What is Inventory in Accounting?

If you have ever wondered, “what is inventory in accounting” and would like to learn a bit more about common inventory functions in manufacturing and warehousing, here are some answers to commonly asked questions:

What is inventory accounting?

Inventory accounting is a method of accounting that takes the different stages of inventory into consideration when calculating costs and pricing. Inventory can be in different stages of production: raw materials (such as ingredients or parts), in-process goods (products at varying stages of assembly) and finished goods (the product ready to go to market).

Items most recently sold can cost more or less than items in earlier stages of assembly. This happens when raw materials are purchased at different prices or must be replaced by alternatives. Goods sold in the later part of the year may have cost more to produce than those sold at the beginning if cost of the raw materials increased. Inventory accounting applies different principles to determine the costs: first in first out (FIFO) will assume that the raw materials purchased first were used first; last in first out (LIFO) assumes the last purchased were sold first, and weighted average costing will calculate an average cost for the raw materials over the course of the year by dividing the cost of goods available for sale by the units available for sale.

What is managing inventory?

Managing inventory refers to the process of controlling the flow of raw materials, production, and fulfillment of goods from the time of arrival of goods (or parts or materials) up to the point of sale to the customer. Usually the objective of managing inventory is to meet customer demands with the least amount of money tied-up in inventory as possible. In an ideal world, inventory and materials would be consumed or dispatched as they arrived, reducing their actual time in stock to a minimum. Only by knowing exact inventory counts, costs and locations of raw materials and goods is a business capable of having a complete view of all areas of production. By working around vendor lead time to establish reorder points that avoid running out of materials and meeting the needs of customers and their deadlines, a business can operate more efficiently.

What is consigned inventory?

Consigned inventory is a supply chain model in which a product is sold by a retailer, but ownership is retained by the supplier until the product has been sold. Because the retailer does not actually buy the inventory until it has been sold, unsold products can be returned.

What is a physical inventory?

A physical inventory is a count of the items actually in stock at a given point in time. Computer based stock systems are periodically ratified by performing a stock-check, with the computer system being overwritten with the manual stock figures (by inventory audit) should there be a discrepancy. A physical count is performed periodically to ensure the numbers in the system accurately reflect what is physically present. Counts can fluctuate if items are damaged, returned to the supply chain, held aside for a customer, or shipped to another location.

Why would the physical count of inventory be different than what is shown in perpetual inventory records?

· Breakages not reported.

· Human error putting items into the wrong stock location.

· Human error picking items from wrong stock location.

· Perishable items becoming unusable (and not being reported).

What is cycle inventory?

Cycle (stock) inventory represents the portion of inventory that a business can sell and replenish according to plan, without dipping into its safety stock. Times of sustained high demand call for increases to the cycle stock to prevent stockouts, which occur when there is not enough cycle stock or safety stock to meet customer demand. Stockouts are costly as they represent lost sales and a failure of inventory management. Keeping cycle stock as low as possible saves money on shipping and storage costs, which is another key role of inventory management in a business.

What is inventory reduction?

One way to reduce inventory is to lessen lead time from the supplier. If products arrive faster from the supplier, it will not be necessary to retain as many in stock to cover order fulfillment demand.

Getting rid of idle inventory items that have been sitting in storage by offering them at a discounted rate is another way to reduce stock counts.