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Faizan
Creating inventory reserves is a proactive approach that companies use to prepare for such events as spoilage, theft and other adverse impacts on their inventories. Companies use inventory reserves as a re-evaluation method to account for inventory that is no longer usable or for which the inventory cost is more than the market value.
Significance
For any manufacturing organization, inventory of its raw materials, materials in progress and finished goods all form critical aspects of operational or inventory management. If you neglect to maintain adequate levels of inventory, your business may risk losing its ability to meet demands, cash its stocks on time or plan its manufacturing. For many companies, inventory management is a strategic matter. These companies do not maintain inventory; rather, they procure, process and manufacture their products as needed.
Function
The purpose of reserves is to set funds aside for distribution of profit, future business expansion or cushion against risk exposures. Generally Accepted Accounting
Principles (GAAPs) allow organizations to form a special inventory reserve that compensates for the portion of inventories that may have deteriorated in value. Furthermore, you can sell these inventories at normal rates.
To report reserve amounts, you credit inventory on the balance sheet and debit the cost of goods sold in the income statement, thereby reducing assets and income. Depending on the severity of losses, you can show reserves as a separate line item on the income statement.
Accounting
Inventory is part of current assets and is usually presented as the least liquid of current assets. According to the International Accounting Standards (IAS) -- which are accounting principles set by participating countries of the International Federation of Accountants -- inventories are those assets that you hold for sale during the normal course of business, similar to the standards of GAAP.
There are two main differences in how the standards account for inventory. First, GAAP allows various stock valuation methods, including LIFO -- Last In First Out, FIFO -- First In First Out and weighted-average cost methods, whereas IAS does not allow LIFO costing. Second, GAAP does not require recognition of inventory losses from market declines when you can reasonably expect to restore inventory levels within the fiscal year; IAS requires such recognition.
Benefit
The use of reserves makes it possible to identify circumstances where stock, equipment or material can be pulled out of normal inventory because of their physical deterioration or obsolescence. Thus, using reserves, you estimate your company’s losses before they occur. This gives your organization the benefit of lessening its tax burden by the amount of the loss it has incurred on its assets. For example, if rain drenches the stock of wheat of your bakery, rendering the wheat useless and unusable to its full value, you can report this loss by adjusting your inventory reserves.
Significance
For any manufacturing organization, inventory of its raw materials, materials in progress and finished goods all form critical aspects of operational or inventory management. If you neglect to maintain adequate levels of inventory, your business may risk losing its ability to meet demands, cash its stocks on time or plan its manufacturing. For many companies, inventory management is a strategic matter. These companies do not maintain inventory; rather, they procure, process and manufacture their products as needed.
Function
The purpose of reserves is to set funds aside for distribution of profit, future business expansion or cushion against risk exposures. Generally Accepted Accounting
Principles (GAAPs) allow organizations to form a special inventory reserve that compensates for the portion of inventories that may have deteriorated in value. Furthermore, you can sell these inventories at normal rates.
To report reserve amounts, you credit inventory on the balance sheet and debit the cost of goods sold in the income statement, thereby reducing assets and income. Depending on the severity of losses, you can show reserves as a separate line item on the income statement.
Accounting
Inventory is part of current assets and is usually presented as the least liquid of current assets. According to the International Accounting Standards (IAS) -- which are accounting principles set by participating countries of the International Federation of Accountants -- inventories are those assets that you hold for sale during the normal course of business, similar to the standards of GAAP.
There are two main differences in how the standards account for inventory. First, GAAP allows various stock valuation methods, including LIFO -- Last In First Out, FIFO -- First In First Out and weighted-average cost methods, whereas IAS does not allow LIFO costing. Second, GAAP does not require recognition of inventory losses from market declines when you can reasonably expect to restore inventory levels within the fiscal year; IAS requires such recognition.
Benefit
The use of reserves makes it possible to identify circumstances where stock, equipment or material can be pulled out of normal inventory because of their physical deterioration or obsolescence. Thus, using reserves, you estimate your company’s losses before they occur. This gives your organization the benefit of lessening its tax burden by the amount of the loss it has incurred on its assets. For example, if rain drenches the stock of wheat of your bakery, rendering the wheat useless and unusable to its full value, you can report this loss by adjusting your inventory reserves.
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