Question

• Why is there a need to consider re-measuring inventory at the end of an accounting period?
• In what situations would the gross profit method be useful?
• How and why do inventory errors affect more than one accounting period? How do we account for errors when discovered?
• What is a purchase commitment? What is the economic impact of entering into one? And what accounting issues do they raise when prices change?

Answer 1

There is a eed to measuring inventory valuation is done at the end of every financial year to calculate the cost of goods sold and the cost of the unsold inventory.It is also important to a business because ending inventory carries over to the new accounting period. An inaccurate measure of stock value would then continue to have financial implications into the new accounting period.Moreover the inventory is re measure at their Net realisable value if the stock is the Dead stock or slow moving stock.

Gross profit method of inventory is a technique used to estimate the amount of ending inventory.

This method is useful :

1. to determine the approximate amount of inventory that has been lost due to theft, fire, or other reasons.

2.The technique could be used for monthly financial statements when a physical inventory is not feasible.

An inventory error affects two consecutive accounting periods because if the error occur in the first accounting year and corrected in the second year or if the error never found in second period also.The reason is that an error in the first period changes the ending inventory number, which is used to calculate the cost of goods sold in that period. Then, the incorrect ending inventory number from the first year becomes the beginning balance of inventory for the second year. in this way this can effect the financial statement of two consecutive years

Purchase commitmnent means a business is commited to purchase goods or service on some future date at some fixed contracted price.

The economic impact of entering into purchase commitment create a problem when the price of the product falls below the contract price. If the contract cannot be cancelled, the business is committed to purchasing products at a price higher than the current market value of that product.

Accounting for purchase commitments is controversial. Some people think that companies should report purchase commitment contracts as assets and liabilities at the time the contract is signed. Others believe that recognition at the delivery date is most appropriate. If a company has a purchase commitment and the price falls below the original cost, a loss should be recognized.