Ending inventory definition
/What is Ending Inventory?
Ending inventory is the cost of those goods on hand at the end of a reporting period. This amount must be included in your balance sheet as a current asset. In addition, 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
How to Calculate Ending Inventory
Ending inventory can be derived from an end-of-period physical inventory count, where counters verify the exact number of units on hand. This is a time-consuming process that is subject to error, so a better approach is a perpetual inventory system. Under the perpetual system, items are included in the inventory database when they arrive at the warehouse, and are subtracted from it when they leave the warehouse, thereby maintaining a continual accurate on-hand balance.
What is Included in Ending Inventory?
Ending inventory is comprised of three types of inventory. The first is raw materials, which is the materials used to construct completed goods, which have not yet been transformed. The second inventory type is work-in-process, which is raw materials that are in the process of being transformed into finished goods. The final type of inventory is finished goods, which is fully complete goods, ready for sale. A variation where goods are purchased in final form from manufacturers and then resold is called merchandise.
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How to Account for Ending Inventory
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. If inventory is found to have spoiled, then it is written off at once; this is a particular concern when food storage is involved, as is the case for a restaurant.
How to Interpret Ending Inventory
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. Conversely, a decreasing trend in the ending inventory balance can indicate that a firm’s production capacity cannot keep up with customer demand levels.
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