Merchandise inventory has a profound impact on the financial health of the business. This is because merchandise inventory is included in calculating the cost of goods sold which is an essential metric for measuring the business's profitability. Moreover, the merchandise inventory turnover rate determines the ability of a company to sell its products. The value of merchandise inventory is a crucial component of the balance sheet of any business enterprise.
Meaning Of Merchandise Inventory
First of all, the question is, what is merchandise inventory? Merchandise inventory includes all the goods that have been purchased from a manufacturer or supplier by a distributor or retailer to sell those goods to a third party. Merchandise inventory means those goods which are ready for sale. Irrespective of whether the goods are in the warehouse or distribution center or even in transit, finished goods intended for selling to a third party come under merchandise inventory.
You must include the value of merchandise inventory in the balance sheet at the end of the fiscal year or accounting period.
Inclusions In Merchandise Inventory
As mentioned above, merchandise inventory includes goods acquired from manufacturers or suppliers to sell to a third party. However, there is often confusion regarding the types of goods that come under merchandise inventory.
Finished goods produced by a manufacturer do not come under merchandise inventory for the manufacturer because the manufacturer is not acquiring the goods for sale. However, the finished goods become merchandise inventory for the retailer or distributor because the latter entities receive the finished goods from the manufacturer to sell them to third parties.
Goods sold by distributors to manufacturers can be categorized under merchandise inventory.
For example, a distributor sells semiconductor chips to a smartphone manufacturer. Even though the smartphone manufacturer would use the semiconductor chips in making smartphones, since the distributor had acquired the semiconductor chips for selling, they are merchandise inventory for the distributor.
The goods used by the business company itself cannot be categorized as merchandise inventory. For example, a computer retailer purchases computers from a manufacturer or supplier and buys tables and chairs to be used by the staff. The tables and chairs are office equipment, while the computers are merchandise inventory because they will be sold to end-users.
How Is Merchandise Inventory Included In The Balance Sheet?
There are two types of assets to be included in the balance sheet: current and noncurrent assets. Existing assets are expected to be converted into liquidity or cash within the financial year or accounting period. Non-current assets include long-term investments, intellectual property, technical know-how, and equipment.
So is merchandise inventory an asset? The answer is yes. Merchandise inventory is a current asset on the balance sheet because it is likely to be converted into cash within a year of being acquired. Merchandise inventory can be the single largest asset on the balance sheets of many businesses.
The cost of merchandise inventory sold during the fiscal year or accounting period is included in the price of goods sold in the income statement as an expenditure. However, the cost of any merchandise inventory not sold during the accounting cycle is recorded as a current asset on the balance sheet until it is sold.
A merchandise inventory account is a holding account because the inventory stays in the merchandise inventory account till it is sold and transfers to an expense account when it is sold.
The value of the merchandise inventory is not independent of its market value. In case the market value of the merchandise inventory reduces below its recorded value, then the recorded value must be decreased to the market value. The difference is added to expenses.
Calculating Merchandise Inventory
To calculate the merchandise inventory, the business company needs to know the values of its beginning inventory, stock purchased, and cost of goods sold or COGS. The formula to calculate merchandise inventory is (Beginning Inventory + Purchased Inventory) – COGS. The formula for calculating beginning inventory is (Ending Inventory + COGS) – Inventory Purchased.
For example, a company sells watches for $30 each. At the end of the previous accounting period, it had 200 unsold watches. The next accounting period sold 300 watches and purchased 150 watches. So as per the formula, the beginning inventory is ($6000 + $9000) - $4500= $10,500
Thus, the company's merchandise inventory is ($10,500 +$4500) - $9000, which equals $6000. This means the value of stock ready to be sold by the company is $6000. This is also the ending inventory of the company.
Tracking Merchandise Inventory
When calculating the value of merchandise inventory, the accountant cannot discriminate between merchandise inventory based on locations. Thus, the following must be accounted for when calculating merchandise inventory:
- Merchandise inventory in transit from a seller
- Merchandise inventory in consignments in the hands of third parties
- Merchandise inventory in the company's warehouses must be accounted for when calculating merchandise inventory.
A company can opt for either a perpetual or periodic inventory system for merchandising inventory.
Perpetual inventory system tracks the merchandise inventory in real-time. The quantity and value of merchandise inventory are updated constantly based on the addition or removal of stock. This is a highly accurate system of tracking and recording merchandise inventory. Automatic inventory software is required to implement a perpetual inventory system because physically verifying the list all the time is tough. This system is beneficial for businesses having large volumes of stocks.
A periodic inventory system does not track the merchandise inventory in real-time. Instead, the quantity and value of merchandise inventory are recorded after specific intervals or periods. The results of two periodic assessments are compared to determine any change in the merchandise inventory. This system is not accurate and prone to human errors. COGS and other inventory metrics are also not tracked in real-time. This system is used by companies having low volumes of orders and stocks. Companies selling so large volumes of low-cost products that perpetual tracking is impossible also resort to the periodic system.
Merchandise inventory is one of the most crucial factors in determining the success or failure of a business. That's why it's important for any company to know how to properly manage their merchandise inventory, which includes knowing what types are appropriate. If you're looking for help with your merchandising needs, Conveyr offers warehouse management services that will take care of everything from stocking shelves to fulfilling orders. Let us give you an overview on our service and see if we can't work together!