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Definition of Inventory

Inventory Image 1


For companies: Raw materials, items available for sale or in the process of being made ready for
sale. They can be individually valued by several different means, including cost or current market value, and
collectively by FIFO, LIFO or other techniques. The lower value of alternatives is usually used to preclude
overstating earnings and assets.
For security firms: securities bought and held by a broker or dealer for resale.


Goods bought or manufactured for resale but as yet unsold, comprising raw materials, work-in-progress and finished goods.


Goods that a firm stores in anticipation of its later sale or use as an input.


The cost of the goods that a company has available for resale.


The cost of unsold goods that are held for sale in the ordinary course of business or
that will be used or consumed in the production of goods to be sold.


Those items included categorized as either raw materials, work-inprocess,
or finished goods, and involved in either the creation of products or service
supplies for customers.

Related Terms:

ABC inventory classification

A method for dividing inventory into classifications,
either by transaction volume or cost. Typically, category A includes that 20% of
inventory involving 60% of all costs or transactions, while category B includes
the next 20% of inventory involving 20% of all costs or transactions, and category
C includes the remaining 60% of inventory involving 20% of all costs or

Average-Cost Inventory Method

The inventory cost-flow assumption that assigns the average
cost of beginning inventory and inventory purchases during a period to cost of goods sold and
ending inventory.

Inventory Image 2

Average inventory

The beginning inventory for a period, plus the amount at the end of
the period, divided by two. It is most commonly used in situations in which just
using the period-end inventory yields highly variable results, due to constant and
large changes in the inventory level.

Blanket inventory lien

A secured loan that gives the lender a lien against all the borrower's inventories.

Book inventory

The amount of money invested in inventory, as per a company’s
accounting records. It is comprised of the beginning inventory balance, plus the
cost of any receipts, less the cost of sold or scrapped inventory. It may be significantly
different from the actual on-hand inventory, if the two are not periodically

Days' sales in inventory ratio

The average number of days' worth of sales that is held in inventory.

Distribution inventory

inventory intended for shipment to customers, usually
comprised of finished goods and service items.

dollar days (of inventory)

a measurement of the value of inventory for the time that inventory is held

Ending inventory

The dollar value or unit total of goods on hand at the end of an
accounting period.

Finished goods inventory

Goods that have been completed by the manufacturing
process, or purchased in a complete form, but which have not yet been sold to

Finished goods inventory

Completed inventory items ready for shipment to

Inventory Image 3

First-In, First-Out (FIFO) Inventory Method

The inventory cost-flow assumption that
assigns the earliest inventory acquisition costs to cost of goods sold. The most recent inventory
acquisition costs are assumed to remain in ending inventory.

Fluctuation inventory

Excess inventory kept on hand to provide a buffer against
forecasting errors.

Hedge inventory

Excess inventories kept on hand as a buffer against contingent

In-transit inventory

inventory currently situated between its shipment and delivery

Inactive inventory

Parts with no recent prior or forecasted usage.

Inventory adjustment

A transaction used to adjust the book balance of an inventory
record to the amount actually on hand.

Inventory Days

The number of days it would take to sell the ending balance in inventory at the
average rate of cost of goods sold per day. Calculated by dividing inventory by cost of goods sold
per day, which is cost of goods sold divided by 365.

Inventory diversion

The redirection of parts or finished goods away from their intended

Inventory issue

A transaction used to record the reduction in inventory from a location,
because of its release for processing or transfer to another location.

Inventory loan

A secured short-term loan to purchase inventory. The three basic forms are a blanket
inventory lien, a trust receipt, and field warehousing financing.

Inventory receipt

The arrival of an inventory delivery from a supplier or other
company location.

Inventory returns

inventory returned from a customer for any reason. This receipt
is handled differently from a standard inventory receipt, typically into an inspection
area, from which it may be returned to stock, reworked, or scrapped.

inventory shrinkage

A term describing the loss of products from inventory
due to shoplifting by customers, employee theft, damaged and
spoiled products that are thrown away, and errors in recording the purchase
and sale of products. A business should make a physical count and
inspection of its inventory to determine this loss.

Inventory Shrinkage

A shortfall between inventory based on actual physical counts and inventory
based on book records. This shortfall may be due to such factors as theft, breakage, loss, or
poor recordkeeping.

Inventory turnover

The ratio of annual sales to average inventory which measures the speed that inventory
is produced and sold. Low turnover is an unhealthy sign, indicating excess stocks and/or poor sales.


The number of times a company sold out and replaced its average stock of goods in a year. The formula is:
(Cost of goods sold) / (Average inventory (beginning inventory + ending)/2 )

Inventory turnover

The number of times per year that an entire inventory or a
subset thereof is used.

Inventory Turnover

Ratio of annual sales to inventory, which shows how many times the inventory of a firm is sold and replaced during an accounting period.

inventory turnover ratio

The cost-of-goods-sold expense for a given
period (usually one year) divided by the cost of inventories. The ratio
depends on how long products are held in stock on average before they
are sold. Managers should closely monitor this ratio.

