Frequently Asked Question: Can Inventory Be a Current Asset?
By Indeed Editorial Team
Published May 14, 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
Inventory is a vital component in the operations of most companies. Tracking and reporting inventory is critical for understanding how it may affect your team or the company where you work. Understanding the different types of inventory can help you manage assets more effectively. In this article, we explain if inventory is a current asset and define it, discuss various types, and outline how businesses can manage and track their inventory efficiently.
Can inventory be a current asset?
One common question that many professionals may ask about this component is "Can inventory be a current asset?" Current assets are short-term resources you expect to use within a fiscal year or the next 12 months and are necessary for the daily operations of a business. Companies often consider inventory as a current asset because they keep inventories with the aim of transforming them into money through sales. A product can qualify as inventory if it's an item that the business uses or sells during its operations.
What is inventory?
Inventory is the total amount of products a company has that it can convert to cash via purchase by customers or clients. Finance professionals may also refer to inventory as stock, which typically includes any raw materials that the company can resell or convert into a product for sale.
For instance, a firm's inventory may contain separate pieces or components of products and commodities or comprise completed products before the sales and production teams market them for sale. You can also consider certain commodities, such as office supplies, as company inventory if the business requires them to conduct commercial activities. Any inventory that a company holds for longer than a fiscal year is no longer a current asset but now a fixed asset. Most businesses typically avoid holding any inventory for longer than a year to avoid it turning into a liability or incurring a loss.
Can inventory be a liability?
While companies typically consider inventory an asset, there are cases where it can turn into a liability. Liability is simply any burden or financial debt a business incurs. Inventory can become a liability to the company when it fails to sell within a fiscal year, and its storage and maintenance costs rise above the value of the goods themselves. When the inventory stays for an extended period in storage, it may occupy the space for new items. This situation may require the company to construct temporary storage facilities to accommodate their inventory of new and liable items.
Another scenario where inventory converts from an asset into a liability is where the value of the inventory depreciates. For example, a business that sells a particular model of computers or phones might release an updated version of that device. Typically, any stock of the current model immediately depreciates in value, and once the value falls below the storage and maintenance costs, the inventory is now a liability to the business.
Types of inventory
Companies often categorize inventories to more conveniently track expenses across the production process. By monitoring expenses at every phase of the production process, firms can ensure they're staying within budget and determine what parts of the process to optimize. Businesses may classify inventories into the following categories:
Companies that manufacture goods typically depend on raw materials and supplies to produce components, parts, or whole items. When estimating raw material costs, businesses often sum together the costs of all parts they presently have in stock but haven't yet used in production. Raw materials may include direct materials and indirect materials. Direct materials are the items applied directly to the final product, while indirect materials are those used during the manufacturing process but not in the final product.
Any product that's still in the production stages qualifies as work-in-progress inventory. This category typically includes raw materials still being developed, products still being processed or not yet packaged, and overhead costs. Businesses use work-in-progress inventory to determine the stock that's still in the development stage at the beginning and end of a fiscal year or accounting period.
Finished goods inventory includes all goods that have passed the production and development stages and are ready for sale. These products consist of raw materials that became works-in-progress and are finally complete. As with work-in-progress inventory, you can assess the value of finished goods inventory to determine when to produce more inventory, what stock sells well, and which goods you can replace. Calculating finished goods can be an efficient technique to ensure that a company maintains continuous stock and minimizes material waste.
Maintenance, repair, and operating supplies
All inventory that a business uses to maintain, repair, and operate any machinery or item qualifies as maintenance, repair, and operating supply (MRO) inventory. For instance, if you use gasoline to operate a motor, purchase machine oil to maintain production equipment, or utilize stationery to write documents in the office, you can categorize these goods as MRO inventory. Operating supplies may include any items used by businesses for day-to-day operations that affect inventory production.
This inventory type includes all items used to pack the finished products for storage, shipping, and delivery to customers. There are three categories of packaging materials inventory. The primary packaging is to protect the product itself from any damage and make it usable. Secondary packaging is the package of the finished goods that contains recognition information, such as labels. The last is tertiary packaging, which is when the company groups finished goods into a bulk package for transport or storage.
How do businesses manage inventory?
Inventory management involves all the methods companies use to track the goods and other inventory it has at a given period. Inventory management is essential because it can help businesses recognize when they're at storage capacity and when to restock, purchase, or limit purchasing of raw materials. As a result, it can also help firms save money and budget wisely. Below are three significant methods of inventory management:
The just-in-time (JIT) method can help ensure that only the exact amount of inventory needed at any particular time is the amount available in storage. By using this method effectively, the inventory is always the number of items the business needs, and when it's below that number, it's a sign that the business can replenish its goods. This method may help maximize resources and prevent inventory from turning into a liability, but because there's usually no extra inventory, the business may not be able to fulfill bulk or emergency orders.
Safety stock method
The safety stock method often ensures that a business has the necessary amount of inventory and a small surplus that acts as a safety or emergency stock. This additional stock is usually just enough to suit any unanticipated needs, such as emergency orders, but it's rarely too much to become a potential liability to the business. In a case where a company doesn't use its safety stock, it can easily supplement the next batch of inventory or the company can discard it with minor loss.
Economic order quantity method
According to the economic order quantity method, a business keeps only the minimum amount of necessary goods. As a result, the inventory is just enough to meet the current demand for the product without getting fully sold out. Any extra stock left after satisfying demand is typically not significant enough that it becomes a liability to the business.
How do businesses track inventory?
Companies can monitor and record inventory using either the perpetual or the periodic approach. Businesses that use a perpetual model typically depend on software solutions to track inventory sales, returns, and discounts. For instance, a firm can employ a point-of-sale (POS) system integrated with digital registers to document each time a client makes a purchase. This event records as a deduction in the inventory in the system and repeats every time clients perform transactions. In contrast, a periodic approach requires businesses to count their inventory at certain intervals across the year manually.
Businesses may track inventory in multiple financial records by documenting the maximum count and value of goods. For instance, the balance sheet often details the business's assets, which include inventories. When inventory sells, they record the revenue from the sale on the income statement. Companies commonly maintain separate accounts for each inventory type and make appropriate adjustments to these records when necessary.
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