Is merchandise inventory debit or credit? Merchandise inventory is goods that have been purchased by a retailer, wholesaler, or distributor from suppliers, with the intention of selling the goods to third parties. For some types of businesses, merchandise inventory can be the single largest asset on the balance sheet.
When these goods are sold during an accounting period, their cost is charged to the cost of goods sold, and in the period when the sale occurred, their cost would appear as an expense in the income statement. However, if these goods are not sold during an accounting period, then their cost is recorded as a current asset in the balance sheet until the time they are sold.
As a current asset in the balance sheet, will merchandise inventory be a debit or credit? In this article, we will discuss merchandise inventory, debit, credit, and its correct journal entries.
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Merchandise inventory in accounting
Merchandise inventory includes all goods in stock (finished goods or raw materials) that have been purchased but not yet sold. This refers to goods that are ready to be sold, and are intended to be resold to customers. Merchandise inventory is named so because retailers, wholesalers, and distributors make money by buying goods from manufacturers or other suppliers and then merchandising the goods for customers. Merchandising involves marketing and selling products to customers.
Unsold inventory is categorized as a current asset on the balance sheet of a company. Current assets on a company’s balance sheet are assets that the company expects to sell or consume within a year. Merchandise inventory is therefore categorized as one because companies generally expect to sell inventory within a year through normal business operations.
The merchandise inventory value would include the price paid to suppliers plus associated costs, like transportation and insurance. Hence, merchandise inventory refers to any goods meant for resale, whether they are in the retailer’s hands, in transit from the supplier, or stored in a warehouse/distribution center ready to be sold. In accounting, a merchandise inventory account is thought of as a holding account for inventory that is expected to be sold soon.
Merchandise inventory account
Merchandise inventory includes a range of costs a retailer, wholesalers, or distributors incurs in the course of purchasing the products they intend to sell to customers. Hence, merchandise inventory would include the price paid for the goods, shipping costs paid by the resellers, and any other associated expenses, like transit insurance, and packaging. This means that the merchandise inventory account would include the cost of all goods the company has purchased, from items in warehouses and retail stores to goods that are still in transit from suppliers.
The merchandise inventory account has an impact on the company’s current assets, accounts payable, expenses, and profit accounts. These accounts are all important measures of the financial health of a business. Therefore, it is crucial to account for merchandise inventory accurately. Since merchandise inventory is represented as an asset on the company’s balance sheet, it doesn’t directly appear on the company’s income statement during a specific accounting period.
However, changes in the merchandise inventory account during each period are reflected as expenses on the income statement. This is so because, when merchandise inventory is sold, its cost is included in the cost of goods sold (COGS) expenses account on the income statement for that period.
In order to understand how the merchandise inventory account works; take, for instance, a retail store purchasing additional volumes of a product that is in short supply. The retailer will have to record the cost of the shipment in the merchandise inventory account, which is an asset account. This cost of shipment is not treated as an expense until the retailer sells the goods.
When these goods are sold, their cost is deducted from the merchandise inventory account and then added to the cost of goods sold (COGS) account for the period which is an expense account. This will directly affect the company’s gross profit for the period because a company’s gross profit is calculated by subtracting COGS from net sales.
In order to calculate the cost of goods sold, accountants must have accurate merchandise inventory figures. Accountants use two basic methods such as perpetual inventory procedure and periodic inventory procedure for determining the amount of merchandise inventory.
When discussing inventory, one needs to be sure whether we are referring to the physical goods on hand or the Merchandise Inventory account, which is the financial representation of the physical goods on hand. Hence, the difference between perpetual and periodic inventory procedures is the frequency with which the Merchandise Inventory account is updated to reflect the physical goods on hand.
The Merchandise Inventory account under the perpetual inventory procedure is continuously updated to reflect the physical goods on hand, whereas under the periodic method we wait until the end of the accounting period to count everything.
Calculating and tracking merchandise inventory
At the close of an accounting period, in order to calculate the ending merchandise inventory, a retailer must know the beginning merchandise inventory value, the total amount spent on additional merchandise inventory, and the cost of goods sold COGS (which is also known as the cost of sales).
The beginning merchandise inventory is the value of inventory at the beginning of the accounting period, before acquiring any more inventory items or selling any existing inventory. Hence, the beginning inventory for the current period is simply calculated as the ending merchandise inventory value from the previous period.
When calculating merchandise inventory, the company adds the amount spent on additional inventory during the period to the beginning inventory and then subtracts the cost of goods sold (COGS).
