Merchandise Inventory Definition and Its Importance
Merchandise inventory is the total cost of goods on hand available for sale at any specific point in time. Keeping close track of merchandise inventory is essential for running an effective business operation since it allows the management to calculate the costs of goods sold in a given period for accounting purposes and manage supply chain better.
As pointed out in the definition of merchandise inventory, the concept refers to the overall cost of goods available for sale at a given moment. Merchandise inventory as a current asset has a normal debit balance, which means that debit will increase, and a credit will decrease. To be classified as a part of the merchandise inventory, an item needs to have two characteristics: it should be owned by the company and ready to be sold to the customer at a moment’s notice. As follows from the name, merchandise inventory as a concept is only applicable to merchandising companies that concentrate on reselling rather than producing goods.
Unlike manufacturing companies, which have to maintain multiple inventory classifications, such as finished goods, work in progress, or raw materials, merchandise inventory includes all types of different items ready for sale and unites them in a single inventory classification. This is also a reason why, all other things being equal, keeping an inventory for a merchandise company tends to be a simpler process than doing it for a manufacturing company. Merchandise inventory management is crucial for running an effective business operation, as it is an important component of effective accounting. In order to calculate the overall costs of goods sold in an accounting period, the company has to know the cost of goods ready for sale at the beginning and the ending of the period.
Calculating the overall cost of goods sold in a given period requires subtracting the costs of purchases and the ending inventory from the beginning inventory for this period – which is the ending inventory for the previous period. The beginning inventory and the ending inventory are both represented by the corresponding inventory accounts. Merchandise inventory account details the expenses incurred by the company while obtaining the goods for the following resell to the customers. The costs included in merchandise inventory are the cost of goods purchased, transit insurance, shipping and handling costs, and storage costs.
To keep track of the goods available for sale at a given time, companies use different merchandise inventory accounting systems. The first and most frequently used one is perpetual inventory control. In this system, the company keeps complete data on every item of merchandise and makes immediate corrections with each addition or subtraction. While being the most accurate way of inventory management, but requires extensive computerization and may prove too costly for smaller companies. Another approach to merchandise inventory is the less costly periodic inventory control based on the recounting of physical items at the company’s disposal.
The first and more thorough way to do it is the actual counting piece – a rigorous process of counting inventory item-by-item, usually with the help of salespeople. The second variety of periodic inventory control is referred to as looking over and based on visual estimations rather than piece-by-piece recounting. While periodic inventory control tends to be cheaper than the perpetual one, it is also less accurate and, as a result, a less reliable source of information for management decisions.