Inventory Meaning

The term "Inventories" represent one of the most important elements of a business and it is sub group in assets. Much of a company's resources is invested in this asset, which is usually its chief source of revenue.

Consideration to the primary inventory

  1. Determining Quantity
  2. Determining Dollar Value

Nature of Inventories will show its meaning to us, any physical items are inventory.

Classes of Inventories

In a merchandising business at the retail or wholesale level, inventories consist of goods held for sale in the same form as purchased and are designated merchandise inventory. A manufacturing business, in contrast, has several types of Inventories as below:

  • Finished Goods
  • Goods in Process
  • Raw Materials

Finished Goods: Finished goods are completed products awaiting sale. All costs (i.e., those for raw materials, direct labor and manufacturing overhead) have been incurred. Finished parts of assemblies purchased or produced for use in the completed product, however, are classified as raw materials.

Goods in Process: Goods in process or work in process consists of partly completed goods. Generally, the cost of raw material, direct labor and manufacturing overhead applied to date can be identified and included in the cost of goods in process.

Raw Materials: Raw materials may be obtained directly from natural resources or from production. Thus, they may be produced by the company manufacturing the finished product or purchased as the finished product of another company. Raw materials cost includes the purchase price, freight, receiving, storage and/or other charges necessary to make the finished goods ready for use{ Factory supplies are auxiliary materials that do not become an integral part of the finished product, such as cleaning supplies, lubricating oils, and fuels.

Inventory Structure

Inventory Structure from begin to end of period

hat is the combination of costs in the units on hand, and in the units shipped out?


Special Inventory Items

While most items are included in inventory when received, the technical procedure is to recognize purchases when ownership changes or title passes. There are cases, however, where the legal rule must be modified because of special circumstances,
some of which are described below.

Goods in Transit: Most goods are shipped f.o.b. shipping point, which means that title passes to the buyer when the goods are loaded on the carrier. When goods are shipped f.o.b destination, title does not pass until the shipment reaches its destination.

Goods on Consignment:  When goods are shipped to dealers on consignnment, title does not change until the goods are sold by the consignee. Such goods are reported as inventory of the consignor (shipper) until the goods are sold and cash or an account receivable is obtained.  The inventory cost includes all handling and shipping costs incurred in transferring the goods to the consignee.

Segregated Goods: When goods are produced on special order, title may pass at the time goods are segregated. At this point the vendor recognizes a sale and the goods are deducted from inventory. The purchaser records a purchase and an inventory increase when notice of segregation is received from the vendor.

Installment and Conditional Sales: In these cases, even though the buyer receives the merchandise, the seller retains title until the full sales price has been received.
Technically, the seller should show goods transferred as inventory with an offset for the equity the buyer has built up through payments. Where the possibility of default is negligible, the seller usually waives his right and permits title to pass. However, there is usually a right to repossession of the product if the contract is not completed.

Cost Flow Methods

Since it is likely that during a specified time period a given item may be purchased at a variety of prices, it is necessary to determine which costs relate to units remaining in inventory and which costs relate to units sold. The concept of a cost flow refers to the entire flow of costs through the system, from purchase or production of goods to their sale. It does not involve the physical flow of goods, Because the value assigned to inventory has a direct effect on net income for both the current and subsequent accounting period, the objective in selecting a cost flow method is the matching of appropriate costs with revenue.

The main cost flow methods are: first-in, first-out (FIFO), last-in, first-out (LIFO), weighted average, and specific identification. They all resolve the basic costing problem: What is the combination of costs in the units on hand, and in the units shipped out?