What is inventory accounting, how does it work, and what are the different types commonly used by companies or manufacturers?
To assess the worth of the company’s inventory assets, any business that handles inventory must employ an inventory accounting procedure.
Companies use a variety of inventory accounting procedures to assign value to their goods and maintain acceptable record-keeping.
Inventory valuation is an important corporate procedure that has a direct impact on profits and taxes.
Inventory management system may also make the process easier by assisting with inventory valuation, tracking inventory movement, such as sales orders and customer purchases, and producing financial statements like a balance sheet or profit and loss statement.
Check out Jurnal warehouse management system if you’re looking for inventory tracking software for your company’s warehouse.
What is Inventory Accounting?
The valuation of inventory products for resale is known as inventory accounting.
Both inventory purchases and inventory turnover should be managed according to GAAP guidelines, which stipulate that all inventory must be correctly accounted for using either the cost method or the market value method.
It’s also worth remembering that inventory is a current asset, which means it’s not depreciable.
Inventory accounting would be straightforward if you just sold one thing, but you’re more likely to have many items in stock and need to account for each of them separately.
Inventory accounting is important for both cost of goods sold and inventory valuation.
Because inventory is an operating expense, materials and product purchases have a direct impact on your income statement, while increased inventory levels have a direct impact on your balance sheet totals.
Inventory accounting is generally used to establish cost of goods sold and inventory valuation at the conclusion of each accounting period.
How Does Inventory Accounting Work?
The sum of your beginning inventory and purchases minus your ending inventory is the primary formula for computing the cost of products sold during a period, which means you must precisely identify the value of your ending inventory using an acceptable inventory accounting system.
For manufacturers, wholesalers, and retailers, inventory accounting is a critical business practice.
Because identical commodities have varying pricing as time passes, many of these product-based organizations confront difficulties attributing value to inventory on hand versus inventory sold.
Businesses, on the other hand, are expected to commit to an inventory cost method in their first year of operation, and while switching methods later on is conceivable, it can be extremely difficult.
As a result, businesses should carefully consider inventory accounting systems to determine which method is best for them, not only now, but in the future as the company (and the amount of inventory controlled) grows.
There is more than one inventory accounting method to use to value inventory.
What are The Types of Inventory Accounting?
Here are some types of inventory accounting method that are generally used:
When utilizing the FIFO method, accountants believe that the products purchased or made first are consumed or sold first, leaving only the most recent items in stock.
The FIFO approach is popular because it aligns with inventory flow in many businesses.
Prices rise each year, thus accountants can charge the least expensive units to the cost of products sold first, assuming the earliest items are used first.
As a result, the cost of goods is falling, resulting in increased operating earnings and higher taxes to pay.
It also implies that businesses use the oldest things first and don’t have to worry about expiration dates or inventory that doesn’t move.
Accountants that use the LIFO method believe that products purchased or made last are sold first, hence the oldest items in stock are those that are still in stock.
As a result, this strategy does not match most companies’ normal inventory flow, and therefore is prohibited by the International Financial Reporting Standards.
When prices rise, the most recently purchased units are the first to be used, causing the cost of goods to rise, resulting in reduced operational earnings and lower income taxes to pay.
Companies using the LIFO method also struggle with obsolete inventory.
Weighted Average Method
Businesses that use the weighted average accounting method only have one inventory tier.
They also factor in the cost of new inventory purchases into the cost of current inventory to arrive at a new weighted average cost, which is updated as more inventory is acquired or manufactured.
Specific Identification Method
This method requires businesses to track the cost of each inventory item separately and charge the specific cost of an item to the cost of goods sold when the item is sold.
This inventory accounting approach is best suited to high-cost items because it demands a lot of data tracking.
To maximize income potential while properly managing record-keeping for tax purposes, choose an inventory accounting method that is appropriate for your business needs.