INITIAL INVENTORY: WHAT IT CONSISTS OF, HOW TO CALCULATE IT, EXAMPLE - DUDAS - 2024

The initial inventory is recorded book value of the inventory of a company at the beginning of an accounting period, and the cost recorded in inventory at the end of the immediately preceding accounting period, which then moves to the beginning of the next accounting period.

Technically, it does not appear on the balance sheet, as the balance sheet is created from a specific date, which is usually the end of the accounting period, so the ending inventory balance is the one that appears on the balance sheet.

Source: pxhere.com

However, as just noted, the beginning inventory is the same as the ending inventory for the immediately preceding accounting period. Therefore, it appears on the balance sheet as ending inventory in the prior period.

Starting inventory is an important indicator of what a company will have to order for the next year. It can also be used to project the future costs of a company to increase its production. It also projects future revenues for its suppliers.

What does it consist of?

Opening inventory is all the products, services, or materials that a company has available for use or sale at the beginning of a new accounting period.

Starting inventory is an asset account and is classified as a current asset. This inventory is the same as the ending inventory of the previous accounting period.

If starting inventory is overestimated, the cost of merchandise sold will be overestimated and net income will be underestimated.

Applications

The primary use of opening inventory is to serve as a starting point for calculating the cost of merchandise sold for an accounting period.

A secondary use of starting inventory is to calculate average inventory. This is used in the denominator of a series of performance indicators. For example, in the inventory turnover formula, which measures the efficiency with which a company delivers its inventory and generates sales from it.

These metrics can use only the ending inventory figure, but using the beginning and ending inventory balances to generate the average inventory amount for an accounting period, there is a tendency to form a smoothing effect that outweighs an unusually high ending inventory value. or low.

Inventory management

Since inventory must be carried by the business at cost of capital, inventory management is one of the main drivers of success in inventory-intensive sectors such as retail stores or supermarkets.

Some companies evaluate managers based on changes in inventory levels.

To get an even more accurate picture of inventory management, analysts can view daily sales in proportion to inventory. This indicates the time it takes for a company to convert its inventory into sales.

Generally accepted accounting practices require that inventory be accounted for properly. For this a very particular set of inventory accounting standards is followed.

This limits the ability of companies to exaggerate profits, simply underestimating the value of inventory.

Inventory for the first time

When a business first receives inventory, it enters the initial cost of that inventory into the accounting system based on the shipment invoice. Sometimes invoices are shipped separately and only one receipt is included in the order.

If that's the case, the receipt of the goods still needs to be recorded, because the company incurs the cost from the day the goods are received.

The company must be sure that it will have the money to pay for the products when the invoice arrives and is due. Pending invoices should be tracked in the Accounts Payable account.

How to calculate it?

If the beginning inventory is greater than the ending inventory, it means that a greater value of products has been sold than that purchased during the period.

When the cost of ending inventory is greater than the cost of beginning inventory, it is because the company bought more than it sold.

Formula

Starting inventory serves as a starting point for calculating the cost of merchandise sold in an accounting period. The formula is as follows:

Cost of merchandise sold = Initial inventory + Purchases during the period - Ending inventory.

In this way, beginning inventory can be calculated using information from accounting records.

Beginning inventory = Ending inventory + Cost of merchandise sold - Purchases during the period.

From the accounting records, the cost of the merchandise sold during the period is first determined. This is the total cost of the products that have been sold during the accounting period.

The ending inventory balance and the amount of new inventory that has been purchased during the period are then on record. Then the ending inventory values ​​and the cost of the merchandise sold are added.

Finally, the amount of purchased inventory is subtracted from the previous result, resulting in the initial inventory.

Example

Initial inventory in units

Suppose company XYZ starts operations in the first year. It produces 5,000 units in the course of the year and sells 2,000 units.

The following year, the company will then have a starting inventory in units of 3,000 units for the next accounting period.

Initial inventory in value

The starting inventory value is calculated by taking the values ​​of the components of the formula, which are found in the accounting records.

Suppose that for company XYZ the cost of the merchandise sold during the following period was $ 5,000. The ending inventory balance for the period was $ 20,000 and a total of $ 3,000 in new inventory was purchased during the period.

The cost of the merchandise sold is taken from the accounting records. The ending inventory balance and the amount of new inventory purchased during the period are also taken from the records.

Applying the formula, the $ 20,000 of the ending inventory and the $ 5,000 of the cost of the merchandise sold are added, to obtain $ 25,000.

Then the amount of inventory that was purchased is subtracted from the previous result ($ 25,000). This results in the initial inventory.

In this example, $ 3,000 is subtracted from $ 25,000, resulting in $ 22,000 of starting inventory.

References

1. Investopedia (2018). Beginning Inventory. Taken from: investopedia.com.
2. Steven Bragg (2018). Beginning inventory. Accounting Tools. Taken from: accountingtools.com.
3. Investing Answers (2018). Beginning Inventory. Taken from: investinganswers.com.
4. Collins Dictionary (2018). Definition of 'beginning inventory'. Taken from: collinsdictionary.com.
5. Bryan Keythman (2018). How to Calculate the Beginning Inventory in Accounting. Small Business - Chron. Taken from: smallbusiness.chron.com