Inventory Turnover Ratio

Provides a measure of how often a company's inventory is sold or
"turned over" during a period. It is calculated by dividing the sales
figure for the period by the book value of the inventory at the end of
the period.

inventory write-down

Refers to making an entry, usually at the close of a
period, to decrease the cost value of the inventories asset account in
order to recognize the lost value of products that cannot be sold at their
normal markups or will be sold below cost. A business compares the
recorded cost of products held in inventory against the sales value of the
products. Based on the lower-of-cost-or-market rule, an entry is made to
record the inventory write-down as an expense.

Just-in-time inventory systems

Systems that schedule materials/inventory to arrive exactly as they are
needed in the production process.

Last-In, First-Out (LIFO) Inventory Method

The inventory cost-flow assumption that assigns the most recent inventory acquisition costs to cost of goods sold. The earliest inventory
acquisition costs are assumed to remain in ending inventory.

Maximum inventory

An inventory item’s budgeted maximum inventory level,
comprising its preset safety stock level and planned lot size.


The value of the products that a retailing or wholesaling company intends to resell for a profit.
In a manufacturing business, inventories would include finished goods, goods in process, raw materials, and parts and components that will go into the end product.

Minimum inventory

An inventory item’s budgeted minimum inventory level.

Moving average inventory method

An inventory costing methodology that calls for the re-calculation of the average cost of all parts in stock after every purchase.
Therefore, the moving average is the cost of all units subsequent to the latest purchase,
divided by their total cost.

Net inventory

The current inventory balance, less allocated or reserved items.

Obsolete inventory

Parts not used in any current end product.

Periodic inventory

A physical inventory count taken on a repetitive basis.

Periodic inventory system

An inventory system in which the balance in the inventory account is adjusted for the units sold only at the end of the period.

Perpetual inventory

A system that continually tracks all additions to and deletions
from inventory, resulting in more accurate inventory records and a running total for
the cost of goods sold in each period.

Perpetual inventory

A manual or automated inventory tracking system in which
a new inventory balance is computed continuously whenever new transactions

Perpetual inventory system

An inventory system in which the balance in the inventory account is adjusted for the units sold each time a sale is made.

Physical inventory

A manual count of the on-hand inventory.

Raw materials inventory

The total cost of all component parts currently in stock that
have not yet been used in work-in-process or finished goods production.

Reconciling inventory

The process of comparing book to actual inventory balances,
and adjusting for the difference in the book records.

Seasonal inventory

Very high inventory levels built up in anticipation of large
seasonal sales.

Surplus inventory

Parts for which the on-hand quantity exceeds forecasted

vendor-managed inventory

a streamlined system of inventory
acquisition and management by which a supplier can
be empowered to monitor EDI inventory levels and provide
its customer company a proposed e-order and subsequent
shipment after electronic acceptance

Vendor-managed inventory

The direct management and ownership of selected
on-site inventory by suppliers.

Work-in-process inventory

inventory that has been partially converted through the
production process, but for which additional work must be completed before it can
be recorded as finished goods inventory.


A ratio that shows how well a company could pay its current debts using only its most liquid or “quick” assets. It’s a more pessimistic—but also realistic—measure of safety than the current ratio, because it ignores sluggish, hard-toliquidate current assets like inventory and notes receivable. Here’s the formula:
(Cash + Accounts receivable + Marketable securities) / (Current liabilities)

actual cost system

a valuation method that uses actual direct
material, direct labor, and overhead charges in determining
the cost of Work in Process inventory

applied overhead

the amount of overhead that has been assigned to Work in Process inventory as a result of productive activity; credits for this amount are to an overhead account

Back flush

The subsequent subtraction from inventory records of those parts used
to assemble a product, based on the number of finished goods produced.

backflush costing

a streamlined cost accounting method that speeds up, simplifies, and reduces accounting effort in an environment that minimizes inventory balances, requires
few allocations, uses standard costs, and has minimal variances
from standard

Bin transfer

A transaction to move inventory from one storage bin to another.

Blend off

The reintroduction of a faulty product into a process production flow by
adding it back in small increments.
1Copied with permission from Appendix B of Bragg, inventory Best Practices, John Wiley
& Sons, 2004.

carrying cost

the total variable cost of carrying one unit of
inventory in stock for one year; includes the opportunity
cost of the capital invested in inventory

Carrying cost

The cost of holding inventory, which can include insurance,
spoilage, rent, and other expenses.

Cash conversion cycle

The length of time between a firm's purchase of inventory and the receipt of cash
from accounts receivable.