The formula for this is expressed as:
Ending merchandise inventory = Beginning inventory + New inventory costs – COGS
In order to explain how merchandise inventory value and COGS are calculated, let us look at an example of a footwear merchandiser who had 10 units of beginning inventory worth $1000, then bought 50 units of shoes from a supplier at $100 a pair. He then sold 40 pairs at $200 per pair and at the end of the accounting cycle, had 20 pairs of footwear left. In order to arrive at the value of merchandise inventory, the amount of unsold inventory will be multiplied by the cost of each unit. That is:
Merchandise inventory value = Inventory cost of each unit x unsold inventory amount
= 100 x 20 = $2000
Therefore, the merchandise inventory value will be $2000, which will be considered the same as the ending inventory. This is then entered into the balance sheet as an asset in the merchandise inventory account. The next thing would be to calculate the COGS (which is the direct costs of producing merchandise inventory for sale). The formula for this is:
COGS = (Beginning inventory + Purchased inventory value) – Merchandise inventory value
That is in the case of the shoe retailer, the COGS would be:
= (1000 + (50 x 100)) – 2000
This means that the COGS will be $4000 which can be used to calculate profits. Profit can therefore be calculated using the formula:
Profit = Total sales – COGS
= (40 x 200) – 4000
This means that the shoe retailer made a profit of $4000
The merchandise inventory calculations have many uses beyond just preparing the company’s balance sheet and income statements. Inventory reconciliation is one of the uses of merchandise inventory calculations. Companies can compare the calculated inventory values with the results of physical inventory counts in order to help them identify and address issues such as inventory shrinkage due to theft, accounting errors, spoilage, or other factors.
Retailers can also use inventory calculations to identify inventory write-offs for tax purposes as well as use trends in inventory to determine optimal ordering strategies. In addition, merchandise inventory is not only reflected on the balance sheet but also used to calculate COGS.
Related: Unearned revenue debit or credit?
Debit and credit explained
Debits and credits are used in Pacioli‘s double-entry accounting system to record transactions. In accounting, a debit entry recorded must have a corresponding credit entry that equals the same amount. That is, every transaction has to be exchanged for something else that has the exact same value; this is the standard in double-entry bookkeeping.
In double-entry bookkeeping, asset and expense accounts increase with a debit entry and decrease with a credit entry. Revenue, equity, and liability accounts, on the other hand, increase with a credit entry and decrease with a debit entry. Recall that merchandise inventory is the account on a balance sheet that reflects the total cost for products that are yet to be sold. It is therefore a current asset, which is basically a holding account for inventory that’s waiting to be sold.
Since merchandise inventory, our main focus is a current asset, it means, it will increase by a debit entry and decrease by a credit entry. Does this mean merchandise inventory is a debit and not a credit entry? Let’s discuss this further.
See also: Unearned service revenue debit or credit?
Is merchandise inventory debit or credit?
Merchandise inventory is a debit and not a credit. Being an asset, merchandise inventory will have a normal debit balance, thereby increasing by a debit entry and decreasing by a credit entry. When companies purchase goods that they intend to sell to customers, they record this transaction in the Merchandise Inventory account, as a current asset. Inventory is recorded at cost, which entails the price paid for the goods plus all necessary costs of getting the goods to the company’s place of business and ready to sell.
Under the perpetual inventory procedure, companies debit the Merchandise Inventory account for each purchase and then credit the Merchandise Inventory account for each sale so that the current balance is shown in the account at all times. Under periodic inventory procedures, on the other hand, companies do not use the Merchandise Inventory account to record each purchase and sale of merchandise. Rather, they correct the balance in the Merchandise Inventory account as the result of a physical inventory count carried out at the end of the accounting period.
As earlier said asset and expense accounts increase with a debit entry and decrease with a credit entry. Therefore, since merchandise inventory is an asset, it will increase with a debit and decrease with a credit. This means that merchandise inventory is a debit and not a credit. Recording purchases will be entered as a debit to the merchandise inventory account and as a credit to the cash or accounts payable account. When these goods are sold, their cost is deducted from the merchandise inventory account and then added to the cost of goods sold (COGS) account for the period.
Related: Salaries expense debit or credit?
Examples of merchandise inventory debit and credit journal entries
In order to illustrate merchandising activities and show merchandise inventory as a debit and not a credit, let’s use Company ABC, a retailer that provides electronic hardware packages for small businesses as our example.
Let’s say each electronic hardware package contains a desktop computer, tablet computer, landline telephone, and a 4-in-1 desktop printer. Company ABC purchases each of these electronic products from a manufacturer and the following are the per-item purchase prices that make up ABC’s electronic hardware package:
- Desktop Computer at $400
- Tablet Computer at $60
- Landline telephone at $60
- The 4-in-1 desktop printer at $100
Debit and credit journal entry for merchandise inventory on a purchase
Assume on Sept 1, Company ABC purchases 10 electronic hardware packages at a cost of $620 each. Say, ABC has enough cash on hand and therefore pays immediately with cash. This is the journal entry that occurs:
Debit and credit journal entry for merchandise inventory to recognize the purchase of 10 packages
|Sept 1||Merchandise Inventory: Packages||$6,200|
As shown in the journal entry above, a debit is made to Merchandise Inventory- Packages for $6,200, and a credit entry is made to Cash for $6,200. The $6,200 ($620 × 10) debit entry increases the Merchandise Inventory account while the Cash account decreases by the $6,200 credit entry because ABC paid with cash.
