Question

What items are included in inventory on the balance sheet? Consider not only those physically present but also those that might be in transit.

Answer 1

Inventory can be defined as assets held

- for sale in the ordinary course of business, or

- in the process of production for such sale, or

- for consumption in the production of goods or services for sale, including maintenance supplies and consumables other than machinery spares, servicing equipment and standby equipment.

There can be different types of inventory based on nature of business of an enterprise. The inventories of manufacturing concern consist of several types of inventories: raw material (which will become part of the goods to be produced), work-in-process (partially completed products in the factory) and finished products. In manufacturing concerns inventories will also include maintenance supplies, consumables, loose tools and spare parts. However, inventories do not include spare parts, servicing equipment and standby equipment which can be used only in connection with an item of fixed asset and whose use is expected to be irregular; such machinery spares are generally accounted for as fixed assets. Similarly, in an enterprise engaged in construction business, projects under construction are also considered as inventory.

At the year-end, every business entity needs to ascertain the closing balance of Inventory which comprise    of Inventory of raw material, work-in-progress, finished goods and other consumable items.

Inventories should be generally valued at the lower of cost or net realizable value

Cost of inventories should comprise

- all cost of purchase,

- costs of conversion, and

- other costs incurred in bringing the inventories to their present location and condition.

Following expenses are generally not included in the costs of inventories:

- abnormal amounts of wasted materials, labour or other production overheads;

- storage costs, unless those costs are necessary in the production process prior to further production stage;

- administrative overheads that do not contribute to bringing the inventories to their present location and condition; and

- selling and distribution costs

Businesses needs to determine what to include in inventory at the end of the accounting period. The last day of the period is the inventory cutoff date. Establishing an inventory cutoff date is very important when there are goods in transit between the business and its customers, or between the company and its suppliers. For example, a business ordered inventory on December 29 and received it on January 5. If the inventory cutoff date is December. 31, the inventory in transit should be included in the company's financial statements.

When goods are in transit its important to note the terms of the shipping agreement. If the inventory is shipped free on board (FOB), the company is the legal owner of the inventory as soon as the supplier ships it. The business should include the shipment in its inventory count if it is shipped by the inventory cutoff date.

Inventories not only includes the physical inventory lying with the entity but also includes inventory lying with the third party.

In addition the entity should have legal ownership rights over the inventory claimed to be held by the entity and recorded in the financial statement.