when you do the comparations
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you just have to have your inventory balance- inventory valuation for certain period of time or a certain specific date, along with the general ledger for the inventory account. So those are the main reports to compare. So, your inventory report reflects the value of the inventory a certain day,
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the same amount it should be in my general ledger balance amount, but if doesn't happen we had to find out which of the following reasons applies or explain the discrepancy: Data entry errors. Of course, if you just make a mistake doing data entry or by the person that is working in
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inventory system or if the system is not integrate with accounting and each clerk
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input different numbers for the same transaction that create a discrepancy.
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And if the information is integrated between the inventory system and the accounting but if somebody put just the wrong information that's going to be transferred to the accounting. If this happened, it could be there is not any discrepancy, but by the time that the accounting has to pay the vendor invoice, probably they have to adjust the invoice or the transaction in accounting, they cannot just go back and adjust it in the
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inventory. So, if they pay the vendor obviously, they going to make the payment with the invoice amount. and inform to inventory department that the amount posted on the inventory system from the beginning that was transferred to accounting was incorrect. So, it is very important to have
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this clear and if you have those ones again you have to reconcile the inventory accounts. Timing difference. very common situation inventory system just input the invoice in a following month instead of the month that supposed to be, because they cannot redate the date in that system due that it is a very strictly system. So, they have to put it in the first day of the following month. In accounting usually, the accounting systems are very flexible,
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so the accounting clerk just posts it in a right month. Either way if they are integrating but somebody just noticed that the invoice date is not posted in the right period, they just move it. It could be like that. So, it's a timing difference. So that can create a discrepancy System integration issues. I already mentioned very quick other things. It could be when the system integrating in between. So, most of the time is just inventory system supply the
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information to accounting system. But it could be in that transition in that integration when we try to upload the information from the inventory system into accounting system. It could be happening many things. It could be the integration just fail at some point, and they don't transfer all the information. It could be they transfer everything but at the end they don't pick all the information as well. So, all those things create discrepancies
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Unrecorded adjustments. It could be especially this happen when it's a manual entry the inventory part just did the adjustment but probably, they don't report it to accounting if it's manually, or it could be if it's an integration that I explained before it could be in that integration the adjustment never transfers. So that create discrepancies. Following out on the AMP inventory, we created in video three of the accounting cycle. I'll
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explain how inventory reports works and how the data flows from the inventory system into the accounting records, especially the inventory from the general ledger. This is also a good opportunity to show that regardless which of the inventory methods is using, there should not be major discrepancy between the records. Okay. I want to just mention in terms of reconciliation that each time that you find discrepancies,
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because the total inventory from the inventory system report doesn't match the total inventory in your accounting system especially the general ledger. So, you have to do the reconciliations and to do the reconciliation is basically just as I mentioned in my video about bank reconciliation. It has to be transaction by transaction, purchases versus debits, cost of sales versus credits in our
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account general ledger. So, the process should be similar to the bank reconciliation. If you haven't watched the video for bank reconciliation, I highly recommend doing it. I'm going to leave the link below in a few minutes. So, you can just watch that one. The principles are the same. You need two reports, one from one system and the other one for the other system. And that's what we call internal reconciliations. So that's very important to keep in mind. Anyway,
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so now let's move to Excel because my exercise was developing in in Excel. Okay, this is the Excel. Um just to refresh for a few of you all these transactions came out from one of the fictitious company transactions that we created in my video number three for the accounting cycle course video one to four and this is in video number three. So, we create all the transaction for the month of August, also we create the trial balance and the balance sheet. So, now let's back to the
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inventory. So, all these transactions are part of the monthly transaction that we created. So, this is the purchases. So let me say something. Every single report could be looks different. I just create one that can explain exactly how that looks. regardless of you manually or a computerized system, it has to have this type of information. So, we have the company name, we have the inventory valuation report we have the month or exactly the report period, in this case it is
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as of August 31st for the year. Okay. So, this has to have the part number or SKU. The SKU is pretty usually for the system that use scan. The item name and the locations where the part is storage islands L16. So you have to create your own systems in terms of locations, in terms of the SKU. Okay. So, we had this activity here. We put just 20. We had the beginning balance zero. We purchase the balance is 20 because 0 + 20 is 20. So, this is quantities only. So, we receive in dollars
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$1,000 of inventory. So, my balance, my beginning was zero. So, my new balance is 1,000. So, and the average cost per unit is $50. So, we sold two units here or we use two units. So, we have 18 because 20 minus 2 is 18. And since we had the unit cost $50, 50 multiply by two equal 100 and we have the new balance for this item. So that's the way that the inventory looks like and that's the way that your report at least has to have all these activities, all this information.
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Anyway, in here technically we use just the average cost. That's what we use. Here we have the average cost. But I'm going to explain it in detail using just this item only just to explain what the difference is between inventory methods. As I said, in the ideal life it should not be any discrepancies since everything that we purchase here in our inventory system, it has to be transferred to our accounting system. It could be here is in detail by item
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and here probably is just by invoice, right? But at the end it should be the same dollar amount. Here we have we had 2,850 purchases. We had 2850 purchase from our general ledger. This is what you need to reconcile the general ledger. And by the way, let me recap a little about general ledger. We went through this one in my video number three in my accounting cycle course. So, we need the account, which is the inventory parts, the period. In this case, we had to go through
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the full month. Okay. August 1st through August 31st. And this one is just up to this time. So, they just provide all the activity or can be just also from August depending how you go to review a visit. But in terms of the constellations, it should be from August 1.
