Exploring accounting bookkeeping topics, one of the essentials is to learn inventory accounting, since this is one of the most important assets business owns and uses in its activities on a daily basis. This article will explore the main inventory types and present basic concept of inventory value to be accounted for when acquired.
Concept and Types
Inventory is attributed to current asset category since it is being used in the activities of the business within the period shorter than one year. For manufacturing or trading company this is one of the most important assets since it usually generates sales revenue for the business when being sold, i.e. significantly contributed to the profit earning activities.
Following the matching principle of accounting expenses are recognized and included into the Income Statement only when they were incurred to earn revenue. Therefore when inventory is acquired or manufactured it is included into current asset category on the Balance Sheet and is kept there until is being sold or consumed in other way to earn revenue.
When inventory is sold, only cost of sold items is included into the Income Statement – Cost of Goods Sold caption. Inventory remaining on hand is still reflected on the Balance Sheet.
Depending on the type of business activities there might be different categories of inventory, i.e.:
finished goods for sale (manufacturing company) or goods for resale (trading company) work in progress (manufacturing company) raw materials (manufacturing company) consumables (low value items and miscellaneous items to be used in daily business activities)
Business involved in provision of services will usually have consumables, but not inventory for sale.
Cost of Inventory Acquired
There are certain expenses which to be included into the acquisition cost of inventory and accounted for in the Balance Sheet, i.e.: import duties transportation costs (carriage in) – expenses incurred by the buyer to transport inventory to the storage place other costs directly attributable to the acquired inventory (for example assembly, packaging, etc.)
For example if the business have acquired raw materials for $4,500, incurred $340 import duties and paid carriage in costs amounting to $670 (transportation of raw materials to the warehouse), cost of raw materials to be accounted for will amount to $4,500+$340+$670=$5,510. The following accounting entry will be made:
D Inventory (raw materials – current assets category) $5,510
C Cash (Accounts Payable – if inventory was acquired on credit) $5,510
Cost of the raw materials to be included into expenses only when it will be used in manufacturing process and finished goods will be sold, i.e. sales revenue will be earned.