Types of Inventory

Inventory means different things to different industries:

• If you are a retailer or wholesaler, you buy goods and resell them. Your inventory cost represents the goods you have bought for resale but have not yet sold.

• If you are a service business, most likely inventory will not be a consideration. However, some service industries, such as the legal and accounting industries, track the time that has been spent on client work but not yet billed as inventory.

• If you are a manufacturer, you will most likely have several categories of inventory (see the next section).

Year End Valuation

We won't spend much time on this issue, but it's important to know that accounting rules in most countries require you to review your inventory valuation at the end of the year and compare its cost to its current market value. If the market value (the value you expect to sell it for) is less than its cost, you are required to write down your inventory to that value. This valuation is called the lower of cost or market (LCM).

You may have inventory that's worth less than you paid for it for a number of reasons. You may still be carrying older models of some items when new models are now available. This might be the case if you sell computers or cars. Your inventory might have been damaged somehow, and you will have to sell it for less. A book­store might have this problem.

The purpose of this rule is to make sure that companies are not inflating their balance sheets with inventory that is not worth at least the cost on the balance sheet.