Lesson 33 - Beginner accounting course

33. Managing Inventory in Accounting

Inventory management is a critical aspect of accounting, particularly for businesses that sell physical products. Properly tracking inventory ensures that a company maintains accurate financial statements, controls costs, and optimizes profitability. Inventory appears on the balance sheet as a current asset and affects the cost of goods sold (COGS) on the income statement.

Types of Inventory

Businesses classify inventory into different categories based on its stage in the production or sales process:

• Raw Materials – Basic materials used to manufacture goods (e.g., wood for furniture production).

• Work-in-Progress (WIP) – Goods that are partially completed but not yet finished.

• Finished Goods – Completed products ready for sale.

• Merchandise Inventory – Products purchased for resale, common in retail businesses.

Inventory Accounting Systems

Businesses use one of two main methods to track inventory:

1. Perpetual Inventory System

• Continuously updates inventory records after each purchase or sale.

• Commonly used with barcode scanning and accounting software.

• Provides real-time inventory tracking.

• Example: A supermarket that updates inventory every time a product is scanned at checkout.

2. Periodic Inventory System

• Updates inventory records at specific intervals (e.g., monthly, quarterly, or annually).

• Requires physical inventory counts to determine ending balances.

• Simpler but less accurate compared to the perpetual system.

• Example: A small business that manually counts stock at the end of each month.

Inventory Valuation Methods

The value of inventory directly impacts financial statements. Businesses can use different methods to determine the cost of inventory sold:

Recording Inventory Transactions

Inventory purchases, sales, and adjustments must be recorded properly.

Example 1: Purchasing Inventory on Credit

A company buys $10,000 worth of inventory on credit.

Example 2: Selling Inventory

A company sells inventory for $15,000 that originally cost $8,000.

Inventory Shrinkage and Adjustments

Inventory losses can occur due to theft, damage, or errors. These must be accounted for to ensure accurate records.

Example: Recording Inventory Shrinkage
A physical inventory count shows $500 worth of missing inventory.

Key Takeaways

• Inventory is a current asset that must be carefully tracked.

• Businesses use perpetual or periodic inventory systems.

• Inventory valuation methods (FIFO, LIFO, Weighted Average) affect COGS and net income.

• Proper recording of purchases, sales, and adjustments ensures financial accuracy.

• Inventory shrinkage must be accounted for to prevent financial discrepancies.

Effective inventory management leads to better financial decision-making and helps businesses optimize costs and profitability.