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to 31st for that year. Okay. So here we have the date, the general journal entry. We already went through the general entries number, reference number, the invoices. This is part of the general ledger, and this is part of the activity the transaction that I show you before here. Okay. So that's what it is in the descriptions. the general ledger has the balance. So, if I calculate here my balance from the inventory valuation report is say that is
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2220 and here is say 2220. If that was the case always you don't have to do anything. Everything is perfect but in the real life is not. It's always different for all the situation that we explained and we listed before. It could be most of the time we had just a few cents. So, we have to adjust the cents and it's easy just to adjust here than try to adjust in inventory system. So this is the ideal situation but I know that it is not going to happen always but
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it doesn't happen just again you have to reconcile you have to compare every single entry from both systems, the parts purchased and the parts used so par here in inventory is a key which should be the same total in debits use it in here, it should be equal to the credits in accounting. Remember that we discussed about assets accounts that we said that the assets accounts increased with debits
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and decreased with credits and also that the general ledger has a balance for every single line and obviously at the end of the report. So, this is the way that's supposed the inventories to work but it never happened. So, you have any discrepancy you have to reconcile it. So let me show you how the inventory methods work. So, we already talk a little bit about the average cost which is basically that you have here. Okay. and your balance it is divide by the
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quantity balance. Your total balance amount. Okay? You have to divide by the total units, and you could just get the average cost. So, we buy here for $1,000. We have 20 units. So, the average cost is 50. We sold one here or two which is $100 but the average cost is still the same. In here we purchase five units. The five units each unit is $55 because 55 by five is 275. So, when we added up the $275 + 900 they give me $1,175. But if I divide this one by the total units,
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my average cost became to $51,09. So that's average cost. So, at the end, if I just calculate how much it is my average cost of sale, based on this method is $355,43. That's the way that the average cost works. Now let's go to LIFO. So, LIFO is Last In First Out. It does means either way we just purchase 50 here, right? So, we sold here. We don't have any other purchase. We just sold two here at the original average cost
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here. But at some point, we purchase five here which is 275 and we say the average cost or the cost is 55 per unit. So that my last purchase so according with these ones if I sold one more item forget about if this the item that we purchase part of the 20. So, it's just the next item. You had to sold that item based on this cost. So, we sold here four. So that four instead of just came out for $50 which is the average cost as we did it hear, right? instead of came out of 55
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sorry 50 they came out at 55 because that was the last purchase that we did it. So, 4 by 55 equal to $220. If we purchase, if we sold the next one, I just try to match this number. But if we sold this one, it has to be at $55. I just put 4 + 1= 5. So, at this point, we already sold the last purchase inventory. So that means if I sold one more item that's going to be out of this inventory by $50. So, one thing that I want to point here
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is about the cost of sales. My cost of sold from the average cost here was $355,43 and here for the same items, same activity it is $375. That's one of the big differences. Okay. Now let's go to FIFO. FIFO is First In First Out. These means that if we purchased 20 here, that's our first purchase. So, we had to sell all the items from our first purchased. using the original cost for that first purchase. So, we sold here two. So, that has to be at
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$50each. Okay. So, we had to make sure that we had to sell all the first units that we purchased. So, we have 20 here, we sold two here, we sold four here and one here. So, we have two, six, seven units. Those sells should be based on the beginning cost. So that means that our cost is based on the first units that came in and that's going to be the first one that we are going to take out from the inventory.
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So, we have seven units here, right? Those were sold at $50each. Either way, as I explained and I left here that information, we purchase a few here that the average cost was $55.00. So, at this point from the 20 we sold seven that mean that we have 13 from the original 20 that has to be sold at $50. And when we finish with those 20 parts, we had to use the next purchase that was at $55.00each. So, let's face this one. So average cost gives me
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$355.43 total cost of sale for the same quantity same units same items LIFO $375 and FIFO $350. So, most of these systems are used for companies depending on which one is more favorable for taxes. right so that's the main discrepancies, but in terms of the information from here to accounting if I had to record my cost of sale is this one or this one or this one depending what method they are using in the inventory system. So that's what I have for inventory. I hope this helps
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to understand more about some inventory concepts. So that's what we did. Okay. Okay. Um that concludes our section on basic inventory concepts. Inventory is a broad and important topic but, in this video, I have covered some fundamental ideas that I hope will help improve your understanding. If you haven't already, please make sure to subscribe so you don't miss future lessons. Below you will find links to related topics including the content cycle and bank
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reconciliation. More video will be coming soon. Again, I just put in here the bank reconciliation, because if you need to reconcile the inventory doing an internal reconciliation between inventory system and accounting records. You can just follow the instruction that I just placed in my video for brank reconsolidation, because the main concepts are the same. The main principles are the same. So, in terms of the procedures. Okay. Thank you very much. I hope you enjoy
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this video. Hopefully I will hear from you and enjoy. Thank you very much. Have a nice one.
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