Inventory recording, when applicable, is one of the types of accounting activities required by law under the FASB and regulated by Generally Accepted Accounting Principles or GAAP. Two kinds of companies must regularly take inventory: merchandizing companies that sell goods and manufacturing companies that make goods. No matter what kind of company, items recorded for inventory share two characteristics. First, the items are owned by the company recording the inventory. Second, the inventory items are ready for sale in the normal course of business activity. As long as the commodity is ready for sale (the way the company sells it), the product could be in any form, from raw material to finished or even refurbished good.

Counting and Costing

Count the inventory. How a company counts inventory is dependent on the type of good. Some products are individually counted, while other products are weighed or measured. The denomination used for counting is called the “unit.” For example, in a perfume inventory counted as individual bottles of perfume, each bottle would be unit. In a perfume inventory counted as raw liquid, a gallon might be the unit.

Determine the ownership of the goods. Products of questionable ownership include goods in transit and goods held by other parties. Depending on the circumstances, goods in transit become owned property either when the product leaves the destination it was sold from or when it arrives at the place of business. Goods held by other parities, called consigned goods, are usually property (and therefore inventory) of the owner, not the holder.

Apply the unit cost to the inventory quantities to determine the total cost of the inventory and the cost of sold goods.

Record the total inventory cost on the company balance sheet using one of three methods. The three generally accepted methods for inventory recording are: first-in, first-out; last-in, first-out and average cost. As each method is legally acceptable, it’s up to management and company accountants to decide which recording method is most appropriate.

First-In, First-Out Recording

Assume that the first goods to be bought are the first goods to be sold.

Record sold inventory as though the oldest goods were sold first.

Adjust historical cost, deprecation and other factors accordingly.

Last-In, Last-Out Recording

Assume that the last goods to be bought are the first goods to be sold. Use this type of recording in situations where the inventory is piles of raw material.

Record sold inventory as though the newest goods were sold first.

Adjust historical cost, deprecation and other factors accordingly.

Average Cost Recording

Assume that previously bought and recently bought inventories are similar.

When a new batch of goods is purchased, factor the cost of each batch into the overall inventory average.

When inventory is sold, subtract the unit average for each sold good form the inventory total.


In both first-in, first-out and last-in, first-out, the way the inventory is recorded is most often not the way it was actually sold. The system runs on assumptions, as it would be nearly impossible to determine the order in which each sold product was initially received.