Cash Flow Provided by Operating Activities

With some exceptions, the cash effects of transactions
that enter into the determination of net income, such as cash receipts from sales of goods
and services and cash payments to suppliers and employees for acquisitions of inventory and

Change in Accounting Estimate

A change in the implementation of an existing accounting
policy. A common example would be extending the useful life or changing the expected residual
value of a fixed asset. Another would be making any necessary adjustments to allowances for
uncollectible accounts, warranty obligations, and reserves for inventory obsolescense.

cost of goods manufactured (CGM)

the total cost of the
goods completed and transferred to Finished Goods inventory
during the period

Current asset

Typically the cash, accounts receivable, and inventory accounts on the
balance sheet, or any other assets that are expected to be liquidated within a short
time interval.

Current assets

Cash, things that will be converted into cash within a year (such as accounts receivable), and inventory.

Current assets

Amounts receivable by the business within a period of 12 months, including bank, debtors, inventory and prepayments.

Cycle counting

The frequent, scheduled counting of a subset of all inventories,
with the intent of spotting inventory record inaccuracies, investigating root
causes, and correcting those problems.

Days Statistics

Measures the number days' worth of sales in accounts receivable (accounts receivable
days) or days' worth of sales at cost in inventory (inventory days). Sharp increases in these measures
might indicate that the receivables are not collectible and that the inventory is not salable.

Departmental stocks

The informal and frequently unauthorized retention of excess inventory on the shop floor, which is used as buffer safety stock.

Earmarked material

inventory that has been physically marked as being for a
specific purpose.

economic order quantity

Order size that minimizes total inventory costs.

Economic order quantity (EOQ)

The order quantity that minimizes total inventory costs.

economic order quantity (EOQ)

an estimate of the number
of units per order that will be the least costly and provide
the optimal balance between the costs of ordering
and the costs of carrying inventory

economic production run (EPR)

an estimate of the number
of units to produce at one time that minimizes the total
costs of setting up production runs and carrying inventory

FIFO (First In, First Out)

An inventory valuation method that presumes that the first units received were the first ones

FIFO method (of process costing)

the method of cost assignment that computes an average cost per equivalent
unit of production for the current period; keeps beginning
inventory units and costs separate from current period production
and costs

Financial year

The accounting period adopted by a business for the production of its financial statements.
Finished goods inventory that is ready for sale, either having been purchased as such or the result of a conversion from raw materials through a manufacturing process.

First in, first-out costing method (FIFO)

A process costing methodology that assigns the earliest
cost of production and materials to those units being sold, while the latest costs
of production and materials are assigned to those units still retained in inventory.

First-In-First-Out (FIFO)

A method of valuing the cost of goods sold that uses the cost of the oldest item in
inventory first.

First-in, first-out (FIFO)

A method of accounting for inventory.

First-in, first-out (FIFO)

An inventory valuation method under which one assumes that the
first inventory item to be stored in a bin is the first one to be used, irrespective of
actual usage.

Fixed-location storage

An inventory storage technique under which permanent
locations are assigned to at least some inventory items.

Floor planning

Arrangement used to finance inventory. A finance company buys the inventory, which is then
held in trust by the user.

Floor stocks

Low-cost, high-usage inventory items stored near the shop floor,
which the production staff can use at will without a requisition and which are
expensed at the time of receipt, rather than being accounted for through a formal
inventory database.

idle time

the amount of time spent in storing inventory or
waiting at a production operation for processing

internal accounting controls

Refers to forms used and procedures
established by a business—beyond what would be required for the
record-keeping function of accounting—that are designed to prevent
errors and fraud. Two examples of internal controls are (1) requiring a
second signature by someone higher in the organization to approve a
transaction in excess of a certain dollar amount and (2) giving customers
printed receipts as proof of sale. Other examples of internal
control procedures are restricting entry and exit routes of employees,
requiring all employees to take their vacations and assigning another
person to do their jobs while they are away, surveillance cameras, surprise
counts of cash and inventory, and rotation of duties. Internal controls
should be cost-effective; the cost of a control should be less than
the potential loss that is prevented. The guiding principle for designing
internal accounting controls is to deter and detect errors and dishonesty.
The best internal controls in the world cannot prevent most fraud
by high-level managers who take advantage of their positions of trust
and authority.

Interplant transfer

The movement of inventory from one company location to
another, usually requiring a transfer transaction.

job order cost sheet

a source document that provides virtually
all the financial information about a particular job;
the set of all job order cost sheets for uncompleted jobs
composes the Work in Process inventory subsidiary ledger

just-in-time manufacturing system

a production system that attempts to acquire components and produce inventory only as needed, to minimize product defects, and to
reduce lead/setup times for acquisition and production

Last-In-First-Out (LIFO)

A method of valuing inventory that uses the cost of the most recent item in
inventory first.

Last-in, first-out (LIFO)

An inventory costing methodology that bases the recognized cost of
sales on the most recent costs incurred, while the cost of ending inventory is based
on the earliest costs incurred. The underlying reasoning for this costing system is
the assumption that goods are sold in the reverse order of their manufacture.







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