Introduction to Merchandise Inventory (Financial Accounting Tutorial #28)
Why is it important to understand merchandising inventory?
Understanding the inventory merchandising process is essential for accountants and financial experts as it is essential for accurately calculating costs, assets, and overall profitability. Additionally, understanding a number of crucial financial terms associated with this process is necessary for correctly calculating merchandise inventory:
What is merchandising inventory?
The method retailers use to keep track of the goods they sell for a profit and the related account on a balance sheet is called “merchandising inventory.” Many businesses’ largest assets may be in their inventory of goods, and when retailers sell that inventory during an accounting period, they factor those costs into their cost of goods sold calculations. Retailers include remaining merchandise inventory as current assets if there is any left over at the end of the accounting period.
What type of account is merchandise inventory?
All purchased items that a retailer intends to resell are included in their merchandise inventory. Normally, these products are in transit from the merchandise suppliers, in storage facilities, on display in shops, or even on consignment in other places. A retailer counts merchandise inventory as a current asset because it contains tangible goods.
Any remaining inventory is listed as merchandise on hand, listed as an asset, and recorded as a debit to accounts payable when a business accountant prepares the balance sheet for the accounting period. When a retailer buys merchandise, they record the transaction as a credit to accounts payable and a debit to the inventory account.
Perpetual versus periodic inventory procedures
Retailers typically use either a perpetual inventory procedure or a periodic inventory procedure when they merchandise inventory. Both approaches ultimately lead to the same outcome, in which accountants compute costs of goods sold and current assets and report these accounts on the balance sheet. However, these two approaches use various accounting procedures.
Perpetual inventory procedure
Retailers who practice perpetual inventory merchandising regularly update information about the inventory they sell. Retailers frequently update their financial records to reflect changes in inventory, transactions made during the accounting period, records of returned goods, and recent sales and purchases. The perpetual inventory procedure, which tracks all aspects of merchandising inventory in real-time, is the most popular system for tracking inventory.
A retailer will typically make the following transactions to update inventory data during an accounting period:
Periodic inventory procedure
Retailers who use the periodic inventory method only adjust the ending inventory balance after a physical inventory count. Companies that track inventory periodically typically conduct physical inventory counts once every three months. Retailers must also list inventory purchases between inventory counts in a different account than they would for perpetual tracking when using periodic inventory tracking.
The retailer records these transactions in the purchases account when purchases are made between the physical inventory count of the retailer. The balance in the purchases account is transferred to the inventory account once they conduct the subsequent physical inventory count. After that, the retailer modifies this value to reflect the costs of their final inventory.
Example of calculating merchandise inventory
The examples below show how a retailer determines and records merchandise inventory to help you understand merchandising better:
Consider a business that sells cleaning supplies in bulk that is calculating its inventory of goods. The company accountant uses a number of factors from the balance sheet to determine the current value of the company’s inventory. The accountant uses the following financial information:
The accountant first determines the initial merchandise inventory using the following formula:
Beginning inventory = (Ending inventory + COGS) – purchased inventory
Assuming that each cleaning product costs $20, the business sells 14,000, buys 650, and has 500 products left over. Using the formula, the accountant calculates the beginning inventory as:
($10,000 + $280,000) – $13,000 = $277,000
Now that the beginning inventory value has been determined, the accountant can use the following formula to determine the merchandise inventory:
Cost of goods available for sale or initial inventory = merchandise inventory – COGS
Plugging the values into this formula, the accountant gets:
Merchandise inventory = ($277,000) – $13,000 = $264,000
The total merchandise inventory for the accounting period is $264,000. This information will help the accountant decide how to allocate additional resources, allocate funds for necessary supplies, and come up with new ways to increase the company’s revenue. Understanding the company’s inventory of goods is essential to calculating its profitability and financial health.
Furthermore, since businesses report this amount on their balance sheets, accountants commonly refer to merchandise inventory as the ending inventory balance. Companies can better set revenue goals and inventory KPIs by using this value, which informs them of the amount of ready-to-sell inventory they have.
What are the two types of merchandise inventory?
- Beginning inventory = (Ending inventory + COGS) – purchased inventory.
- ($10,000 + $280,000) – $13,000 = $277,000.
- Cost of goods available for sale or initial inventory = merchandise inventory – COGS
What is the difference between inventory and merchandise inventory?
The two methods for keeping track of inventory are periodic and permanent.
What type of asset is merchandise inventory?
The primary distinction between manufacturing inventory and merchandise inventory is that the manufacturing process for merchandise inventory has already been completed before it reaches the merchant or retailer while the manufacturing process is still ongoing for the latter.
Where do you put merchandise inventory?
Any asset that will generate income for or within a year is a current asset. Since supply and demand are typically closely correlated, inventory typically sells within a year of production. Therefore, inventory/merchandise is a current asset.