By ALICIA TUOVILA Updated Dec 9, 2019
What Is Ending Inventory?
Ending inventory is the value of goods still available for sale and held by a company at the end of an accounting period. The dollar amount of ending inventory can be calculated using multiple valuation methods. Although the physical number of units in ending inventory is the same under any method, the dollar value of ending inventory is affected by the inventory valuation method chosen by management.
- Ending inventory is an important component in the calculation of cost of goods sold.
- The method chosen to assign a dollar value to inventory and COGS impacts values on both the income statement and balance sheet.
- There are three common valuation methods for inventory: FIFO (first in, first out), LIFO (last in, first out), and weighted-average cost.
Understanding Ending Inventory
At its most basic level, ending inventory can be calculated by adding new purchases to beginning inventory, then subtracting the cost of goods sold (COGS). A physical count of inventory can lead to more accurate ending inventory. But for larger businesses, this is often unpractical. Advancements in inventory management software, RFID systems, and other technologies leveraging connected devices and platforms can ease the inventory count challenge.
Ending inventory is a notable asset on the balance sheet. It is essential to report ending inventory accurately, especially when obtaining financing. Financial institutions typically require that specific financial ratios such as debt-to-assets or debt-to-earnings ratios be maintained by the date of audited financials as part of a debt covenant. For inventory rich businesses such as retail and manufacturing, audited financial statements are closely monitored by investors and creditors.
Inventory may also need to be written down for various reasons including theft, market value decreases, and general obsolescence in addition to calculating ending inventory under typical business conditions. Inventory market value may decrease if there is a large dip in consumer demand for the product. Similarly, obsolescence may occur if a newer version of the same product is released while there are still items of the current version in inventory. This type of situation would be most common in the ever-changing technology industry.
Auditors may require that companies verify the actual amount of inventory they have in stock. Doing a count of physical inventory at the end of an accounting period is also an advantage, as it helps companies determine what is actually on hand compared to what’s recorded by their computer systems. Any discrepancy between a company’s actual ending inventory versus what’s listed in its automated system may be due to shrinkage—a loss of inventory for any number of reasons including theft, vendor or accounting errors, problems with delivery, or any other related issue.