Inventory is the total of raw materials, work in process (WIP), finished goods and merchandise purchases that a business holds for sale in the ordinary course of business. The important point to remember here is that the goods are intended for sale.
Raw materials is items waiting to be used in the manufacturing process, work in process are partially manufactured goods, finished goods are those held for sale, and merchandise is products and goods the business has purchased and holds for resale.
Beginning inventory is the goods unsold at the start of the accounting period, and ending inventory is the goods unsold at the end of the accounting period.
Inventories in the Balance Sheet
Inventory is recorded in the balance sheet of the business at cost, or if lower market value, under the heading current assets, that means it is expected to be convertible into cash within a year. Cost in this context means the price paid plus the direct and indirect costs of bringing the item to its existing condition and location ready for sale.
How do you Record Inventory?
Bookkeeping and accounting is achieved using three separate accounts as follows.
- The Sales account which records the reductions in inventory at selling prices and is transferred to the income statement at the period end.
- The Purchases account which records the additions to inventory at cost and is transferred to the income statement at the period end.
- The Inventory account in the balance sheet which maintains the beginning and ending balances.
The reason for the three accounts is that purchases (increases) are at cost, and sales (decreases) are at selling price (i.e. they include a profit). If both sales and purchases were recorded on one account the balance would be a meaningless figure including the profit element, and would not represent the correct beginning or ending balance.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University.