On Sept 7, ABC purchases 30 desktop computers on credit at a cost of $400 each. The credit terms are n/15 with an invoice date of Sept 7. This is the journal entry that occurs:
Debit and credit journal entry for merchandise inventory to recognize the purchase of 30 computers on credit
|Sept 7||Merchandise Inventory: Desktop Computers||$12,000|
As shown in the journal entry above, a debit is made to Merchandise Inventory-Desktop Computers for $12,000 and a credit entry is made to Accounts Payable for $12,000. The $12,000 ($400 × 30) debit entry increases the Merchandise Inventory account while the Accounts Payable increases by the $12,000 credit entry since ABC purchased the computers on credit.
On Sept 17, ABC makes full payment on the amount due from the Sept 7 purchase. The following journal entry occurs:
Debit and credit journal entry for merchandise inventory to recognize the full payment of 30 computers purchased
|Sept 17||Accounts Payable||$12,000|
The journal entry above shows a debit to Accounts Payable for $12,000 and credit to Cash for $12,000. The Accounts Payable account decreases by the debit entry and the Cash account decreases by the credit entry for the full amount owed. Recall, that the credit terms were n/15, which is net due in 15 days. No discount was offered with this transaction, so ABC makes the full payment of $12,000.
Debit and credit journal entry for merchandise inventory on purchase discount transaction
On October 1, ABC purchases 67 tablet computers at a cost of $60 each on credit. The payment terms are 5/10, and n/30, and the invoice is dated October 1. The following journal entry occurs:
Debit and credit journal entry for merchandise inventory to recognize the purchase of 67 tablets on credit
|Oct 1||Merchandise Inventory: Tablet Computers||$4,020|
The journal entry above shows a debit to Merchandise Inventory- Tablet Computers for $4,020 and a credit to Accounts Payable for $4,020. The Merchandise Inventory account increases by the debit entry of $4,020 (67 × $60) and the Accounts Payable account also increases by the credit entry of $4,020.
Notice that the credit terms are a little different from the previous example. The credit terms in this example include a discount opportunity (5/10), meaning that, ABC has 10 days from the invoice date to pay on their account to receive a 5% discount on their purchase. Assume, on Oct 10, ABC pays their account in full. The following journal entry occurs:
Debit and credit journal entry for merchandise inventory to recognize the payment of 67 tablets, less purchase discount
|Oct 10||Accounts Payable||$4,020|
|Merchandise Inventory: Tablet Computers||$201|
As shown above, a debit to Accounts Payable for $4,020 as well as credits to Merchandise Inventory and Cash for $201 and $3,819, respectively are made. The Accounts Payable decreases by the debit entry for the original amount owed of $4,020 before any discounts are taken. Since ABC paid on Oct 10, they made the 10-day window and therefore received a discount of 5%. Hence, Cash decreases by the credit entry for the amount owed minus the discount. Then, Merchandise Inventory decreases by the credit entry for the amount of the discount of $201 ($4,020 × 5%).
Now, assuming ABC paid their debt on Oct 25 and didn’t make the 10-day window. The following journal entry would occur instead:
Debit and credit journal entry for merchandise inventory to recognize the payment of 67 tablets with no discount
|Oct 25||Accounts Payable||$4,020|
This journal entry shows a debit entry to Accounts Payable for $4,020 and a credit entry to Cash for $4,020. Accounts Payable account decreased (debit) and Cash account decreased (credit) by $4,020. Since ABC paid its debt outside of the discount window but within the total allotted timeframe for payment, it does not receive a discount in this case but pays in full and on time.
Debit and credit journal entry for merchandise inventory on purchase returns and allowances
On Nov 1, ABC purchased 300 landline telephones with cash at a cost of $60 each. On Nov 3, ABC discovers that 25 of the landline telephones are the wrong color and returns the phones to the manufacturer for a full refund. The following entries occur recording the purchase and subsequent return:
Debit and credit journal entry for merchandise inventory to recognize the purchase of phone with cash
|Nov 1||Merchandise Inventory: Landline telephones||$18,000|
As shown in the journal entry, Merchandise Inventory- Landline telephones increase by a debit entry of $18,000 ($60 × 300), and Cash decreases by a credit entry of $18,000.
Debit and credit journal entry for merchandise inventory to recognize the return of 25 phones and cash refund
|Merchandise Inventory: Landline telephones||$1,500|
Since ABC already paid in full for their purchase, a full cash refund is issued. This would increase the Cash account by a debit of $1,500 and decreases Merchandise Inventory-Phones by a credit entry of $1,500 because the merchandise has been returned to the manufacturer or supplier.
Furthermore, on Nov 8, ABC discovers that 60 more phones from the Nov 1 purchase are slightly damaged. ABC decides to keep the phones but receives a purchase allowance from the manufacturer of $8 per phone. The following journal entry occurs for the allowance:
Debit and credit journal entry for merchandise inventory to recognize allowance for 60 phones
|Merchandise Inventory: Landline telephones||$480|
The journal entry shows that since ABC already paid in full for their purchase, a cash refund of the allowance is issued in the amount of $480 (60 × $8). This increases Cash by the debit of $480 and decreases Merchandise Inventory- Phones by a credit of $480 because the merchandise is less valuable than before the damage discovery.
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