10 topics covering inventory accounting from foundational concepts through advanced intermediate accounting. Click any topic to expand. All concepts are free and publicly accessible.
Inventory is one of the most significant assets for many businesses — often the largest single item on the balance sheet. It represents goods held for sale in the ordinary course of business, or materials used to produce goods for sale.
Why Inventory Matters
Inventory directly affects two critical financial statement lines: it appears as a current asset on the balance sheet, and when sold, its cost flows to Cost of Goods Sold (COGS) on the income statement. The method used to assign costs to inventory and COGS can significantly alter reported profits, tax obligations, and financial ratios.
Types of Inventory by Business
| Business Type | Inventory Accounts | Description |
|---|---|---|
| Merchandising | Merchandise Inventory (1 account) | Goods purchased ready to sell without further processing |
| Manufacturing | Raw Materials | Inputs purchased — wood, steel, components not yet in production |
| Manufacturing | Work in Progress (WIP) | Partially completed units currently in the production process |
| Manufacturing | Finished Goods | Completed units awaiting sale |
| Service firms | (None — no inventory) | Service companies generally have no inventory account |
Manufacturing Cost Flow
For manufacturers, costs flow sequentially through three inventory accounts before becoming an expense:
Raw materials move into WIP when production begins. Direct labor and manufacturing overhead are added in WIP. When production completes, costs transfer to Finished Goods. When sold, they become COGS.
Product Costs vs Period Costs
| Type | Definition | Examples | Balance Sheet / P&L |
|---|---|---|---|
| Product cost | Costs necessary to bring inventory to its present location and condition | Direct materials, direct labor, manufacturing overhead, freight-in | Balance sheet (Inventory) → P&L when sold (COGS) |
| Period cost | Costs that cannot be capitalized into inventory | Selling expense, administrative expense, freight-out, advertising | P&L immediately in the period incurred |