Inventory

Inventory is the tangible goods held by a business for the production of goods and services.

Inventory can fall into three categories: raw materials, work-in-process (WIP), and finished

goods. Raw materials inventory represents items or commodities purchased by a firm to create

products and services. WIP inventory represents “partially completed goods, part or

subassemblies that are no longer part of the raw materials inventory and not yet finished

goods.” [3] The valuation of WIP should include the cost of direct material, direct labor, and

overhead put into the WIP inventory. Finished inventory represents products that are ready for

sale. Generally accepted accounting principles (GAAP) require that a business value its

inventory on either the cost price or the market price—whichever is lowest. This inherent

conservative approach to valuation is due to the desire to prevent the overestimation of

inventory during inflationary periods.

Total current assets are the summation of the aforementioned items and are defined as follows:

total current assets = cash + marketable securities + accounts receivable + prepaid expenses + inventory.

The next set of items in the asset section of the balance sheet is long-term assets. Long-

term assets are those assets that will not be turned into cash within the next year. Long-term

assets may include a category known as investments. These are items that management holds

for investment purposes, and they do not intend to “cash in” within the upcoming year. They

might consist of other companies’ stock, notes, or bonds. In some cases, they may represent

specialized forms—money put away for pension funds. The next major category of long-term

assets is fixed assets. Fixed assetsinclude plant, equipment, and land. Generally, these are

valued at their original cost. The value of these assets will decline over time. As an example, you

purchase a new car for $25,000. If you were to sell the same car one, two, or five years later, its

value would be less than the original purchase price. This recognition is known as depreciation,

which is a noncash expense that specifically recognizes that assets decline in value over time.

Accumulated depreciation is a running total of all depreciation on assets. Depreciation is also

found on the income statement. Its presence in that financial statement enables a business to

reduce its taxable income. There are many methods by which you can compute the depreciation

value on fixed assets. These methods can be split into two broad categories: straight-line

depreciation and accelerated depreciation. Straight-line depreciation is fairly easy to illustrate.