Inventory
Inventory
Inventory accounting answers two questions:
- Which costs remain as an asset?
- Which costs become expense when goods are sold or lose value?
What enters cost
| Usually included | Usually excluded |
|---|---|
| Purchase price net of trade discounts | Abnormal waste |
| Import duties and non-refundable taxes | Avoidable storage after production |
| Freight needed to bring goods to location | General administration unrelated to production |
| Direct labour and production inputs | Selling costs |
| Systematic production-overhead allocation | Idle-capacity cost above normal allocation |
Labels do not decide treatment. Ask whether the cost brought inventory to its present location and condition.
Northstar cost-flow example
Northstar has 300 identical battery packs:
| Batch | Units | Unit cost | Total |
|---|---|---|---|
| Opening | 100 | £50 | £5,000 |
| Purchase 1 | 100 | £55 | £5,500 |
| Purchase 2 | 100 | £60 | £6,000 |
| Available | 300 | £16,500 |
It uses 220 packs and has 80 left.
| Cost formula | Cost of sales | Closing inventory |
|---|---|---|
| FIFO | 100×£50 + 100×£55 + 20×£60 = £11,700 | 80×£60 = £4,800 |
| Weighted average | 220×£55 = £12,100 | 80×£55 = £4,400 |
Both preserve the total £16,500. In a rising-price example, FIFO reports lower cost of sales and higher closing inventory. That is a mechanical effect, not evidence of better operations.
Under IAS 2, ordinarily interchangeable items use FIFO or weighted average; LIFO is not permitted. Specific identification applies to items that are not ordinarily interchangeable or are segregated for specific projects.
Lower of cost and net realisable value
For 40 specialised packs:
- cost = £60 each;
- expected selling price = £58;
- completion cost = £3;
- selling cost = £2.
Write-down:
Dr Inventory write-down expense £280
Cr Inventory or allowance £280
IAS 2 permits reversal when NRV recovers, limited to the original write-down. US GAAP generally does not reverse a write-down that established a new cost basis; its subsequent-measurement rules also depend on the cost method. Use the framework-specific rule.
Cut-off before formula
Before calculating FIFO or average cost, test:
- who controls goods in transit under the shipping terms;
- whether consigned goods belong to consignor or consignee;
- whether purchases and related payables are recorded in the same period;
- whether count differences, damage or obsolescence require adjustment.
A perfect spreadsheet cannot repair the wrong population.
Real-report check
Target’s 2025 Form 10-K discusses inventory, reserves and vendor consideration. Its treatment of vendor income shows why analysts read the policy note: a supplier payment may reduce cost of sales unless it reimburses a specific, incremental and identifiable cost.
Quick check
If the 220 packs support revenue of £18,000, calculate gross profit under each formula.