Discuss inventory accounting concepts and issues

INVENTORY

Inventory refers to goods and other items that a firm owns and holds for sale or for further processing as part of its operations. Inventory is also called "stock" in some countries; do not confuse this usage with common stock, which is an entity's contributed equity capital. When the firm sells inventory, the carrying amount of that inventory becomes an expense, Cost of Goods Sold (sometimes called Cost of Sales). Inventories are a major asset for merchandising and manufacturing firms, and cost of goods sold is typically their largest single expense.

The inventory equation describes changes in inventory. The following equation measures all quantities in physical units:

Beginning Inventory + Additions - Withdrawals = Ending Inventory

Financial statements report financial amounts (such as dollars, euros, and pesos), not physical amounts (such as units, kilograms, and cubic feet). The accountant transforms physical quantities of inventories into financial amounts by assigning costs to those physical quantities. When acquisition costs of inventory are constant, all inventory items carry the same per-unit cost; physical quantities and financial amounts change together so that variation in the monetary amounts recorded for inventories results from changes in quantities. The major problems in inventory accounting arise because the per-unit acquisition costs of inventory items change over time.

There are three issues in inventory accounting:

1 . The types of costs included in the acquisition cost of inventory.

2 . The treatment of changes in the market value of inventories subsequent to acquisition.

3 . The cost flow assumption used to trace the movement of costs into and out of inventory, including the effects of per-unit inventory costs changing over time.