All businesses that sell a product or goods have inventory. Inventory is the raw materials, work-in-progress goods, and the company’s finished goods held for sale in the ordinary course of business. Depending on the company, the exact makeup of the inventory account will differ. For example, a manufacturing firm will carry a large amount of raw materials from which they produce their finished goods. For example a furniture manufacturer will have lumber and hardware in inventory awaiting its conversion to tables or desks. On the other hand, a retailer, like Home Depot or Lowe’s, will purchase finished goods ready for sale to the consumer and therefore their inventory will be comprised of finished goods—generally referred to as merchandise or merchandise inventory. Regardless of whether the inventory is held by a manufacturer or a re-seller, inventory amounts are reflected on the the Balance Sheet as an asset.

The figure below shows how inventories from a manufacturing firm would be reported on the Balance Sheet:

However, inventory does not just impact the Balance Sheet. Some costs associated with inventory are recognized as expenses and thus appear on the Income Statement. For a retailer, merchandise inventory includes all of the costs of expenditures necessary, directly or indirectly, to bring an item to the business to be sold to consumers. This means that the cost of an inventory item includes its invoice cost minus any discount for early or cash payment, plus any incidental costs. Incidental costs can include shipping, storage, and insurance. The matching principle states that inventory costs should be recorded as cost of goods sold in the period when inventory is sold. This is illustrated on the excerpt from the Income Statement shown below:

Because inventory impacts both the Balance Sheet and Income Statement properly accounting for inventory costs is a critical responsibiity of managers, bookkeepers and accountants.