Merchandise Inventory is the most common form of inventory or the inventory that everyone knows. In simple words, it is the inventory that a company has in hand for sale at a given time.
Merchandise inventory is the finished goods that a distributor, wholesaler, or retailer acquires from the supplier, who may be a manufacturer. The objective of the distributor, wholesaler, or retailer is to sell the inventory.
Generally, the merchandise inventory is attributable to the distributor, wholesaler, or retailer. Manufacturers’ inventory is not the merchandise inventory because they don’t purchase but produce it. The finished goods stock of the manufacturers is called the finished goods inventory.
Merchandise Inventory vs. Finished Goods Inventory
Finished goods inventory is the stock of finished goods with the manufacturer. On the other hand, the merchandise inventory is the finished good that a distributor, wholesaler, or retailer gets from the supplier (or a manufacturer). A simple rule distinguishing merchandising and finished inventory is that the former includes products that are ready for sale.
There may be a case that a seller acquires the inventory that needs minor finishing to sell them. Such inventories would also come under merchandising inventory. For instance, retailers need to assemble bicycles to sell them. On the other hand, manufacturers need raw materials to make different bicycle parts and their finished products.
There could also be a case that a merchandising inventory of one company gets a different treatment by another company. For instance, Company A sells furniture, such as tables and chairs. For Company A, these will be merchandising inventory. Company B, which sells mobiles, buys chairs and tables from Company A. For Company B, the merchandising inventory of Company A will be office equipment. Though for Company B, they will still be a current asset, they wouldn’t come under inventory.
Accounting of Merchandise Inventory
Merchandise inventory is the current asset for a company, and it usually has a debit balance. Some businesses’ inventory could be the most significant asset on the balance sheet.
If a company can sell the inventory, the accountant charges the cost of the inventory to the COGS (cost of goods sold). This way, it becomes an expense and also appears in the income statement.
The amount of goods that a company is not able to sell in a period comes as a current asset in the balance sheet, i.e., as inventory. An accountant records them at the cost. They continue to appear on the balance sheet until a company sells them.
In case the market value of the merchandise inventory drops below the cost. Then the company needs to adjust by reducing the value of inventory to be at par with the market value. The difference between the market value and the cost is treated as an expense.
A point to note is that the merchandise inventory includes the entire inventory. It means the inventory in transit from suppliers, in the company’s storage, and in the storage facilities of third parties together constitute merchandising inventory. So, when calculating the total inventory with the company, an accountant must consider stock lying in all the above three locations.
Accounting for Distributors, Retailers, etc.
When a distributor, wholesaler, or retailer buys a product from a manufacturer, the purchase treatment is like an asset. The entry is to debit the inventory account and credit the cash or account payable if the purchase is on credit.
Now when the retailer sells the inventory or part of it, the cash account is debited, and the revenue account is credited. In this case, the amount is the actual money that a customer pays. Another entry happens involving the inventory account and COGS (cost of goods sold) amount. The amount is the cost of the goods that a company sells.
We can say that the merchandise inventory first comes into the inventory account. It then gets transferred to an expense account as and when the company sells them. Or, we can say the inventory account is the holding account, where the inventory waits for the customers.
To easily account for the inventory, a company could use the perpetual inventory system. Under this system, an accountant updates the inventory as and when it arrives. To get the average COGS at any time, we multiply the units that a company sells with the average COGS. Companies selling products that cost more, such as automobiles, go for a perpetual inventory system.
Another not-so-popular method is the periodic inventory system. Under this, an accountant takes stock of the inventory only at the end of the specific period. Companies selling low-value units, such as nuts, cards, and more, usually go for a periodic inventory system.
Merchandise Inventory and COGS
A company needs the merchandise inventory information to come up with the COGS for a period. It needs the following information to calculate the COGS:
- The cost of the goods in inventory at the beginning of the accounting period (Opening stock).
- The total cost of the purchases during that period.
- The cost of goods for closing inventory at the end of the accounting period (closing stock).
A company already has information on the opening inventory. The closing stock of the last year is the opening stock of the next year. The following information, i.e., the cost of purchases, include purchases, return, discount, allowances, transport cost, and more. Thus, the company only needs the value of the closing stock to calculate the COGS.
Merchandise Inventory, as you would have got by now, is the inventory of the goods with the distributor, wholesaler, or retailer. Like with any inventory, a company also needs to optimize this inventory. It means not storing too much and paying more in carrying costs and not storing too little to miss on potential revenue opportunities. A company must use an efficient inventory management system to forecast and keep track of its inventory.
Read Types of Inventory / Stock to learn more about other types.