Inventory Accounting

Inventory Accounting

The accounting for inventory involves determining the correct unit counts comprising ending inventory, and then assigning a value to those units. The resulting costs are then used to record an ending inventory value, as well as to calculate the cost of goods sold for the reporting period.

These basic inventory accounting activities are expanded upon in the following points:

Determine ending unit counts.
A company may use either periodic or perpetual inventory system to maintain its inventory records. A periodic system relies upon a physical count to determine the ending inventory balance, while a perpetual system uses constant updates of the inventory records to arrive at the same goal.

Improve record accuracy.
If a company uses the perpetual inventory system to arrive at ending inventory balances, the accuracy of the transactions is paramount.

Conduct physical counts.
If a company uses the periodic inventory system to create ending inventory balances, the physical count must be conducted correctly. This involves the completion of a specific series of activities to improve the odds of counting all inventory items.

Estimate ending inventory.
There may be situations where it is not possible to conduct a physical count to arrive at the ending inventory balance. If so, the gross profit method or the retail inventory method can be used to derive an approximate ending balance.

Assign costs to inventory.
The main role of the accountant on a monthly basis is assigning costs to ending inventory unit counts. The basic concept of cost layering, which involves tracking tranches of inventory costs, involves the first in, first out (FIFO) layering system and the last in, first out (LIFO) system. A different approach is the assignment of a standard cost to each inventory item, rather than a historical cost.

Allocate inventory to overhead.
The typical production facility has a large amount of overhead costs, which must be allocated to the units produced in a reporting period.