Inventory Definition

Inventories consist of raw material, work-in-process and finished goods which are held by a business in
ordinary course of business, either for sale or for the purpose of using them in the process of producing goods
and services.
Types of Inventory
Raw Material

Raw material is a type of inventory which acts as the basic constituent of a product. For example cotton is raw
material for cloth production and plastic is raw material for production of toys. Raw material is usually held by
manufacturing companies because they have to manufacture goods from raw material.

Work-In-Process
Work in process is a type of inventory that is in the process of production. This means that work-in-process
inventory is in the middle of production stage and it is partly complete. Work-in-process account is used by
manufacturing companies.

Finished Goods
Finished goods is a type of inventory which comes into existence after the production process in complete.
Finished goods is ready for sale inventory.
In financial accounting we are usually concerned with merchandise inventory. The other types of inventories are
studied in cost accounting.

Cost of Inventory
When inventory is purchased, the cost of inventory includes the purchase price, delivery costs, excise and
custom duties etc. less any discount that is obtained. When inventory is manufactured, its cost includes the
production cost plus any cost which is incured on making the inventory saleable for example packing cost.
However if abnormal cost is incurred on delivery or handling etc. then only normal portion will be added to the
cost of inventory. The rest should be expensed.
The valuation of ending inventory is done using FIFO, LIFO, AVCO or specific identification methods under
either periodic inventory system or under perpetual inventory system.

First-In, First-Out (FIFO) Method

First-In, First-Out (FIFO) is one of the methods commonly used to calculate the value of inventory on hand at
the end of an accounting period and the cost of goods sold during the period. This method assumes that
inventory purchased or manufactured first is sold first and newer inventory remains unsold. Thus cost of older
inventory is assigned to cost of goods sold and that of newer inventory is assigned to ending inventory. The
actual flow of inventory may not exactly match the first-in, first-out pattern.

First-In, First-Out method can be applied in both the periodic inventory system and the perpetual inventory
system. The following example illustrates the calculation of ending inventory and cost of goods sold under
FIFO method:
Example
Use the following information to calculate the value of inventory on hand on Mar 31 and cost of goods sold
during March in FIFO periodic inventory system and under FIFO perpetual inventory system.
Mar 1
5
9
11
16
20
29

Beginning Inventory
Purchase
Sale
Purchase
Purchase
Sale
Sale

68 units @ $15.00 per unit

140 units @ $15.50 per unit
94 units @ $19.00 per unit
40 units @ $16.00 per unit
78 units @ $16.50 per unit
116 units @ $19.50 per unit
62 units @ $21.00 per unit

Solution
FIFO Periodic
Units Available for Sale
Units Sold
Units in Ending Inventory

= 68 + 140 + 40 + 78
= 94 + 116 + 62
= 326 272

= 326
= 272
= 54

Cost of Goods Sold

Sales From Mar 1 Inventory
Sales From Mar 5 Purchase
Sales From Mar 11 Purchase
Sales From Mar 16 Purchase

Units
68
140
40
24
272

Unit Cost
$15.00
$15.50
$16.00
$16.50

Total
$1,020
$2,170
$640
$396
$4,226

Ending Inventory
Inventory From Mar 16 Purchase

Units
54

Unit Cost
$16.50

Total
$891

FIFO Perpetual
Date
Mar 1
5

Purchases
Units Unit Cost

Total

140

$2,170

$15.50

9
11

40

$16.00

$640

16

78

$16.50

$1,287

20

Sales
Units

Unit Cost

Total

68
26

$15.00
$15.50

$1,020
$403

114
2
38
24

29

$15.50
$16.00
$16.00
$16.50

$1,767
$32
$608
$396

Balance
Units Unit Cost
68
$15.00
68
$15.00
140
$15.50
114
$15.50

Total
$1,020
$1,020
$2,170
$1,767

114
40
114
40
78
38
78
54

$1,767
$640
$1,767
$640
$1,287
$608
$1,287
$891

$15.50
$16.00
$15.50
$16.00
$16.50
$16.00
$16.50
$16.50

Last-In, First-Out (LIFO) Method

Last-In, First-Out is one of the common techniques used in the valuation of inventory on hand at the end of a
period and the cost of goods sold during the period. LIFO assumes that goods which made their way to
inventory (after purchase, manufacture etc.) later are sold first and those which are manufactured or acquired
early are sold last. Thus LIFO assigns the cost of newer inventory to cost of goods sold and cost of older
inventory to ending inventory account. This method is exactly opposite to first-in, first-out method.

Last-In, First-Out method is used differently under periodic inventory system and perpetual inventory system.
Let us use the same example that we used in FIFO method to illustrate the use of last-in, first-out method

Example
Use LIFO on the following information to calculate the value of ending inventory and the cost of goods sold of
March.
Mar 1
5
14
27
29
Solution

Beginning Inventory
Purchase
Sale
Purchase
Sale

60 units @ $15.00
140 units @ $15.50
190 units @ $19.00
70 units @ $16.00
30 units @ $19.50

LIFO Periodic
Units Available for Sale
Units Sold
Units in Ending Inventory

= 60 + 140 + 70
= 190 + 30
= 270 220

= 270
= 220
= 50

Cost of Goods Sold

Sales From Mar 27 Inventory
Sales From Mar 5 Purchase
Sales From Mar 1 Purchase

Units
70
140
10
220

Unit Cost
$16.00
$15.50
$15.00

Total
$1,120
$2,170
$150
$3440

Ending Inventory
Inventory From Mar 27 Purchase

Units
50

Unit Cost
$15.00

Total
$750

LIFO Perpetual
Date
Mar 1
5

Purchases
Units Unit Cost

Total

140

$2,170

$15.50

14
27
29
31

70

$16.00

Sales
Units

Unit Cost

Total

140
50

$15.50
$15.00

$2,170
$750

$1,190
30

$16.00

$480

Balance
Units Unit Cost
60
$15.00
60
$15.00
140
$15.50
10
$15.00

Total
$900
$900
$2,170
$150

10
70
10
40
10
40

$150
$1,120
$150
$640
$150
$640

$15.00
$16.00
$15.00
$16.00
$15.00
$16.00