1.What is Inventory?
Inventory refers to the goods a company intends to sell to customers. It’s an important asset for businesses that sell physical products (like retailers, wholesalers, and manufacturers).
2. Why is Inventory a Current Asset?
Inventory is classified as a current asset because it is expected to be sold, used, or converted into cash within one year or one operating cycle, whichever is longer.
3. Types of Inventories (Especially in Manufacturing):
- Raw Materials: Basic inputs not yet used in production (e.g., wood, metal).
- Work-in-Progress (WIP): Goods that are in the process of being manufactured.
- Finished Goods: Completed items ready for sale.
4. Inventory Valuation Methods (Affect Financial Statements):
- FIFO (First In, First Out): Oldest inventory is sold first. During inflation, this leads to lower cost of goods sold (COGS) and higher profits.
- LIFO (Last In, First Out): Newest inventory is sold first. This usually leads to higher COGS and lower profits (not allowed under IFRS).
- Weighted Average: COGS and ending inventory are based on the average cost of all inventory.
5. Impact on Financial Statements:
- Balance Sheet: Inventory appears as a current asset.
- Income Statement: When inventory is sold, its cost moves to Cost of Goods Sold (COGS).
- Cash Flow Statement: Buying inventory is a cash outflow under operating activities.