Inventory as an Asset - dummies

Inventory as an Asset

By John A. Tracy

For businesses that sell products, inventory is typically a major asset. It’s also typically the most problematic asset from both the management and accounting points of view.

First off, the manager should understand the accounting method being used to determine the cost of inventory and the cost of goods sold expense. In particular, the manager should have a good feel regarding whether the accounting method results in conservative or liberal profit measures.

Managers should ask these questions regarding inventory:

  • How long, on average, do products remain in storage before they are sold? The manager should receive a turnover analysis of inventory that clearly exposes the holding periods of products.

    Slow-moving products cause nothing but problems. The manager should ferret out products that have been held in inventory too long. The cost of these sluggish products may have to be written down or written off, and the manager has to authorize these accounting entries. The manager should review the sales demand for slow-moving products, of course.

  • If the business uses the LIFO method (last-in, first-out), was there a LIFO liquidation gain during the period that caused an artificial and one-time boost in profit for the year?

The manager should also request these reports:

  • Inventory reports that include side-by-side comparison of the costs and the sales prices of products (or at least the major products sold by the business). It’s helpful to include the mark-up percent for each product, which allows the manager to focus on mark-up percent differences from product to product.

  • Regular reports summarizing major product cost changes during the period, and forecasts of near-term changes. It may be useful to report the current replacement cost of inventory assuming it’s feasible to determine this amount.