What is Ending Inventory?
Ending inventory is the value of goods available for sale at the end of an accounting period, for e.g. at the end of the quarter or financial year.
Importance of Determining Ending Inventory
Determining ending inventory is important for inventory management, and also to be able to accurately generate the financial statements of a retail business.
The P&L statement, for example, will calculate the gross margin of the business based on the cost of goods sold (COGS), which is calculated using ending inventory.
Ending inventory is also reported on the balance sheet as an asset, and based on that, several important financial ratios such as GMROI and Inventory Turnover are calculated using this figure.
Also, a retail business needs to calculate its buying budget (OTB) on a regular basis, in order to purchase the right amount of inventory needed to deliver forecasted sales
While calculating calculating open to buy, beginning and ending inventory figures are needed.
Beginning vs. Ending Inventory
The current period’s ending inventory is the next period’s beginning inventory.
For example, if the business closed May with a closing stock of $156,859, the beginning inventory or opening stock for June will be the $156,859 (see above pic.)
Ending Inventory Formula
Ending Inventory = Beginning Inventory + Purchases – Cost of Goods Sold (COGS)
For example, if the business had a beginning inventory of $131,080 at the beginning of May, and then during this month purchased products with the value of $33,244 and sold goods worth $7465, then the ending inventory will be $156,859
Ending Inventory = $131,080 + $33,244 – $7465 = $156,859
Lower of Cost or Market Rule
In general, ending inventory is recorded at the acquisition cost (i.e cost value). However, if the market value of the current inventory has been found to be lower than the acquisition cost, then it will be recorded at the realizable market value. The realizable market value is the market value of the inventory, less the selling costs associated with selling this merchandise.
This is based on the Lower of Cost or Market rule (LCM) under the GAAP framework.
This situation happens in retail due to aging inventory. At some point, the inventory carried in the business becomes too old, that its realistic selling price becomes lower than the cost price it has been bought at.
When this happens, the inventory value is written down, and the difference is expensed and included under COGS; i.e it reduces the gross margin of the business for that period.
Actual vs. Books
Retail businesses track inventory by recording all the received inventory when it enters the business, and then tracking its movements through transactions recorded on the system, where each transaction either adds or subtracts from this inventory level.
For example, when an item is sold or written off as damaged, it gets deducted from the inventory level on the system for that particular item. When an item is returned by a customer, it gets added back to the system and increases the level of stock for this item. So, hypothetically, the business should always have an accurate record of its inventory levels.
However; in reality, stock loss does happen in retail, due to different reasons, such as theft or administrative errors that result in changes in inventory not being recorded on the system.
When this happens, discrepancies start to show between what’s on the books and what is actually there at the stores and warehouses.
That’s why retailers need to conduct a physical inventory count (aka stock count or stocktake) on a regular basis, so that they can reconcile those discrepancies between the books and the actual, and report any resulting losses on their financial statements.
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