Inventory is the total of raw materials, work in process (WIP), and finished goods that a business holds for the purpose of resale. The important point to remember here is that the goods are intended for resale.
Raw materials is inventory waiting to be used in the manufacturing process, work in process are partially manufactured goods, and finished goods are inventory held for resale.
Beginning inventory is the goods unsold at the start of the accounting period, and ending inventory is the goods unsold at the end of the accounting period.
Inventory is recorded in the balance sheet of the business at cost, or if lower market value, under the heading Current Assets, that means it is expected to be convertible into cash within a year.
The word stock is often used instead of inventory and in relation to goods held by a business, mean the same thing.
How do you record Inventory?
The recording of inventory is split into three accounts
- The Sales account which records the reductions in inventory at selling prices and is transferred to the profit and loss at the period end.
- The Purchases account which records the additions to inventory at cost and is transferred to the profit and loss account at the period end.
- The Inventory Account in the balance sheet which maintains the opening and closing inventory balances.
The reason for the three accounts is that purchases (increases) are at cost, and sales (decreases) are at selling price (i.e. they include a profit).
If both sales and purchases were recorded on one account the balance would be a meaningless figure including the profit element, and would not represent the inventory balance.