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 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 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 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.
Written by Irfanullah Jan