A guide to inventory accounting
What is inventory accounting?
Inventory accounting is bookkeeping that involves tracking changes in the quantity and value of a company’s inventory.
It includes keeping records on:
Benefits of inventory accounting
Avoid overstocks and stockouts
Overstocks and stockouts are two of the most common inventory issues businesses face.
Businesses that don’t properly track and manage inventory might end up with too much stock or not enough. Overstocks occur when inventory levels are too high, leading to unnecessary costs related to storage and handling.
Stockouts occur when levels are too low — resulting in missed sales opportunities. Inventory accounting helps you avoid these problems by tracking stock levels and ensuring inventory is always available when needed.
Enhance customer experience and satisfaction
Keeping stock levels optimal is essential for upholding customer confidence and satisfaction.
Customers expect you to have what they need when they visit your business. Neglecting inventory control could cause products to drop below the minimum stock level, which could lead to stockouts and revenue losses.
Cut costs and improve cashflow
Identify inventory that’s no longer selling, so you don’t waste money on stock that you can’t sell. This can also help you become more profitable by focusing your efforts on what’s in demand. It can also unlock capital your business could use for investments elsewhere.
Make better decisions and increase profits
Inventory accounting also provides you with data to make informed business decisions. To make data-driven decisions about inventory sales, you can:
analyse sales patterns
monitor inventory levels
track inventory trends.
Inventory accounting helps you increase profits by stocking in-demand inventory and getting rid of unprofitable items.
Types of inventory
Cycle inventory includes items you use regularly in the production and sale of products.
Decoupling inventory is the process of setting aside extra raw materials so that manufacturing can continue, even during a supply shortage.
Finished goods are products ready for sale.
Maintenance, repairing and operating (MRO)
MRO inventory refers to the items that aren't sold to a customer, but are nonetheless essential to the maintenance, repair and operations of the business. Examples of MRO inventory include employee uniforms, office supplies and spare parts.
Raw materials inventory includes materials a business needs to generate its products or offer its services — for example, if you’re a tailor, your raw materials inventory could include your fabric for making clothing.
Safety stock inventory includes goods in reserve to meet unexpected surges in demand.
WIP inventory includes products in production that aren’t ready for sale.
Periodic vs. perpetual inventory accounting systems
When accounting for inventory, businesses typically use two accounting inventory systems: periodic and perpetual.
Periodic: Under the periodic method, businesses take inventory readings regularly — usually at the beginning and end of accounting periods — and record them in their books. Many small businesses prefer the periodic inventory system because there’s no need for software or scanning.
Perpetual: Under the perpetual (continuous) method, businesses keep track of inventory by recording transactions as they occur. This method is usually more accurate and provides more timely information than periodic accounting. Software tools, such as inventory management systems, can automate this process.
What are the most common inventory accounting methods?
First-in, first-out (FIFO)
FIFO inventory accounting presumes the earliest-received stock will sell first. Companies offering perishable products or items vulnerable to becoming out of fashion, can benefit from this approach.
Last-in, first-out (LIFO)
LIFO is an accounting method that’s only used in the US. It presumes that inventory costs increase over time, decreasing profit margins and the amount of tax payable. US businesses with large inventories and increasing costs may use LIFO to reduce their taxable income. These businesses may include:
gas and oil companies
Specific identification (SI)
With the SI method, businesses track inventory by serial number or another identifier to track each purchase and price individually. Businesses use this method when inventory items are easily distinguishable. The type of businesses that use SI include:
Weighted average cost (WAC)
Businesses use WAC inventory accounting when items are similar and have a fast turnover rate. This method provides the average costs of inventory per unit. To calculate this value, divide the cost of goods available by the total number of units in your inventory. Industries that typically use WAC include:
Choosing the right inventory accounting method for your business
Talking to an inventory accounting specialist or accountant can help you choose the inventory accounting method that’s best for your business and circumstances.
Further, investing in inventory management software can help streamline inventory tracking and decrease the chance of accounting errors.
Disclaimer: This information shouldn’t replace the advice given by a professional. If you’re looking for advice on business decisions, find a qualified expert near you.
Get control of your stock with MYOB
With MYOB’s inventory management software, you can get control of your stock. You can:
Review your inventory information to identify trends and keep track of your business
Reconcile your inventory to help identify errors
Run inventory reports to dive deeper into inventory data, stock levels and pricing
Export your inventory data to Microsoft Excel and more.
At MYOB, we’ve got you covered.