Auto Parts Inventory - March 12, 2024
Automotive parts inventory is constantly flowing in and out of your department. To ensure that your records are properly maintained to meet your specific goals, it is important that it is properly valued, and in some instances, devalued.
When valuing your inventory, there are a number of valuation methods to choose from. The most common are last in, first out (LIFO) and first in, first out (FIFO).
These inventory valuation methods have contrasting effects on the value of your assets on the balance sheet and on the income statement.
LIFO assumes that the last unit purchased is the first to be sold. As the costs for parts rises, LIFO would assume that the most recent, most expensive parts are sold first, resulting in a higher COGS, lower net income (and tax liability) and higher asset value on the balance sheet.
It is important to note that the International Financial Reporting Standards (IFRS) does not allow the use of LIFO.
FIFO assumes the opposite – that the first part purchased is the first item sold. As costs increase, so do the profits on parts that were purchased first, when prices were lower. Using FIFO in this situation allows you to report lower COGS, increased profit on your financial statements and lower asset value on the balance sheet. However, it can also result in increased income tax payable come year end.
When you need to decrease your parts inventory, you must create a write down.
Often, this process is confused with depreciation, an accounting convention that refers to the reduction of a tangible asset’s value over its useful life and applies to long-term fixed assets with a longer life - such as repair equipment, computers, specialty tools and commercial vehicles.
Because parts inventory is expected to have a faster turnaround and does not suffer regular wear and tear until it has been sold and installed, it is assumed that it does not lose value.
There are, however, instances when adjustments need to be made to the value of your inventory, as is the case when it becomes obsolete and is no longer saleable – the value of the part can be written down to zero.
Two other examples of when a write down of inventory is permitted is when a part is stolen, in which case the value is written down to zero, or if the part is damaged enough to be worth less than the value on your books.
The loss on your inventory, for these three situations, will be recognized as soon as you are aware of them, and not accumulated over a period of time, as depreciation is.
Depending on the reason for the write down, you will either credit your cost of goods sold account (COGS) or credit an inventory write down account.
For more information on effectively valuing and devaluing your automotive parts inventory, contact the Pro Count West team of experts today!
