Inventory

The raw materials, work-in-process goods and finished goods are collectively called inventory. Inventory represents one of the most important assets that most businesses possess, because the turnover of inventory is a primary source of revenue generation. Inventory, the life blood of merchandising and manufacturing businesses has significant impact on both the balance sheet and the income statement. Inventory may be controlled with a perpetual or periodic inventory system.

In the periodic inventory system acquisition of inventory is debited to a special account, the Purchases account. To find the cost of goods sold it must be calculated. Too net purchases add beginning inventory then subtract ending inventory. A physical count of the inventory is required to determine ending inventory.

Cost of Goods Sold = Net Purchases + Beginning Inventory - Ending Inventory

In a perpetual inventory system, purchases and sales are recorded directly in the inventory account as they occur. This way data are available at any time on the quantity of material and merchandise on hand. A Cost of Goods Sold account is used to accumulate issuances from inventory. Even in a perpetual inventory system a physical inventory should be taken at year end.

A physical inventory involves counting all the inventory items and comparing the count with inventory records. Any discrepancies are corrected to agree with the physical count. A reconciliation between the recorded inventory and the actual on hand should happen at least once a year to due to potential for error, loss or shrinkage.

Inventory control is important to success in merchandising and manufacturing businesses. An excessive amount of inventory for long periods of time is not usually good for a business because of inventory storage, obsolescence and spoilage costs. Carrying too little inventory isn't good either, because the business runs the risk of losing out on potential sales and potential market share.