Accounting for inventory

 

🏷️ Accounting for Inventory – Complete Guide

Inventory accounting deals with how a company tracks, values, and reports its stock of goods. It directly affects cost of goods sold (COGS), gross profit, and net income.

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📦 Types of Inventory

1. Raw Materials – Basic components for production

2. Work-in-Progress (WIP) – Goods partially completed

3. Finished Goods – Ready-for-sale items

4. Merchandise Inventory – For retailers, ready-made goods for resale

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📚 Key Inventory Accounting Concepts

Concept	Description
Inventory Valuation	Assigning monetary value to items in stock
Cost of Goods Sold (COGS)	Direct cost of items sold during the period
Ending Inventory	Value of unsold inventory at period end
Periodic vs Perpetual System	Timing of inventory updates

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🧾 Inventory Accounting Methods

1. FIFO (First In, First Out)

• Oldest inventory is sold first

• Ending inventory = most recent costs

Used when: prices are rising → higher profits

2. LIFO (Last In, First Out)

• Newest inventory sold first

• Ending inventory = older costs

Used when: prices are rising → lower taxable income
❌ Not allowed under IFRS

3. Weighted Average Cost

• Average cost per unit = Total Cost / Total Units

• Smooths out price fluctuations

Used when: Inventory is homogeneous (e.g., fuel, grains)

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🔁 Periodic vs. Perpetual Inventory Systems

System	Description	Use Case
Periodic	Updates inventory at set intervals (e.g., monthly)	Small businesses
Perpetual	Real-time updates using tech/barcodes	Retail, manufacturing

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📊 Journal Entry Examples

➤ Purchase of Inventory (Perpetual System)

Inventory A/c ............ Dr
     To Cash / Accounts Payable

➤ Sale of Inventory (Perpetual)

Cash / Accounts Receivable ....... Dr
     To Sales Revenue

COGS ............................. Dr
     To Inventory

➤ End-of-Year Adjustment (Periodic System)

COGS ............................. Dr
     To Inventory (Beginning)
     To Purchases
     To Inventory (Ending)

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📉 Impact on Financial Statements

Statement	Impact
Income Statement	Affects COGS → Gross Profit → Net Income
Balance Sheet	Inventory under Current Assets
Cash Flow Statement	Inventory increase = outflow in Operating Activities

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🧠 Best Practices for Inventory Accounting

• Perform regular physical counts to avoid shrinkage.

• Choose method (FIFO/LIFO/Weighted Avg.) aligned with strategy & compliance.

• Use ERP or accounting software for real-time tracking.

• Maintain clear documentation for audits.