Press Release
Soren McAdam Christenson LLP
Certified Public Accountants and Business Advisors
Contact: Roger Wadell, Partner
909.798.2222
PR Contact: Ron Burgess
909.798.5737
FOR IMMEDIATE RELEASE
December 2, 2008
The Lowly Widget Can Really Be Much More Interesting Than You Might Expect
Inventory accounting is the body of accounting that deals with valuing and accounting for changes in inventoried assets. Like cash, inventory is an asset that is always moving, changing, and in most cases losing value. A widget is the mythical object that represents a unit of inventory or product in an academic discussion about physical objects in business.
While the value and location of cash is easily understood, inventory is not. Cash lives in bank accounts and accounts receivable, while inventory can generally be seen and counted. Money only comes in dollars, while inventory comes in numbers, and costs of SKU’s.
In manufacturing, those same SKU’s (or parts) are combined into a single new product. The “inventory” of an automobile will include thousands of smaller parts, all needing to be valued and accounted for, creating a complex accounting issue. Inventory is an asset that is difficult to manage, measure and control. Poorly measuring or valuing inventory creates a tangible difference to the balance sheet that flows through to the bottom-line as shrinkage or overages. Naturally, this distorts the reality of profit and return on investment.
Valuing even a single part or SKU can be tricky, because several influences are imposed on the item by economic realities. However tangible that the widget may be, many businesses do not properly recognize cost, depreciation, shrinkage, or obsolescence until much after the event. This may be because each of these inventory maladies “creep” over time, and the accounting department is not able to make
adjustments to “book” the change to inventory. The value, that is carried on the books, can first be subject to several methods.
The classic LIFO and FIFO come to most minds. LIFO (Last-In¬-First¬¬-Out) is a method of carrying an SKU at the value of the oldest cost paid for that identical item. This raises the book value of all. FIFO (First-In-First-Out) as implied, is the cost that the last or newest unit is carried at. You can quickly see that the same inventory may have two values! Let’s look at other circumstances that can affect the value of the widget:
Shrinkage is when the value is less than expected— when a physical count is made against the computer or book inventory. Shrinkage can be disappearing inventory, due to breakage, theft, or other issues. One obscure example is the DIS shrinkage in a pet shop. DIS is the tongue-in-cheek term for Dead-In-Stock. Clearly, the salvage value is much lower than the retail value!
Theft requires obvious responses, but anticipating and discovering it can require fortitude. In one retail company (even though the unit sales were spot-checked against physical inventory and balanced daily) one enterprising employee discovered that he could sell a pair of boots by keeping the box with the inventory tags, and putting one boot from another box into the newly emptied one; the box remained, while the inventory was gone. Another type of shrinkage is spoilage such as bananas. Estimating this type of shrinkage requires a close look at historical inventory shrinkage levels, to account for closer write-offs to inventory, and reduced profit.
Depreciation has a few forms. One is a deduction to value, based on expected mark-downs due to obsolescence. A part can become worthless if it goes to a product that is no longer maintained. Just try to get a part to fix a record player! Changing trends and fads cause rapid and large changes in apparel, high technology and home furnishings. When a company has too many items for the current demand, markdowns occur before they are sold. Large fashion retailers use the “Retail Inventory Method,” which accounts for cost, retail, and multiple markdowns on each SKU or style. The reducing value is immediately accounted for when a permanent markdown is taken on the selling floor.
As you can see, the way inventory is accounted for does matter, and the CPA you use matters too. Soren McAdams Christenson LLP, understands the need for specialists who understand the nuances that can really make a difference in how you report widget values, as well as how it effects your tax bill.
Dave Harris, a partner at Soren McAdams Christenson has spent decades working all kinds of widgets and all the ways of valuing and controlling them. If you feel like you’ve lost touch with your widgets, give Dave a call. He’ll re-introduce you.
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