What it is:
How it works/Example:
Cost of Goods Sold:
Beginning Inventory: $7,000,000
Cost of Goods Available for Sale: $20,000,000
Less: Ending Inventory: $8,000,000
Cost of Goods Sold: $12,000,000
Gross Profit on Sales: $3,000,000
For manufacturers, ending inventory is comprised of three account balances instead of just one; materials inventory, work in process inventory, and finished goods inventory. Materials inventory ending balance is equal to its beginning balance plus the cost of materials purchased less the cost of materials used. Work in process ending inventory balance is equal to its beginning balance plus total manufacturing costs less the cost of goods manufactured. Finished goods inventory ending balance is equal to its beginning balance plus the cost of goods manufactured less the cost of goods sold. These three account balances combined comprise the total ending inventory for manufacturers.
Why it matters:
Many companies take a physical count of inventory at the end of a fiscal year to verify that the inventory they actually have on hand represents what is listed on their automated systems. Often, auditors require this verification. If the tally comes out vastly different, there may be an issue of shrinkage or other issues. If the ending inventory balance is understated then, correspondingly, the net income for the same period will also be understated.
In addition, since the later reporting periods start with the beginning balance from the previous reporting period’s ending balance, it is crucial that the correct and accurate ending balance be reported on the financial statement to ensure accuracy of future reports.
For manufacturers, this ending inventory number is crucial in determining if they stuck to their budget and if there are production inefficiencies that should be investigated.