Accountants' Handbook Volume One: Financial Accounting and General Topics, Eleventh Edition

Chapter 20. INVENTORY

Richard R. Jones, CPA

Ernst & Young LLP

Gary L. Smith, CPA

Ernst & Young LLP

OVERVIEW

Accounting for inventory has been guided more by practice than by pronouncement. As advances in manufacturing processes have occurred, accounting practices have evolved to identify the applicable costs to be allocated to inventory. Authoritative accounting literature related to inventory accounting and financial reporting is not extensive. The accounting profession has made it clear that examining individual facts and circumstances is important when valuing inventory and applying the established standards.

Historical cost is the normal starting point to record inventory as an asset. In determining inventory cost, a cost flow assumption must be selected. Alternate valuation methods that are exceptions to the historical cost convention are used for certain specialized types of inventory (e.g., sales price less cost of disposal for precious metals, and net realizable value for trade-in inventory). The write-down of inventory to amounts below cost may be necessary due to factors such as damage or changing market conditions.

This chapter addresses inventory costing in greater detail by identifying the pertinent guidance in the authoritative accounting literature and by citing examples that illustrate the practical application of the fundamental principles. The chapter also explains the various types of inventory and practical ways to determine inventory quantities. Finally, the chapter ...