Inventory-Cost Of Sales
What is Merchandise Inventory ?
Merchandise inventory refers to the goods or products that a company acquires and holds with the intention of selling them to customers. Merchandise inventory can consist of various types of products, such as clothing, electronics, furniture, or any other items that a company sells. Merchandise inventory is classified as an asset on the balance sheet until it is sold, at which point it becomes an expense on the income statement.
Importance of Merchandise Inventory
Maintaining an accurate record of merchandise inventory is crucial for businesses, as it helps in tracking the quantity and value of goods available for sale. This information is essential for financial reporting, determining the cost of goods sold, and evaluating the profitability of the business. Inventory management systems and procedures are used to monitor and control merchandise inventory levels, ensuring that the right amount of inventory is available to meet customer demand while minimizing carrying costs and the risk of obsolescence. Additionally, accurate tracking of merchandise inventory allows businesses to assess their financial health by providing insights into stock levels and turnover rates.
Types of Inventory Systems
- Perpetual Inventory Systems: This system continuously updates records with every purchase and sale, providing real-time stock levels.
- Periodic Inventory Systems: This system updates inventory values at fixed intervals (e.g., monthly or quarterly) and involve physical counts to determine ending inventory.
| Bookkeeping Entries for Periodic and Perpetual Inventory Methods | ||
| Transaction Type | Periodic | Perpetual |
| Purchase of Products | Debit Purchases Account Credit Cash/Accounts Payable | Debit Inventory Control Account Credit Cash/Accounts Payable |
| Sale of Products | Debit Cash/Accounts Receivable Credit Sales Credit Sales Tax Payable No Entry Made to Record Cost Of Goods Sold and Reduce Inventory Value | Debit Cash/Accounts Receivable Credit Sales Credit Sales Tax Payable Debit Cost Of Goods Sold Credit Inventory Control Account |
| Adjust Entries | Debit Inventory Account Credit Purchases Account Debit Cost Of Goods Sold Credit Inventory Account | No Adjusting Entries Needed To Record Cost Of Goods Sold and Adjust Ending Inventory |
Advantages & Disadvantages of Each Method
Perpetual
Advantages:
- Better Overall Control.
- Allows you to monitor your inventory levels and provides information for helping determine optimum inventory levels and ordering requirements.
- You know what you have on hand at all times-better customer service.
- No need to estimate or count inventory when preparing financial statements.
- Helps prevent stock out conditions.
- Information is available for determining profit by customer and product lines.
Disadvantages:
- Detailed records required.
Periodic
Advantages:
- Simple to use.
- Less record keeping is required-but don't be fooled !
Disadvantages:
- Determining cost to assign to your ending inventory can be quite a hassle.
Purchase orders and invoices normally contain many different products and their associated unit costs. Determining what cost(s) to use for valuing ending inventory may require a substantial effort. - Less overall management control-theft, etc.
- Information is not available for determining optimal inventory levels.
- Stock outs may occur.
- Information is not readily available for determining profitable customers and product lines.
- Information is not readily available for preparing financial statements.
As a general rule, the perpetual method should be used for high dollar value products such as jewelry, cars, boats, lawn mowers, mink coats, etc. . The periodic method is acceptable for low dollar value products and items where the cost of maintaining detail records is greater than the benefits derived. An example would be a hardware store's nuts, bolts, screws, and, nails.
Observation:In the ole manual record keeping days (I know some businesses still don't use a computer), I could probably present a better case for using the Periodic and not using the Perpetual Inventory Method. Now, however, when you can purchase a computer and the necessary software for less than $1000 its difficult (except for the smallest businesses) for me to make that case.
Inventory Costing Methods
There are several types of inventory costing systems that businesses can use to determine the value of their inventory. Here are three common types:
- First-In, First-Out (FIFO): This method assumes that the first items purchased or produced are the first ones sold. Under FIFO, the cost of the oldest inventory is assigned to the cost of goods sold, while the cost of the most recent inventory is assigned to ending inventory.
- Last-In, First-Out (LIFO): This method assumes that the most recent items purchased or produced are the first ones sold. Under LIFO, the cost of the most recent inventory is assigned to the cost of goods sold, while the cost of the oldest inventory is assigned to ending inventory.
- Weighted Average Cost: This method calculates the average cost of all units of inventory available for sale during a specific period. The average cost is then used to assign the cost of goods sold and the cost of ending inventory.
It's important to note that the choice of inventory costing method can have a significant impact on a company's financial statements, such as the cost of goods sold, gross profit, and inventory valuation. The selection of the most appropriate costing method depends on various factors, including industry practices, tax regulations, and management's objectives.
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