Is Inventory an Asset? (Plus Types of Inventory)
By Deepti Sharma
Updated October 17, 2022 | Published June 22, 2021
Updated October 17, 2022
Published June 22, 2021
Deepti Sharma spent nine years in the corporate world before starting her own human resources consultancy. Her experience includes accounts, HR and statistics.
Inventory management is a key component in most businesses, as it assists them in determining how much inventory they need to order and at what time. It's important to track and report inventory to understand how it impacts a business. Understanding the concept of inventory being an asset or a liability might help you record it more accurately in accounting books.
In this article, we explain whether inventory is considered an asset and we answer some frequently asked questions related to inventory and assets.
Is inventory an asset?
In most cases, businesses consider inventory an asset. This is because it is something you spend money on and it has value. As long the inventory is something your company uses or sells as part of business operations, you can consider it as inventory. For example, your company's inventory can include sections or parts to products and materials. Inventory also includes the finished products before sales and production teams market items for sale. Additionally, some items like office supplies can also account for company inventory, so long as the organization relies on these items to perform business operations.
Is inventory always an asset?
Inventory is almost always an asset, and businesses typically consider inventory to be a current asset. Inventory that your organization records as current assets include those products and materials that staff sells or uses within a year of the product's manufacture or supplies' purchase. Several more examples of the current assets a business may account for along with inventory include cash, short-term investments and accounts receivable.
Conversely, if your company holds inventory for longer than a year, it then becomes a fixed asset. However, companies avoid holding inventory for a longer time than necessary, as doing so can cause the inventory to become a liability.
Can inventory be a liability?
Businesses typically consider inventory an asset, but sometimes it can become a liability. A liability represents a financial debt or debt for the business. Most companies take on costs to store, secure and maintain inventory, so when inventory doesn't sell, companies might owe money. Typically, inventory becomes a liability if it doesn't sell within an allotted time frame and the storage costs surpass the inventory's value.
A business may also consider inventory a liability if it depreciates. For example, if an updated version of an electronic appliance comes out in the consumer markets, current models become obsolete, resulting in depreciation in value. Once the value depreciates beyond the cost to store the inventory, it becomes a liability.
How do businesses track inventory?
Businesses can use either the perpetual or periodic method for tracking and documenting inventory. Companies rely on software applications in a perpetual system that monitors inventory sales, returns and discounts. For example, a company can use a point-of-sale application within digital registers to record each time a customer purchases an item. Businesses record this action as a deduction in the inventory in the system and repeat it each time customers make transactions. In a periodic system, a company counts its inventory manually at specific intervals throughout the year.
When tracking inventory, businesses record the total number and value of items in various financial documents. For example, the business lists its assets on its balance sheet, including inventory. When inventory sells, it lists the income from the sale on the income statement. It's common practice for businesses to keep separate accounts for each inventory type and adjust these documents as necessary.
What are the types of inventory?
Businesses often classify inventory to track costs across all production operations easily. By monitoring costs at each stage of the production process, companies can ensure they're operating within budget and evaluating the system for improvements. Companies often classify inventory into the following types:
Companies that manufacture products rely on raw materials and supplies to create a piece, section or whole product. When calculating the costs of raw materials, businesses combine the cost of all the parts they currently have in stock that the staff hasn't yet used in production.
Raw materials can include direct materials and indirect materials. Direct materials are components that production teams apply directly to a final product. For example, vegetables and groceries are the direct materials for a caterer. Indirect materials can include any materials production teams use during the manufacturing process but don't incorporate into the final product, like the aprons and disposable gloves that the caterer uses.
Work in progress
Businesses consider any product in production as a work in progress. Works in progress can comprise raw materials, overhead costs and labor costs. Businesses create a work-in-progress account to help them track the flow of costs during the production process. For example, completed products often require packaging before manufacturing companies distribute them for sale.
The products that companies package but have yet to ship account for work in progress since the company still needs to distribute the inventory before it's eligible for sale. Businesses can calculate work-in-progress inventory to determine inventory that's in production at both the beginning and end of an accounting period.
Inventory accounts for finished goods when all production stages are complete and ready for sale. Like work-in-progress inventory, you can determine the finished goods inventory value to gain insight into when you need to replace inventory, what inventory sells well and what to reduce. Calculating finished goods effectively ensures the company keeps inventory in stock continuously and reduces material waste.
Maintenance, repair and operating supplies
Maintenance, repair and operating supplies encompass the company's inventory for producing parts and sections of an item, rather than the entire product itself. For example, if you use gas to power an engine, machine lubricant for manufacturing equipment or paper supplies in the office, you can account for these items as inventory under the maintenance and supply category. Operating supplies can account for any supplies companies require for business operations that affect inventory production.
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