Inventory accounting in a Finnish company
Inventory account and inventory change account
All inventory purchases of a business are recorded on the purchases account (in Finnish, ostotili). Purchase account is a debit balance account. An increase in expenses, i.e., the costs of buying inventory, is recorded on the debit side of the Purchase account and, any decreases in expenses, as well as expenditure reductions and transfers of expenditure, on the credit side of the account.
According to the Revenue and Expense recognition principle (Finnish Accounting Act 1336/ 1997), expenses have to be recognized in the same period as the related revenues. Thus, we have to record only costs of goods sold, however, at the balance sheet date, there is usually always part of the inventories being unsold. In practice, besides the Purchase account, two more separate accounts are used: inventory account (in Finnish, varastotili) and inventory change account (in Finnish, varaston muutostili).
In order for the purchase account to show the goods purchase costs only for the current fiscal year, the cost of unsold goods carried over from the previous year are not recorded as an opening balance in the purchase account but a separate inventory account is used for it. Thus, when preparing the financial statements, the costs of unsold goods at the end of the financial year are recorded at the inventory account and after making an inventory.
The balance of the purchase account is transferred as such to the debit side of the income account (financial result account) when preparing the financial statements. When the purchase costs of goods are recorded in the purchase account and the revenue from the sales of goods in the sales account, these business transactions do not require any entries in an inventory account to be made at the same time. While inventory account opening, the book value of the goods in stock is entered on the debit side of the inventory account as the opening balance.
The inventory account is the so-called dormant account, which means an account not used during the financial year and is applied once to adjust the cost of the ending inventory at the end of an accounting period. In order to prepare the next financial statements, the company’s inventories have to be measured and change in inventory has to be calculated - increase or decrease, which is recorded to the inventory account and inventory change account. After the stock change is recorded, the book value of the unsold goods remains at the inventory account and is transferred then to the balance sheet account.
EXAMPLE 1: Decrease in inventory
- Assume that the value of the inventory, i.e., the residual value of unsold goods, was EUR 22 000 at the beginning of the period and EUR 21 000 at the end of the period. The inventory has, thus, decreased by EUR 1 000.
- Purchase costs have been EUR 28 000 and sales revenue EUR 49 000.
- Purchase, sales, inventory and inventory change accounts are balanced. The balance sheet account shows the book value of unsold goods in amount EUR 21 000. There is an income of EUR 49 000 on the credit side of the financial result account and an expense on the debit side of account in amount EUR 29 000 = EUR 28 000 + EUR 1 000. The income of EUR 49 000 has been obtained by selling the goods acquired during the financial year and earlier.
EXAMPLE 2: Increase in inventory
- Let's see the situation in which inventory has increased during the financial year. Assume that the value of the inventory has been EUR 11 000 at the beginning of the period, purchases in amount of EUR 31 000, sales of EUR 49 000, and the inventory at the end of accounting period is EUR 13 000.
- The financial result account shows sales of EUR 49 000 and purchase costs of EUR 31 000, which, however, is not entirely the expense of the financial year since part of the purchases, i.e., EUR 2 000, has gone to increase an inventory. Thus, the cost of the sold goods is only EUR 29 000 = EUR 31 000 - EUR 2 000.
- In both examples, the gross margin of the goods sold is EUR 20 000:
EUR 49 000 - (EUR 28 000 + EUR 1 000)
EUR 49 000 - (EUR 31 000 - EUR 2 000)- The recognition of expenses is implemented in such a way that the expense is only the amount of the acquisition cost of the goods sold.
