Accounting technology / Glossary / Inventory accounting

What is inventory accounting?

Definition

Inventory accounting is the valuation of goods a business holds for sale, and the recording of their cost as they are sold. It decides which cost each sold item carries, using a method such as first-in, first-out or weighted average, so that cost of goods sold reaches the profit and loss statement and unsold stock stays on the balance sheet.

Also calledstock accountinginventory valuation

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Measured at: Lower of cost and net realisable value
IFRS methods: FIFO or weighted average
LIFO: US GAAP only, not IFRS

How inventory accounting works

Inventory includes goods bought for resale, raw materials and work in progress in manufacturing, and finished goods. Its cost covers purchase price plus costs of bringing it to its location and condition, such as freight, duty and, for manufacturers, production overheads. Under IAS 2, inventory is measured at the lower of cost and net realisable value, and the cost of interchangeable items is assigned by first-in, first-out (FIFO) or weighted average cost; last-in, first-out (LIFO) is not allowed under IFRS but is permitted under US GAAP. A perpetual system updates stock and cost of goods sold with every movement; a periodic system works out cost of sales from stock counts. Counts and reconciliations catch shrinkage, and slow-moving stock is written down. E-commerce and product businesses often run inventory in an ERP or a specialist tool that posts to the ledger.

Common questions

What is the difference between FIFO and weighted average?+

FIFO assumes the oldest stock is sold first, so closing stock carries the latest prices. Weighted average recalculates one average cost for all units, which smooths out price changes.

What is net realisable value?+

The estimated selling price less the costs to finish and sell the item. If it falls below cost, for example for damaged or obsolete stock, the inventory is written down to that value.

What is the difference between perpetual and periodic inventory?+

A perpetual system updates stock quantities and cost of sales with each purchase and sale. A periodic system counts stock at period end and calculates cost of sales from opening stock, purchases and closing stock.