Definition: Inventory consists of the goods that a company legally owns and expects to sell for a profit in the course of normal operations. In other words, it’s the products the company owns and intends to sell.
There are three important parts of this definition that are often over looked. First, inventory is something that is legally owned by the company. This means that in order to call it merchandise inventory the company must have ownership of it. Consignments are not considered inventory to the consignee because another company owns them. Even though the consignor doesn’t have possession of the consignments, it still owns them.
Second, the products have to be for sale. This one might sound obvious, but goods that a company plans on keeping are not considered merchandise. For example, a real estate broker who purchases a piece of land and intends to hold on to it for several years until the property increases in value would not count the piece of land as inventory. It would be considered an investment because it’s not for sale and is being held with the hopes of receiving a return.
Third, inventory is sold in the course of normal business. This means the company actually has to be in the business of selling this product. For example, a car dealership is in the process of selling cars, so it lists it’s fleet of cars on the balance sheet as an inventory asset. This same dealership might also be selling one of its car lot buildings and garages too. These are not considered merchandise because the car dealership isn’t in the business of selling buildings and land. It’s in the business of selling cars.
What Does Inventory Mean?
This asset is reported on the balance sheet as a current asset because it’s expected to be sold within the next accounting period. It is typically listed after cash and accounts receivable.