Inventories can simply be defined as asset items that a company holds for sale in the ordinary course of business, or items that will be used or consumed in the production of goods to be sold.

Raw Materials Inventory reports the cost of goods and materials on hand which will be used in production.

Work in Process Inventory reports the cost of goods, materials and other components of manufacturing process used for the inventory which are still in production process, in other words unfinished at the time financial statements are prepared.

Finished Goods Inventory reports the cost of goods, materials and other components of manufacturing process used for the inventory produced and available for sale.

Inventories are usually made up of a combination of goods, raw materials and finished products.

Generally Accepted Accounting Principles (GAAP) rests on a conceptual framework that identifies the objectives, characteristics, elements, and implementation of financial statements and creates the accepted accounting principles.

The consistency principle holds that companies should
use the same accounting methods and procedures in each
accounting period, so that the information provided
will help investors and creditors to compare a company’s
financial statements from one period to the next.

The disclosure principle holds that a company should report enough information for financial statement users to understand methods and procedures used for each component of the financial statements to make wise decisions about the company by providing additional information.

The materiality concept states that a company must perform strictly proper accounting only for significant items.2 Information is significant (material in accounting terms) when it would cause someone to change a decision. The most important point about this concept is to understand what is significant or material.

Conservatism in accounting means being careful in reporting items in the financial statements.

The purpose of conservatism is to report realistic figures and never exaggerate assets or net income.

There are two basic inventory accounting systems: “Perpetual Inventory System” and “Periodic Inventory System”.

Perpetual Inventory System is an inventory system of tracking and recording inventory and cost of goods sold on a continual basis.

Periodic Inventory System is a system of determining the quantity of inventory on hand only periodically.

Inventory Cost Flow Method is a method of approximating the flow of inventory costs in a business that is used to determine the amount of cost of goods sold and ending merchandise inventory.

Specific Identification Method is an inventory costing method based on the specific cost of particular units of inventory.

Specific Identification Method is an inventory costing method based on the specific cost of particular units of inventory.

The First-In, First-Out (FIFO) method assumes that the earliest goods purchased are the first to be sold. Under the first-in, first-out (FIFO) method, the cost of goods sold is based on the oldest purchases – that is, the first units to come in are assumed to be the first units to go out of the warehouse (sold).

Method is an inventory costing method in which the last costs into inventory are the first costs out to cost of goods sold. The method leaves the oldest costs –those of beginning inventory and the earliest purchases of the period- in ending inventory.

Lower of Cost or Market Value Method (LCM) is a valuation method which requires inventory to be reported in financial statements at whichever is lower – its historical cost or its market value.

Net Realizable Value is the estimated sales value minus estimated cost of completion and minus estimated cost of sale.