Chapter 6: Reporting and Analyzing Inventory
6.1 Classifying and Determining Inventory
− Two important steps in the reporting of inventory at the end of the accounting period
are as follows:
o 1. The classification of inventory based on its degree of completeness
o 2. The determination of inventory amounts
Classifying Inventory
- How a company classifies inventory depends on whether the firm is a merchandiser
or a manufacturer
o Difference between a manufacturer and a merchandiser = manufacturers
make products; merchandisers buy those products to sell to consumers
- In a merchandising company, inventory consists of many different items. These
item have two common characteristics:
▪ 1. the are owned by the company
▪ 2. they are in a form ready for sale to customers in the ordinary course
of business
o Thus, merchandisers need only one inventory classification, merchandise
inventory, to describe the many different items that make up the total
inventory
- In manufacturing companies, some inventory may not yet be ready for sale. As a
result, manufacturers usually classify inventory into three categories: raw
materials, work in progress, and finished goods
o Raw materials are the basic goods that will be used in production but have
not yet been placed into production
o Work in progress is that portion of manufactured inventory that has been
placed into the production process but is not yet complete
o Finished good inventory is manufactured items that are completed and
ready for sale
▪ Helpful Hint: regardless of the classification, companies report all
inventories under Current Assets on the balance sheet
- By observing the levels and changes in the levels of these three inventory types,
financial statement users can gain insight into management’s production plans
o Low levels of raw materials and high levels of finished goods suggest that
management believes it has enough inventory on hand and production will
be slowing down—perhaps in anticipation of a recession
, o High levels of raw materials and low levels of finished goods probably signal
that management is planning to step up production
- Many companies have significantly lowered inventory levels and coasts using just-
in-time (JIT) inventory methods
o Under a JIT method, companies manufacture or purchase goods only when
needed
o The success of the JIT system depends on reliable suppliers
Determining Inventory Quantities
- Companies take a physical inventory at the end of the account period.
o Taking a physical inventory involves actually counting, weighing, or
measuring each kind of inventory at tother times during the accounting
period for the following reasons
▪ 1. to check the accuracy of their perpetual inventory records
▪ 2. to determine the amount of inventory lost due to “shrinkage”
- Companies using a periodic inventory system take a physical inventory for two
different purposes:
o 1. Taking a physical inventory of goods on hand
o 2. determining the ownership of goods
- Take a Physical Inventory
o In many companies, taking an inventory is a formidable task
o An inventory count is generally more accurate when goods are not being sold
or received during the counting
o Consequently, companies often “take inventory” when the business is
closed or when business is slow
o Many retailers close early on a chosen day in January—after the holiday
sales and returns, when inventories are at thier lowest level—to count
inventory
- Determining Ownership of Goods
o One challenge in computing inventory quantities is determining what
inventory a company owes
▪ Two questions must be answered:
• 1. Do all of the goods included in the count belong to the
company?
• Does the company own any goods that were not included in
the count?
- Goods in Transit
6.1 Classifying and Determining Inventory
− Two important steps in the reporting of inventory at the end of the accounting period
are as follows:
o 1. The classification of inventory based on its degree of completeness
o 2. The determination of inventory amounts
Classifying Inventory
- How a company classifies inventory depends on whether the firm is a merchandiser
or a manufacturer
o Difference between a manufacturer and a merchandiser = manufacturers
make products; merchandisers buy those products to sell to consumers
- In a merchandising company, inventory consists of many different items. These
item have two common characteristics:
▪ 1. the are owned by the company
▪ 2. they are in a form ready for sale to customers in the ordinary course
of business
o Thus, merchandisers need only one inventory classification, merchandise
inventory, to describe the many different items that make up the total
inventory
- In manufacturing companies, some inventory may not yet be ready for sale. As a
result, manufacturers usually classify inventory into three categories: raw
materials, work in progress, and finished goods
o Raw materials are the basic goods that will be used in production but have
not yet been placed into production
o Work in progress is that portion of manufactured inventory that has been
placed into the production process but is not yet complete
o Finished good inventory is manufactured items that are completed and
ready for sale
▪ Helpful Hint: regardless of the classification, companies report all
inventories under Current Assets on the balance sheet
- By observing the levels and changes in the levels of these three inventory types,
financial statement users can gain insight into management’s production plans
o Low levels of raw materials and high levels of finished goods suggest that
management believes it has enough inventory on hand and production will
be slowing down—perhaps in anticipation of a recession
, o High levels of raw materials and low levels of finished goods probably signal
that management is planning to step up production
- Many companies have significantly lowered inventory levels and coasts using just-
in-time (JIT) inventory methods
o Under a JIT method, companies manufacture or purchase goods only when
needed
o The success of the JIT system depends on reliable suppliers
Determining Inventory Quantities
- Companies take a physical inventory at the end of the account period.
o Taking a physical inventory involves actually counting, weighing, or
measuring each kind of inventory at tother times during the accounting
period for the following reasons
▪ 1. to check the accuracy of their perpetual inventory records
▪ 2. to determine the amount of inventory lost due to “shrinkage”
- Companies using a periodic inventory system take a physical inventory for two
different purposes:
o 1. Taking a physical inventory of goods on hand
o 2. determining the ownership of goods
- Take a Physical Inventory
o In many companies, taking an inventory is a formidable task
o An inventory count is generally more accurate when goods are not being sold
or received during the counting
o Consequently, companies often “take inventory” when the business is
closed or when business is slow
o Many retailers close early on a chosen day in January—after the holiday
sales and returns, when inventories are at thier lowest level—to count
inventory
- Determining Ownership of Goods
o One challenge in computing inventory quantities is determining what
inventory a company owes
▪ Two questions must be answered:
• 1. Do all of the goods included in the count belong to the
company?
• Does the company own any goods that were not included in
the count?
- Goods in Transit
