Unpacking Inventory Accounting for the U.S. FAR CPA Exam

Written By Kyle Ashcraft

Inventory is one of the most crucial aspects of a business, affecting everything from profitability to liquidity. For CPA candidates preparing for the Financial Accounting and Reporting (FAR) section, a thorough understanding of inventory accounting under U.S. Generally Accepted Accounting Principles (U.S. GAAP) is vital. This article aims to demystify the key concepts and accounting treatments concerning inventory, complete with journal entries and examples at a college-level understanding.

Definitions

Inventory

Inventory consists of tangible property held for sale in the ordinary course of business, in the production process, or to be used in the manufacturing of goods. Inventory categories often include raw materials, work-in-process, and finished goods.

Inventory Accounting Methods

U.S. GAAP allows several inventory valuation methods, including:

1. First-In, First-Out (FIFO)

2. Last-In, First-Out (LIFO)

3. Average Cost Method

Recognition and Measurement

Under U.S. GAAP, inventory should be initially measured at cost. This cost includes all expenditures directly attributable to bringing the inventory to its current condition and Location.

Example 1: Journal Entry for Inventory Purchase

Let’s say a business buys $10,000 worth of raw materials. The journal entry would be:

  • Debit Inventory $10,000

  • Credit Accounts Payable $10,000

Example 2: Journal Entry for Inventory Sold

If the company sells inventory that cost $4,000 for $7,000, the journal entries would be:

  • Debit Accounts Receivable $7,000

  • Credit Sales Revenue $7,000

  • Debit Cost of Goods Sold (COGS) $4,000

  • Credit Inventory $4,000

Example 3: Journal Entry under FIFO Method

If the company started with an opening inventory of $2,000 and purchased another inventory for $3,000, under the FIFO method, the first inventory to be sold would be from the opening stock. If goods worth $4,000 were sold, then:

  • Debit COGS $4,000

  • Credit Inventory $4,000

Here, $2,000 worth of opening inventory and $2,000 of newly purchased inventory would be accounted for in COGS.

Example 4: Journal Entry under LIFO Method

Using the same figures as above, under the LIFO method, the last inventory to be bought is the first to be sold. The COGS would include $3,000 of the new inventory and $1,000 from the opening stock:

  • Debit COGS $4,000

  • Credit Inventory $4,000

Disclosures

Companies need to disclose their inventory accounting policies, methods of valuation, and any writedowns. This is essential for investors and financial analysts to accurately evaluate a

company’s financial standing.

Kyle Ashcraft
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