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Inventory is the amount of goods available for sale carried on the balance sheet.

Expanded Definition

In the vernacular, so to speak, inventory are the gadgets and gizmos sitting on retail shelves or the food sitting in the freezers, fridges, and shelves of the back rooms and kitchen of a restaurant. Physical objects.

For accountants, it's slightly different. (Isn't it always?) And for investors, it's important to track because it is tied directly to the cost of goods sold expense line on the income statement, and thus is tied directly into net income.

Inventory on the balance sheet is the cumulative, unused cost for the items sitting on shelves and in freezers. The actual amount paid for the items actually sitting on the shelves is not what is carried on the balance sheet. The amount on the balance sheet depends on what accounting policy the company follows. This is tied into calculating cost of goods sold (COGS).

Under first-in, first-out (FIFO), the cost of the inventory purchased first is the cost that is used first in COGS. In a time of rising prices (which is usual, thanks to inflation), COGS is lower and inventory is higher, as the most expensive (last purchased) remain on the books at the end of the reporting period.

Under last-in, first-out (LIFO), the cost of the inventory purchased last is used first in COGS. This is the opposite of FIFO, so inventory is lower, but COGS is higher.

Inventory can also be tracked by actual cost, so COGS is the actual cost of the items sold. However, for large inventories, this is very cumbersome and impractical.

The inventory accounting policy is outlined in the footnotes to the financial statements. Replacement cost of the inventory is best determined under FIFO, while best amount for COGS is best determined using LIFO.

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