Inventory and depreciation

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Inventory

This is goods that exist within your business that have some value on your books. Finished goods, raw materials, work in progress, consumables and spare parts. There are two main ways of handling Inventory in the accounts function and the choice reflects your choice between raising investment funds and avoiding tax:

  1. FIFO (First in first out): The inventory that is purchased first (the oldest stock on the shelf) is sold first. When prices are rising, FIFO results in higher income figure as inventory is sold off. Business owners that want to show higher earnings to investors, bankers etc. use FIFO, but higher incomes come with a higher tax burden.
  2. LIFO (Last in first out): The inventory that is purchased last (The newest items to be put on the shelf) is sold first.  When prices are rising LIFO results in lower-income figures as inventory is sold off. LIFO reports a lower net income but results in a lower tax burden.

Depreciation

No assets last forever, in time they become worn, decrepit and malfunction. Assets do not wear out at the same rate. It is fair to say that they decline at a rate that means that it does not retain 100% of its value throughout its working life and then suddenly lose value at the end of its useful term.

Therefore it seems right to quantify its rate of decline by some system that is in keeping with the conservatism of accountancy. Depreciation is that system, a non cash expense that reduces the value of an asset due to deterioration, obsolescence or age. The most common methods of depreciation are as follows:

  1. Straight Line: divide the cost of the asset by its expected life-time in years.

2.     Double Declining: also known as an accelerated method of depreciation. It pushes the majority of the total depreciation amount into the early years

3.      Sum of the years digits: another form of accelerated depreciation. This maximizes tax deductions sooner rather than later, resulting in a better financial outcome.

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