Inventory is defined by FASB Accounting Standards Codification as "the aggregate of those items of tangible personal property that have any of the following characteristics:
a. Held for sale in the ordinary course of business
b. In process of production for such sale
c. To be currently consumed in the production of goods or service to be available for sale".1
The accounting standards codification further explains that inventory includes retail merchandise, manufactured finished goods, work in process, and raw materials and supplies. Typically the cost of inventory also includes any duties, transportation, warehouse, insurance and any costs associated with getting the goods available for sale. Similarly, any purchase discounts are subtracted from the cost of inventory. Depreciable assets should never be classified as inventory, even where they are retired from regular use and held for sale.
Perpetual Inventory System
There are two systems for accounting for inventory: (1) a perpetual inventory system or (2) a periodic inventory system. Under a perpetual system, each time an item is sold the inventory and cost of goods sold accounts are updated. This system is usually more practical for businesses that sell single, unique, big ticket items: such as a jewelerly shop or car dealership. However, with the advent of RFID tags and better technology for tracking inventory, the perpetual system is becoming more common. Under the perpetual system, a sale or sales return can be recorded with a compound journal entry.
Periodic Inventory System
Under a periodic system, inventory is only updated periodically (typically at the end of the period) by doing a physical inventory count. When a sale or sales return occurs under the periodic system, we simply record the sale and corresponding accounts receivable. Although we know that the sales has reduced our inventory, we do not update the inventory account at the time of the same.
We wait until the end of the period to calculate ending inventory and cost of goods sold. We calculate ending inventory by taking the number of units of inventory left and multiplying this number by its per unit cost.
The periodic system has special implications for accounting. Our main concern using the periodic method is how to value ending inventory. That is, when we do our ending inventory count, we have to decide what value to use for our inventory's per-unit cost. There are four generally accepted 'cost-flow' methods for assigning costs to ending inventory and costs of goods sold: FIFO, LIFO and Weighted-Average Cost.2
Additionally, sometimes under the periodic method we are required to estimate our current inventories. For example, in the case of theft or fire, we may need to estimate our inventories for insurance purposes. The two most common methods for estimating inventories are the gross profit method and the retail inventory method.
References:
1. FASB ASC 330-10-20
2. FASB ASC 330-10-30-11
- Business
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- Accounting
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- Financial Accounting & Bookkeeping
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- Purchases, Inventory and Cost of Goods Sold (COGS)
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Inventory
BrainMass Categories within Inventory
FIFO
First in, first out (FIFO) assumes that goods that are acquired earlier are sold first.
LIFO
Last in, first out (LIFO) assumes that goods acquired most recently are sold first, and goods acquired earlier do not move (ie. "first in, still here").
Specific-Unit Cost
Specific unit costing allocates actual costs to identifiable goods. This is most often used where goods sold are unique and more expensive, such as automobiles or jewelry.
Weighted-Average Cost
Weighted-average costing assigns an average cost to ending inventory and cost of goods sold based on the total cost and total number of units available for sale during the period. Moving-average cost is the same, but allows a weighted average cost to be used under a perpetual inventory system.
Estimating Inventories
In the case of theft or fire or verifying internal controls, an accountant may find it necessary to estimate or predict the current level of inventory.
Lower of Cost or Market
When the replacement cost or sales price of inventory is below the purchase price, inventory must be accounted for at the lowest value.
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