What Is Inventory? Raw Materials, WIP, & Finished Goods

Being able to have a constant awareness of how much inventory in stock you have is key to running your business properly. Especially when it comes to your inventory balance to ensure you don’t overorder or run out after an inventory transaction. Utilizing good accounting software can hugely help with this process.

What Can Inventory Tell You About a Business?

There may not be one perfect type of inventory management because there are pros and cons for each. But taking advantage of the most appropriate type of inventory management can go a long way toward ensuring a company’s success. The four main types of inventory management are just-in-time management (JIT), materials requirement planning (MRP), economic order quantity (EOQ), and days sales of inventory (DSI).

• The balance sheet is also referred to as the Statement of Financial Position.
• Accounting for pipeline inventory, also called in-transit inventory, comes with unique complications due to the sometimes-unclear ownership of in-transit goods.
• However, when it comes to inventory accounting, this department becomes a whole other type of beast.
• If everybody had to file independent contractor taxes, we’d see a revolution in our nation’s tax code.
• Thus, they need to account for the inventory at every stage of production.

Remember that the costs can flow differently than the physical flow of the goods. Since inventory is an asset, it should be listed at what is inventory in accounting the top of your balance sheet along with other current assets. It’s not as liquid as cash, but more easily sold than long-term assets like land or commercial property.

Rather than the Inventory account staying dormant as it did with the periodic system, the Inventory account balance is updated for every purchase and sale. With the LIFO cost flow assumption, the latest (or most recent) costs are the first ones to leave inventory and become the cost of goods sold on the income statement. The first/oldest costs will remain in inventory and will be reported as the cost of the ending inventory on the balance sheet. Periodic means that the Inventory account is not updated during the accounting period. Instead, the cost of merchandise purchased from suppliers is debited to the general ledger account Purchases. At the end of the accounting year the Inventory account is adjusted to the cost of the merchandise that is unsold.

FIFO and LIFO pros and cons

DSI is also known as the average age of inventory, days inventory outstanding (DIO), days in inventory (DII), days sales in inventory, or days inventory and is interpreted in multiple ways. The EOQ model seeks to ensure that the right amount of inventory is ordered per batch so a company does not have to make orders too frequently and there is not an excess of inventory sitting on hand. It assumes that there is a trade-off between inventory holding costs and inventory setup costs, and total inventory costs are minimized when both setup costs and holding costs are minimized. At the same time, inventory can be thought of as a liability (if not in an accounting sense).

Periodic LIFO

Managing inventory and determining the turnover rate can help companies determine just how successful they are and where they can pick up the slack when the profits begin to dry up. Company management, analysts, and investors can use a company’s inventory turnover to determine how many times it sells its products over a certain period of time. Inventory turnover can indicate whether a company has too much or too little inventory on hand. It is defined as the array of goods used in production or finished goods held by a company during its normal course of business.

The components of the formula are used to calculate FIFO and LIFO accounting values. The gross profit method for estimating the cost of the ending inventory uses information from a previously issued income statement. To illustrate the gross profit method we will assume that ABC Company needs to estimate the cost of its ending inventory on June 30, 2023.

Perpetual vs. Periodic Inventory Accounting Systems

The balance sheet is also referred to as the Statement of Financial Position. With perpetual FIFO, the first (or oldest) costs are the first costs removed from the Inventory account and debited to the Cost of Goods Sold account. Therefore, the perpetual FIFO cost flows and the periodic FIFO cost flows will result in the same cost of goods sold and the same cost of the ending inventory. There were 5 books available for sale for the year 2023 and the cost of the goods available was $440.

Beginning inventory, also called opening inventory, refers to the total value of a company’s inventory at the start of each accounting period. It is equal to the ending inventory of the previous accounting period. Products and components often account for the greatest capital outlay in a business. Because of this, inventory accounting plays a critical role in maintaining the profitability and liquidity of any product-based business. Inventory accounting is the practice of valuing and reporting on the physical inventory a business holds.