Ending inventory is the cost of those goods on hand at the end of a reporting period. The aggregate cost of this inventory is used to derive the cost of goods sold of a business that uses the periodic inventory system. Under the periodic system, the cost of goods sold is derived as follows:
Cost of goods sold = Beginning inventory + Purchases - Ending inventory
Ending inventory is comprised of three types of inventory, which are:
- Raw materials. This is the materials used to construct completed goods, which have not yet been transformed.
- Work-in-process. This is raw materials that are in the process of being transformed into finished goods.
- Finished goods. This is fully complete goods, ready for sale. A variation where goods are purchased in final form from manufacturers and then resold is called merchandise.
Ending inventory is recorded at its acquisition cost. In addition, if it is found that the market value of inventory items has declined, they are to be recorded at the lower of their cost or market value. The risk of such a write down increases if inventory is held for a long period of time, or if market prices are volatile.
A trend of ending inventory balances that are increasing over time can indicate that some inventory is becoming obsolete, since the amount should remain about the same as a proportion of sales.