Like accounts receivable, inventory involves the everyday operations of the company; and can also contain a huge portion of the company’s current assets. However, unlike accounts receivable, inventory isn’t just a monetary concept.

Inventory represents physical goods that a company has purchased (or manufactured) in order to sell to its customers. The Inventory has a value that can alter unpredictably and even decline over time. Accountants can make errors in tracking the value of inventory as it moves from receiving to shipping. They can also have a hard time figuring out what inventory to count and how to count it. These are some of the challenges confronting a company in handling its inventory assets.

Perpetual vs Periodic

Under a perpetual inventory system, a continuous record of the changes to inventory is maintained. While under periodic inventory system a company determines the quantity of inventory on hand only periodically. Read more…

Perpetual Inventory System

A perpetual inventory system involves the recording of all transactions affecting the balance of inventory on hand, as they occur. Read more…

Periodic Inventory System

The periodic inventory system determines the quantity of inventory on hand only periodically. A physical count is taken at the end of the period to determine the value of the ending inventory and cost of goods sold. Read more…

Physical Inventory Counts

As required by GAAP and the US tax authority IRS (Internal Revenue Service), a business must take a physical count of its inventory accounts at least once a year. Read more…

Inventory Valuation Methods

Once an inventory system has been chosen, there are four methods that companies can use, based on the type of business and choice of management, to value the inventory. Read more…

Specific Identification Method

Specific identification is used when a business wants to value specific items individually. High value items such as cars, houses and diamonds are often valued in this way. Read more…

Weighted Average Cost Method

Weighted average cost method is used when a business simply applies an average cost to all its inventory. Homogeneous (standardized) materials, such as plastic used in the making of garbage bags, or oil used in making gasoline, are often valued in this way. Read more…

First in First Out Method (FIFO)

First in First Out method is used when a business assumes that the first items received in inventory are also the first items moved out of inventory. Perishable items that expire within a certain amount of time, such as fruit and vegetables, are often valued in this way. Read more…

Last in First Out Method (LIFO)

Last in first out method is used when a business assumes that the last items received in inventory are also the first items moved out. Think of a product that is kept in a pile, with newer purchases being added to the top of the pile. A non-perishable product such as computer ink cartridges might be a good example. Suppose the cartridges are kept in a large bin. Newer purchases are simply added to the bin resulting in the oldest purchases being left at the bottom of the pile and sold last. Read more…

Inventory Valuation Principles

There are two principles that apply when a company chooses an inventory valuation method. Read more…

Applying Valuation Methods

We’ll use sample Company’s inventory as an example to illustrate these valuation methods. For all of the following examples, we will use a perpetual inventory system to account for purchases and sales. Read more…

Lower of Cost or Market (LCM)