defining inventory
A business involved in trading, purchases goods and stock to resale so they can earn revenue and make profit out of it. Similarly, a manufacturing business purchases raw materials, works on it and sells finished goods to the customers. Even businesses involved in provision of services usually have stock items e.g. stationary, cleaning materials etc. which are consumed daily to perform effectively.
International Accounting Standard (IAS)-2 provides a comprehensive definition of Inventory. It states that Inventories are
Tangible assets held for;-
Sales in the ordinary course of business. This means the inventories are only those products which business sells during its day to day activity. For example, a car is inventory for a car manufacturing business whereas the same car being used in business, will be a non-current asset for a grocery retailer. Even, if the grocery retailer put this car on sale, it still will be accounted as Non-current asset held for sale, instead of Inventory.
Further Production/ processing before sale. A manufacturing business purchases raw materials and works on these raw materials. Add some value in it and make finished goods. The Finished products are then sold to the customer in the ordinary course of the business. All these raw material, semi-finished and finished items are accounted for as Inventory.
Consumption within one year. Any item held by business, which is not being used directly in the process of producing finished goods, however usually is consumed to perform day to day, ordinary business activities. Examples of such inventory items include spare parts for regular maintenance of plant and machinery & IT and network infrastructure, stationary items and materials held for office cleaning etc.
In any manufacturing concern, the value of inventories is significant and usually make the second largest monetary item after property, plant and equipment on its balance sheet. Therefore, it is very important that inventories are properly accounted for.
Inventory includes different types of items which are measured in different ways. For example Liquid inventories are measured in Liters, whereas many types of raw materials are measured based on its weight. Similarly, spare parts are counted in numbers. The variations in units of measurement, and the way these items are consumed provide the basis for different inventory valuation methods, currently being used by businesses. The availability of choices for valuing inventory, provide room for manipulation while preparing financial statements.
Therefore, it is very important that you know the different inventory recording and valuations methods are available and how changing one method to another can result in changing the profit and balance sheet of the business.
