Definition of Inventory and Its Functions

Definition: Inventory consists of goods and materials that a company holds for sales purposes or use in production, including raw materials, work-in-progress, and finished goods. Inventory is considered a current asset on the balance sheet and represents an important financial investment for the company.

Functions:

Inventory serves multiple functions essential for successful commercial and industrial operations:

• Meeting Demand: Ensuring products are available when customers need them
• Seasonal Storage: Preparing for peak periods or fluctuations
• Production Continuity: Providing necessary materials without interruption
• Discount Benefits: Purchasing large quantities at better prices
• Inflation Protection: Buying before price increases
• Service Improvement: Reducing customer waiting times

Types of Inventory

Inventory varies in organizations based on business nature and production stage:

• Raw Materials: Basic materials used in manufacturing final products
• Work-in-Progress: Items in various production stages not yet completed
• Finished Goods: Items that have completed manufacturing and are ready for sale
• Operating Supplies: Supporting materials used in production without entering the final product
• Spare Parts: Replacement parts stored for maintenance and repair
• Seasonal Inventory: Held to meet peak periods
• Safety Stock: Reserve inventory to protect against stockouts

Accounting Treatment and Classification

Accounting Treatment: Inventory is treated accounting-wise by recording it at cost or market value, whichever is lower, according to the conservatism principle. It's valued using different methods based on business nature and accounting policy:

• First In, First Out (FIFO)
• Weighted Average
• Last In, First Out (LIFO)

Provisions are also calculated for damaged or slow-moving inventory to ensure fair valuation.

Classification in Financial Statements: In the balance sheet, inventory appears as a current asset within current assets. In the income statement, cost of goods sold appears within cost of sales as a basic expense. Supplementary notes include details of valuation methods used, applied accounting policies, and additional information about inventory composition.

Inventory Cost and Valuation

Cost Components: Inventory cost includes all direct costs for obtaining goods and making them ready for sale, such as purchase price, transportation and shipping costs, customs duties, insurance costs, and direct storage expenses.

Valuation Methods:

• First In, First Out (FIFO): Assumes goods purchased first are sold first
• Weighted Average: Calculates average cost of all available units
• Last In, First Out (LIFO): Assumes goods purchased last are sold first

Valuation Rule: The lower of cost or market principle is applied to ensure no overstatement of asset values.

Impact on Financial Statements: Choosing a valuation method affects cost of goods sold, net profit, and inventory value in the balance sheet. This impact is important for investors and management to make informed decisions and comply with accounting standards.

Inventory Management Steps

Inventory management is an integrated process requiring careful planning and systematic implementation to ensure required materials are available at the right quantity and time while minimizing costs and waste. It begins with forecasting needs and ends with distribution and delivery. Key steps include:

• Setting plans for future needs based on expected and seasonal sales
• Analyzing historical demand and identifying patterns and trends
• Purchasing supplies and raw materials from appropriate sources
• Negotiating with suppliers and managing commercial relationships
• Storing goods in suitable environments to ensure safety and quality
• Classifying and numbering materials for easy tracking and access
• Tracking movements and updates through data management systems
• Conducting periodic counts to match reality with records
• Supplying departments with required materials for operations and sales
• Continuously reviewing performance and improving processes

Inventory Control

Inventory control is a vital process aimed at tracking and monitoring inventory movement and quantities continuously to ensure accuracy and control levels. It includes collecting and analyzing data about available quantities, consumption rates, and daily movement of materials and products. It helps make purchasing and production decisions and avoid problems like stockouts or excessive material accumulation.

Control Methods:

• Perpetual Inventory: Real-time tracking of movement and changes
• Periodic Inventory: Comprehensive review at regular intervals
• ABC System: Focus on high-value and important items
• Reorder Point: Setting minimum threshold for inventory renewal
• Modern Technologies: ERP systems, barcodes, and RFID
• Performance Indicators: Turnover rate, record accuracy, and dead stock

Inventory Risks and Protection Methods

Inventory faces multiple risks that may lead to significant financial losses, including natural, human, and technical risks. Managing these risks is essential for protecting investment and ensuring operational continuity.

Main Risks:

• Theft and embezzlement by employees or outsiders
• Damage due to poor storage or expiration
• Fires and natural disasters
• Obsolescence and technical depreciation
• Price fluctuations and market losses

Protection Methods:

• Security Systems: Surveillance cameras and alarm devices
• Comprehensive Insurance: Against all risks
• Preventive Maintenance: And appropriate storage environment
• Quick Turnover: And date management
• Diversification: In suppliers and markets
• Internal Control: And separation of duties