What is Inventory?


Here are the lessons in this section, along with a brief description of each one (Remember that you most probably will get the maximum benefit by doing the lessons in the order presented):

Lesson One: What is Inventory? (current page)
Lesson Two: FIFO Method and Weighted Average Cost
Lesson Three: Sales, Cost of Goods Sold and Gross Profit
Lesson Four: Perpetual and Periodic Inventory
Lesson Five: Accounting for Manufacturing Businesses
Lesson Six: The Manufacturing Cost Statement





Inventory are stock, goods, merchandise. It's those assets, those products, those things of value, that you either buy from another or make yourself, that you then sell on to someone else (at a higher price than what it cost you to buy or make the inventory).

Inventory are classified as current assets, as the business intends to sell them (and usually does) within a year from the date that it is listed on the balance sheet.


Here are some examples of inventory:

Sneakers

1) Joe Superathlete Shoes sells Adidas and Nike shoes. Guess what? Those are both inventory for his business because they are bought from the manufacturers of the shoes and are sold to the public at a higher amount, resulting in a profit for the business.

Inventory

2) Morgan Used Cars sells used cars. Are these inventory? Well, usually motor vehicles would fall under non-current assets in our balance sheet. However, in this particular case, the business intends to sell them as part of their regular business operations (they definitely intend to sell them in less than a year), and so these cars are classified as "inventory" under the category of "current assets."

Land and building

3) Davison Investments is a property investment company, trading in residential and commercial properties. Now, these properties - land and buildings - couldn't possibly be anything but a non-current asset, could they? Actually, they could. Just like motor vehicles, land and buildings would usually fall under "non-current assets" in our balance sheet. However, because Davison Investments trade in properties - meaning they want to sell them as a regular part of their business operations - meaning sell them within a year - then these properties are also classified as "inventory."

So as you can see, inventory aren’t necessarily small items that are sold quickly. The size of the asset, or how quickly one can sell it, is not the overriding factor when classifying an asset as inventory. The overriding factor is what the business intends to do with the asset. If they bought it (or made it) with the intention of reselling it for a higher price, and they routinely resell this type of asset to others, then the asset is inventory.

Service business

Now, up until now we have been looking at transactions, journals (debits and credits), T-accounts and reports for service businesses. Service businesses are businesses that provide a service, such as accounting services, tailoring services, electrical services, banking and medical.

But there are two other types of businesses apart from service businesses, both of which revolve around the selling of inventory.

Those two other types of businesses are trading and manufacturing businesses. In this section on inventory we're going to look at the different accounting rules regarding inventory and how they are applied in both of these businesses.

But first, let's make sure we understand what trading and manufacturing businesses are and what they have to do with inventory.

Trading businesses are businesses that buy inventory at a low price and sell it to someone else at a higher price. Examples of trading businesses are clothing stores, hardware stores and supermarkets. Retail stores are always trading businesses as they buy inventory at a low price from a wholesaler or manufacturer and sell these at a higher price to consumers.

Manufacturing Unlike trading businesses, manufacturing businesses do not buy products at a low price and sell at a higher price. Instead manufacturing businesses make products, which they then sell. Some common examples of manufacturing businesses are construction companies, car manufacturers and even bakeries (bakeries manufacture cakes, cookies, bread, etc.).

By the way, there may be one other category of business apart from service, trading and manufacturing businesses... A business that also deals with inventory... Care to take a guess?

This category consists of businesses who extract or gather natural resources and sell these. Businesses like mining companies and farmers. These guys don't manufacture (make) gold or wool. They also don't buy it at a low price and sell it at a higher price. They extract it or grow it in nature themselves. I don't know what you'd call this category exactly, but they're definitely a category on their own.




Here again are the lessons in this section:

Lesson One: What is Inventory? (current page)
Lesson Two: FIFO Method and Weighted Average Cost
Lesson Three: Sales, Cost of Goods Sold and Gross Profit
Lesson Four: Perpetual and Periodic Inventory (two different systems for recording inventory transactions)
Lesson Five: Accounting for Manufacturing Businesses
Lesson Six: The Manufacturing Cost Statement



Read Other Questions Relating to This Lesson
(along with their answers)

Click below to see questions and solutions on this same topic from other visitors to this page...

Four Ways for Valuing Inventory 
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Work-In-Progress Inventory &
Stage Of Completion Valuation
 
Q: I want to ask how do you calculate opening work in progress inventory and closing work in progress inventory... and whether this calculation should …

What are Merchandise Inventory? 
Q: What are merchandise inventory? What does this consist of? A: Merchandise are finished goods that can be sold to the consumer. This includes anything …

Scrap Gold And Inventory? 
Q: I have a company that buys gold from people (jewelry, coins, etc). They then send this gold to a company out of state who in turn sends them a check …



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