Calculating Beginning Inventory: Formula, Lesson & Quiz
One of the most important assets, besides cash, a company must protect and control is inventory. In this lesson you'll learn how to calculate beginning inventory, the first step of accounting for inventory changes during an accounting period.
Definition of Beginning Inventory
Beginning inventory is the dollar value of all inventory held by an organization at the beginning of an accounting period. That inventory can be anything - whatever it is the company sells. If we are talking about a large electronics store, then the dollar value of TVs, computers, and whatever else they have can be considered inventory. For a grocery store, inventory is the total of the apples, cherries, peaches, and all other food.
Using Beginning Inventory
Each accounting period, managers and investors rely on financial statements to give them valuable information about the health and strength of the business. One of the considerations they are very interested in is any change in inventory levels.
Decreasing inventory may be an indicator that sales are accelerating, but it could also suggest issues with the supply chain. Increasing inventory could happen when companies are preparing for a busy season, but it could also mean the company is producing more than it is selling. Whatever the cause, changes in inventory levels are often an early indicator that something is changing in the business environment.
To calculate the change in inventory, there are four variables that must be known: ending inventory, additions to inventory, inventory sold/used, and beginning inventory.
Formula for Beginning Inventory
Technically speaking, beginning inventory should always be the same as the ending inventory from the previous accounting period. While this is true, there are two reasons that the formula for beginning inventory should not just be '= last period's ending inventory.'
First, there isn't always a 'last accounting period.' At some point, beginning inventory has to be calculated independent of the previous accounting period. Second, and more importantly, if ending inventory is miscalculated at some point, and then it is used as beginning inventory, the error won't be caught and if it is, it would be very difficult to identify why and when it happened.
The formula for calculating beginning inventory without considering the previous accounting period is shown below.
Okay, let's check this formula out. It's the end of the accounting period, and as the financial reporting manager you are responsible for calculating the inventory numbers for Fancy Freddie's Car Lot. Since you sell cars, the value of each car in your inventory is pretty accurate, and it's pretty easy to know what inventory you have. Right now, you have $1.2 million in inventory sitting on your lot
The first thing you have to do is add back in the inventory that left during the latest accounting period. When you pull up your inventory numbers - not sales number, since what you sold it for not be what you were valuing it for - you see that you had sold $600,000 in cars this last month.
But you didn't just sell cars - you brought some in as well. Some were trades, and some were from the manufacturer or auction. When you check your purchasing records, you see you brought in $200,000 in trades and $200,000 in new vehicles, for a total of $400,000 of new (at least new to you) inventory.
So, what was your beginning inventory? If you figured out $1.4 million, you are right! Using our numbers in the example and the formula, we get $1,200,000 + $600,000 - $400,000 = $1,400,000.
Each line of the financial statements is the result of an analysis or calculation that usually takes at least a calculator and some pretty good analytical skills. Inventory is certainly one that needs to be watched, and because it is so important, it's critical that the data is correct. When it is all said and done, having an accurate inventory report is key, and it's impossible to do that without a precise and correct figure for beginning inventory.
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