Adjustment of inventories;

              Bulletin H A S K I N S & SELLS 33
Adjustment of Inventories
BY W . G . L A R U E , Kansas City Office
PRACTICALLY every accountant has
at some time or other encountered
technical problems in the execution of en­gagements.
The following has to deal
with the determination of a method to be
used in adjusting physical inventories of
work in process, finished parts and finished
goods (priced at values as shown by cost
department records) to approximate cost.
Preliminary to the discussion of the deter-mination
of this method, the following
facts are set forth:
The client maintains a most complete
and comprehensive cost accounting sys­tem.
The factory burden, which includes
interest on investment as one of the ele­ments,
is based on predetermined depart­mental
machine hour rates. The overhead
absorbed in production costs, based on the
predetermined rate, has, over a period of
years, been in excess of the actual amount
of overhead.
The cost records and the general books
are reconciled monthly by crediting the
difference between the amount of overhead
absorbed in production cost, based on the
predetermined rate, and the actual amount
of overhead to an account known as current
variation or factory profit, which, in turn,
is credited to profit and loss. The differ­ential,
represented by total of the interest
and of the current variation or factory
profit, is not applied in the cost records as
a reduction of the total cost of the various
articles of finished parts and finished goods,
owing to their being too numerous and
varied in character.
If all the finished parts and finished goods
produced were sold, it would not be
necessary to make any adjustment as the
interest on investment and factory profit
would then be entirely earned.
In order to eliminate the factory profit
and interest, included as an element of
cost, from the inventory valuations, the
following method was adopted.
The ratio of the total cost of finished
parts and of finished product sold, to the
average inventory of work in process,
finished parts, and finished goods, was de­termined.
This ratio, when applied to the
total of the amount of interest, included in
cost, and of factory profit, results in the
ascertainment of the amount by which the
closing inventory should be reduced, in
order to eliminate the interest and over-absorbed
burden included therein. A
practical illustration of the determination
and application of the method as above
outlined follows: