Ending inventory is the amount of inventory a company has in stock at the end of its fiscal year. It is closely related to the ending cost of inventory, which is the amount of money that was spent to get these products in stock.
Ending inventory is the cost of items available in inventory at the end of a financial reporting period. The aggregate cost of this inventory is used to generate a company's cost of merchandise sold.
The tendency for an ending inventory balance to increase over time may indicate that inventory is becoming obsolete, as this quantity should remain roughly equal to its proportion to sales.
Ending inventory is recorded at its acquisition cost. However, if the market value of inventory items is found to have decreased, it should be recorded at the lower of their acquisition cost and market value.
This makes ending inventory the value of products available for sale at the end of an accounting period.
What does it consist of?
Inventory types
The ending inventory is made up of three different types of inventory, which are the following:
Raw Materials
This is the material used to make the finished products, which has not yet been transformed.
Products in process
They are the raw materials that are already in the production process, transforming them into finished products.
Finished products
This is the merchandise already completely finished, ready for sale and delivery to customers.
The most important factor affecting ending inventory value is the inventory valuation method that a business chooses.
The customer could get discounts for purchases, or pay fees for express deliveries. Also, when the economy experiences inflation, prices tend to go up across the board.
All of this modifies the price of each individual unit of inventory. The company then chooses an inventory valuation method to account for these changing costs.
During a period of rising prices or inflationary pressures, FIFO (first in, first out) generates a higher ending inventory valuation than LIFO (last in, first out).
Importance of ending inventory
Many companies perform a physical inventory count at the end of the fiscal year to verify that the inventory they actually have on hand represents what appears on their automated systems. A physical inventory count leads to a more accurate inventory valuation.
For manufacturers, this ending inventory amount is crucial in determining whether it is on budget or if there are production inefficiencies that need to be investigated.
Also, since the next report period begins with an opening balance, which is the ending period balance of the previous report, it is crucial that the correct ending balance is reported in the financial statement to ensure the accuracy of the future report.
Auditors often require this verification. If the count is very different, there may be some leakage problem or other problems. If the ending inventory balance is underestimated, the net income for the same period will also be underestimated.
How to calculate it?
First method
There are several ways to calculate the cost of ending inventory for a business. The first method is to physically count the quantity of each of the items in inventory and then multiply those quantities by the actual unit cost of each item.
The actual unit costs must be consistent with the cost flow (FIFO, LIFO, weighted average, etc.) assumed by the company.
Special attention is required for items that are on consignment or in transit. Taking physical counts can be time consuming and complicated if inventory items are moving between different operations.
As a consequence, large companies are likely to physically count inventory items only at the end of the accounting year.
Second method
A second method that can be used for interim financial statements is to calculate ending inventory using existing quantities in the company's inventory system.
These amounts are multiplied by the actual unit costs reflected in the flow of costs assumed by the company.
Throughout the year, the quantities in the inventory system must be adjusted, according to any physical count carried out. Some companies will physically count a different group of inventory items each month and compare those counts to the quantities in the system.
Basic level
At its most basic level, ending inventory can be calculated by adding new purchases to starting inventory and then subtracting costs from merchandise sold.
Under the periodic system, the cost of merchandise sold is derived as follows: Cost of merchandise sold = Beginning inventory + Purchases - Ending inventory.
Example
Ending inventory formula
The formula for ending inventory is beginning inventory plus purchases, minus cost of goods sold.
Suppose a company started the month with $ 50,000 in inventory. During the month, he bought $ 4,000 more of inventory from vendors and sold $ 25,000 in finished goods.
End of month inventory = $ 50,000 + $ 4,000 - $ 25,000 = $ 29,000.
Ending inventory under FIFO
Under the "first in, first out" FIFO method, the company assumes that the oldest inventory is the first inventory sold.
In a time of price increases, this means that the ending inventory will be higher. Suppose a company purchased 1 unit of inventory for $ 20. Later, he bought 1 unit of inventory for $ 30.
If you now sell 1 unit of inventory under FIFO, assume you sold the inventory for $ 20. This means that the cost of the merchandise sold is only $ 20, while the remaining inventory is valued at $ 30.
Ending inventory under LIFO
As an alternative to FIFO, a company can use "last in, first out" LIFO. The assumption under LIFO is that the most recently added inventory is the inventory that is sold first.
Unlike FIFO, choosing LIFO will create lower ending inventory during a period of price increases.
Taking the information from the example above, a company using LIFO would have $ 30 as the cost of merchandise sold and $ 20 in remaining inventory.
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