Inventory refers to goods bought by a trading business to sell to its customers. They are classified as current assets, and whether an item is inventory or a non-current asset depends on how the business uses it — not on what the item is.
Businesses use a perpetual inventory recording method to keep real-time records of inventory, balancing the risks of stock-outs (lost sales) against over-stocking (higher storage costs and obsolescence).
When choosing which inventory to buy, businesses weigh both accounting information (cost, storage cost) and non-accounting information (product features, storage requirements, customer preferences). In scenario-based questions on this topic, always state your decision first, then support it with evidence linked to financial impact — 2 points for G2, 3 points for G3. This SBQ format appears again in later chapters.
The cost of inventory purchased includes the purchase price plus all costs to bring goods in and get them ready for sale — such as transport, customs duties, and insurance in transit. Costs to send goods out to customers are excluded.
Cost of sales is determined using the FIFO method: the oldest inventory is assumed to be sold first. Each sale triggers two journal entries — one for cost (Dr Cost of sales / Cr Inventory) and one for revenue (Dr Trade receivables / Cr Sales revenue).
When the net realisable value of inventory falls below cost, the prudence theory requires the business to write the inventory down to NRV and record the difference as an Impairment loss on inventory (an expense). Failure to do so overstates both profit and current assets.
To interpret the Inventory account, read the particulars column on each entry — it names the other account, which tells you the real transaction (a purchase, a sale, a return, or an impairment loss) — rather than reading the debit/credit side alone.