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Definition of 'Inventory'

Inventory is defined as work-in-process goods, raw materials, and completely finished goods that are taken as a portion of a business's assets that is ready or will be ready for sale any time. Inventory presents one of the highly significant assets that most businesses have, because the earnings generated from inventory represents one of the chief source of revenue generation and consequently increases earnings for the company's shareholders/owners.

Inventory management forecasts and strategies, such as a just-in-time inventory system, can help reduce inventory costs because goods are created or received as inventory only when needed.

Introduction to inventory cost flow methods

Earlier when we talked about inventory, we already assumed that inventory costs did not change. On the other hand, in actual inventory purchase prices change and consequently in varying inventory costs. That is why there is a question of which cost to assign to the cost of goods sold and the finale inventory at period end.

Majorly there are four inventory cost flow methods. These four methods are stated below:

1.      Specific identification method

2.      Weighted-average method

3.      First-in, first-out (FIFO) method

4.      Last-in, first-out (LIFO) method

Specific identification cost flow method

Companies which are producing or trading easily identifiable inventories use the specific identification method. For Example: Cars, airplanes and ships etc. Each item of inventory is marked or coded with "specific" unit cost. This technique allows costing of inventory on the basis of its actual physical flow.

This method is very hard to apply by companies that have huge inventory volumes with low unit costs. For example, it will be tough for a grocery store to keep a track record of all soup cans taken at different costs. Therefore, entities like grocery stores and similar do not apply this method of inventory cost flow.