Change in inventory

What it means

The change in inventory of own production is an income statement line showing by how much the value of work in progress, semi-finished goods, finished goods and livestock rose or fell during the period. It is recorded in account group 61 within income.

Its purpose is to match costs and income. Production costs such as materials, wages and energy are booked in the period they arise. If goods produced have not yet been sold, the increase in inventory adds their production cost to income, so the result is not distorted by a loss that has not really occurred.

When goods from earlier periods are sold, inventory falls and the change appears as a negative amount. The sales revenue and the reduction in inventory offset each other, and profit shows only when the goods are sold.

How it works in practice

For manufacturing clients we book the change in inventory continuously under method A, or once per period under method B based on the stock-take. The key is valuing inventory correctly at production cost, as that determines the size of the change and the result.

When analysing results we always explain the change in inventory separately. Profit that arises only because stock has built up brings in no cash and may signal a sales problem. For management purposes we therefore also track cash flow.

We distinguish the change in inventory from capitalisation, by which own work used within the company, such as an asset built in-house, is recognised in income. Both are shown separately in the income statement.

What to watch out for

Overvalued self-produced inventory inflates the change in inventory and thus the current year’s result. If the goods later sell for less or prove unsaleable, the loss is pushed into the future. We therefore also check valuations against selling prices.

An inaccurate stock-take of work in progress, such as an unsupported estimate of the percentage complete, directly distorts the result. For large jobs we recommend documenting the stage of completion at the reporting date.