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  1. This answer was edited.

    I believe that every business organization uses inventory for generating sales. If an organization manufactures products by using raw material instead of offering service then he needs to prepare accounting records for inventory. Inventory can be purchased in two ways- on cash (or) credit. In this qRead more

    I believe that every business organization uses inventory for generating sales. If an organization manufactures products by using raw material instead of offering service then he needs to prepare accounting records for inventory. Inventory can be purchased in two ways- on cash (or) credit.

    In this question, I would like to tell you about inventory purchased on credit. Starting with its meaning followed by Journal Entry and a simple practical problem.

    Purchased Inventory on Credit

    When an organization purchases raw materials for manufacturing finished products from another organization on agreed terms that consideration (price or value) of raw materials (Inventory) will be paid on some future date then it is called Credit Purchase of Inventory.

     Journal Entry for Inventory purchased on credit

    1. Modern Accounting Approach

    DateParticularsL.F.AmountNature of AccountAccounting Rule
    1st FebInventory- Raw material a/c1,00,000AssetDebit- The Increase in Asset.
     To Accounts Payable/Supplier a/c 1,00,000LiabilityCredit- The Increase in Liability.

    2. Traditional Accounting Approach

    DateParticularsL.F.AmountNature of AccountAccounting Rule
    1st FebInventory- Raw material a/c1,00,000RealDebit- What comes into the business.
     To Accounts Payable/ Supplier a/c 1,00,000PersonalCredit- The giver.

    Practical Example

    On 1st May Alexa Co., a manufacturer of sofa sets, purchases hardwood from Anna Co. for 5,00,000 on a credit period of 2 months. Journalise the following transaction in the books of Alexa Co.
                                                                 In the books of Alexa Co.

    1. When Inventory is purchased on credit from Anna Co.-

    DateParticularsL.F.AmountNature of AccountAccounting Rule
    1st MayInventory- Raw material a/c5,00,000AssetDebit- The Increase in Asset.
     To Accounts Payable/ Anna Co. a/c 5,00,000LiabilityCredit- The Increase in Liability.

    (Being Inventory purchased on credit).

    2. When the consideration (price or value) of Inventory is duly paid-

    DateParticularsL.F.AmountNature of AccountAccounting Rule
    1st AugAccounts Payable/ Anna Co. a/c5,00,000LiabilityDebit- The Decrease in Liability.
     To Cash/Bank a/c 5,00,000AssetCredit- The Decrease in Asset.

    (Being consideration duly paid on the due date).

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  1. This answer was edited.

    Sure, NK Designer, I would like to share the important key differences between Assets and Inventory. I hope this will help you in understanding and analyzing the concept better. Difference between Assets and Inventory- S.No. Basis of Difference Assets Inventory 1. Meaning Asset refers to the economiRead more

    Sure, NK Designer, I would like to share the important key differences between Assets and Inventory. I hope this will help you in understanding and analyzing the concept better.

    Difference between Assets and Inventory-

    S.No.Basis of DifferenceAssetsInventory
    1.MeaningAsset refers to the economic resources that are owned or controlled by an entity or business for deriving short-term and long-term future benefit.Inventory refers to the set of finished goods (or) raw materials used for manufacturing goods to sell them in the market.
    2.TypesAssets are classified into two types namely- Fixed and Current assets. Fixed Assets are further classified into Tangible and Intangible Assets.Inventory is classified into 3 types namely- Raw Materials, Work In Progress and Finished Goods.
    3.Period/DurationFixed Assets are kept in the business for a longer period whereas Current Assets are kept in business for a short period but they are not meant for immediate sale.Inventory is not kept in the business for a longer period. They are meant for immediate sale to generate revenue.
    4.ScopeAssets have a broad scope because they remain in the business for both long-term (Fixed Assets) and short-term (Current Assets).Inventory has a narrow scope because they are quickly converted into revenue by selling them.
    5.Key featuresi) Price (or) value.

    ii) Generates revenue for a longer period.

    iii) Maintenance cost.

    iv) Highly Durable.

    v) Subject to Depreciation.

    i) High liquidity

    ii) Readily accessible to end-users.

    iii) Contributes to working capital management.

    iv) Creates seasonal demand.

    v) Economies of scale.

    6.Methods of Valuationi) Cost Method.

    ii) Base Stock Method.

    iii) Fair value Method.

    iv) Standard Cost Method.

    i) FIFO Method.

    ii) LIFO Method.

    iii) Simple Average Method.

    iv) Weighted Average Method.

    7.Examplesi) Plant and Machinery.

    ii) Furniture.

    iii) Bills Receivables.

    iv) Sundry Debtors.

    v) Patents and Trademarks.

    i) Aluminium and steel for manufacture of utensils.

    ii) Flour for bakery production.

    iii) Crude oil for refineries.

    iv) Cotton for cloth production

    8.PresentationAll Assets are shown in the balance sheet on the assets side as a non-current and current asset.Inventory is shown on the credit side of the trading account and under the head current assets in the balance sheet.

     

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  1. This answer was edited.

    Yes, inventory is a current asset. Before moving to the main part of the question. I would like to familiarise you with few terms such as the meaning of inventory and current asset. I hope this answer will clear all your doubts related to this concept. Meaning of Inventory In simple terms, InventoryRead more

    Yes, inventory is a current asset. Before moving to the main part of the question. I would like to familiarise you with few terms such as the meaning of inventory and current asset. I hope this answer will clear all your doubts related to this concept.

    Meaning of Inventory

    In simple terms, Inventory (stock) is a tangible asset which refers to the stock of goods that is either available for sale in the form of finished products or raw material used in the production of goods meant for sale in some future period held by an enterprise.

    For example – A furniture dealer purchases wood, fibreglass, moulded plastic, wrought iron etc., for 1,00,000 from Amazon for manufacturing wooden chairs, sofa sets, dining tables, beds etc., then wood, fibreglass, moulded plastic, wrought iron would be considered as inventory.

    Meaning of Current Asset

    Current asset refers to all the assets of an organization which are expected to be used, consumed or easily sold through business operations within one accounting period (within a year). In simple terms, currents assets represent all the assets which can be encashed with one accounting period. Current assets are also known as short-term assets.

    For example – ABC and Co. purchases office tools and furniture from E bay on credit for 30 days then it will be considered as a bill receivable in the books of E bay. Hence bills receivable is treated as a current asset.

    Moving to the main part of the question

    Inventory as a current asset

    Inventory is treated as a current asset because the organization intends to sell them within one accounting period or 12 months from the date it is recorded in the balance sheet. All the current assets including inventory have high liquidity and convertibility.

    Inventory is a primary source of revenue, especially for wholesale and retail businesses. More than 50% of the working capital revenue is generated from inventory within a year. Therefore, it is recorded under the head – Current Asset.

    In terms of liquidity and convertibility inventory is placed somewhere in the middle of the scale of current assets. It is highly liquid as compared to the non-current asset (say land & building, plant & machinery).

    Placement in the Balance Sheet

    Inventory - Current Asset

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