Accounting Standards Codification 330 (ASC 330) was released to address the more specific topic of inventory which a company sells in the normal course of business.
Inventory Effects the Income Statement and Balance Sheet
Inventory is significant to the financials of a company because if effects both the income statement of a company, through cost of goods sold, and the balance sheet of a company, in which it sits as a current asset. Cost of goods sold is an important measure due to it factoring into the gross margin of a company and thus being able to impact perceived profitability of the businesses core activities. One company may appear to be better managed than another due to having a better gross margin than its competitor. Furthermore, having a higher amount of inventory in current assets can increase the liquidity of a company and be a sign that either the company is building inventories in anticipation of increased demand or be a signal that the company is performing poorly and having trouble selling inventories (which could result in inventory needing to be written down due to obsolescence).
Characteristics of Inventory, the effect of Accounting
Inventory is one type of transaction that is characterized by typically having very high volume and therefore has an increased risk of misstatement from this standpoint. This risk is often mitigated by having periodic inventory counts to ensure that the inventory levels are appropriately stated and if any misstatements have occurred including theft or damaged goods, they would be detected during this process. However, certain activities can make the accounting for inventory tricky, such as those goods that are in transit, those goods that are consigned, and bill and hold arrangements; these situations are those concerned with the ownership of product and can have a significant impact on the financials of a company. There have been various accounting scandals surrounding inventories, as it can easily be manipulated and has caused this to become a focal area of accounting. For example, some companies have sent their inventories to customers and recorded them as sales, only to instruct the customer to return them shortly thereafter. While in the grand scheme of things this ends up washing out, it creates the illusion of false profits in one year that must be eaten in the next and therefore could create the perception that a company was more profitable than it truly was in the first accounting period only to result in disappointment in the following accounting period.
Inventories are relevant to several industries in the businesses world, namely retailers, wholesalers, and manufacturing entities. Each of these is going to have a different focus on the types of accounting which are typically utilized. Whereas a retailer is typically concerned with the purchase and resale of goods, a manufacturer would be concerned with the creation of inventory and applying various items such as labor and overhead to these items. FASB ASC 330 provides guidance on the generally accepted methods utilized to account for inventory.
We have included the following inventory related articles below to expand on the subject of inventory accounting fundamentals.
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