What is Inventory?
Inventory, in accounting, refers to a list created for a formal purpose like the contents of a house let furnished, or the details of an estate going to probate.
Meaning and definition of Inventory Accounting
Inventory Accounting refers to the part of accounting dealing with assessing and accounting for changes in inventoried assets. These changes in value can be a result of various reasons like deterioration, depreciation, obsolescence, increased demand, change in customer taste, decreased market supply, and similar more.
As explained by the Investopedia, it is a requirement of the GAAP that inventory should be accounted properly as per the specific set of standards. This is aimed at limiting the potential of overstating profit by understanding inventory value in addition to limiting the potential of overstating a company’s value through overstated value of inventory which has actually resulted in materially depreciated value.
What is included in Inventory Accounting?
The main elements included in inventory accounting are:
- Retailer inventory costs
The direct cost of inventory, for a retailer, includes purchasing the product in addition to the costs necessary to acquire the product ready for resell, like shipping costs and sales tax. Since gross profit refers to the difference between the selling price and the cost of a product, retaining the low cost of goods sold as compared to the sale price is an old core measure of business strength.
- Manufacturing inventory costs
For any company manufacturing its own product, direct costs count direct material costs like raw materials, manufacturing overhead and direct labor costs like wages of the staff involved in production of a product. Manufacturing overhead refer to those expenses incurred during production but are linked directly to the direct labor or direct materials. Examples of manufacturing overhead include materials to maintain machinery, electricity for machinery, and the salary of factory supervisors.
Monitoring Inventory Levels
Monitoring inventory levels is essential for meeting demand as well as maximizing the sales as preventing too much inventory can tie up cash in addition to creating risk for inventory obsolescence, price reductions, and write-downs thus leading to a decrease in profit margins.