Correctly attributing costs is critical in inventory management because it directly affects your profitability.
This article clearly defines one of the main types of inventory in a business: merchandise inventory. You’ll need to know about it to ensure your costs are accurate. We explore common merchandise inventory examples, methods for calculating it, and a few best-practice accounting tips.
What is merchandise inventory?
Merchandise inventory refers to finished goods that have been purchased – typically by a retailer, wholesaler, or distributor – to be resold to a third party. Items that qualify as merchandise inventory are ready to be marketed and sold as they are (with no further manufacturing required).
Merchandise inventory includes any unsold stock ready for sale. That means all the products lining retail shelves, finished goods stored in the backroom, or spare stock kept off-site at a warehouse.
In inventory accounting, merchandise inventory is reported as a current asset on the balance sheet. When sold, the costs of merchandise inventory are recorded as part of the cost of goods sold on the merchant’s income statement. Those costs include the amount paid to acquire the goods, along with shipping, storage, and insurance costs.
Merchandise inventory examples
Walk into any warehouse or retail shop, or browse an online store, and you’ll come across dozens of examples of merchandise inventory; if it’s available to be purchased right now, it meets the criteria.
Here are some classic examples of merchandise inventory:
- Manufactured furniture – Completed furniture goods such as tables or chairs are common examples of merchandise inventory that’s been developed in a manufacturing factory.
- Supermarket products – Everything that lines the shelves of a supermarket, from cereals to toilet rolls, qualifies as merchandise inventory.
- Consumer electronics – Computers, televisions, gaming devices, and USB sticks available for purchase from an electronic goods retail store are all examples of merchandise inventory in the electronics industry.
- Amazon-listed goods – In-stock products sold through eCommerce channels like Amazon (or Shopify, WooCommerce, and Magento) are merchandise inventory that can be purchased online by consumers.
What merchandise inventory includes
Not all inventory held by a business is merchandise inventory. But it’s often a company’s largest inventory asset.
Merchandise inventory does include:
- Finished goods ready for sale. This is the main criterion for merchandising inventory: they are goods or assets that are ready to be sold to the customer. They do not require any more production or finishing touches.
- Packing materials for the completed goods. Also included when accounting for merchandise inventory are the various packaging requirements and costs for getting the product to the customer, including boxes, labels, and freight charges.
- Consigned goods. Consignment stock is products held by the reseller but owned (legally speaking) by the supplier until they are resold. These products are included as part of the merchandise inventory.
What merchandise inventory doesn’t include
The goods which do not fall into the category of merchandise inventory include:
- Goods that have been sold. Once a product has been sold to a customer, it can no longer be counted as merchandise inventory. The sale means it is recorded in the accounts as part of the business’s revenue and profits.
- Raw materials and components. Raw materials and parts are not categorised as merchandise inventory because they cannot yet be sold to customers. These are materials that still require production work before they are ready to be marked ‘for sale’.
- Work-in-progress goods. Much like raw materials, goods that are continuing to be worked on are not yet ready for a customer to hit the ‘buy now’ sign.
Merchandise inventory management methods
There are two common methods for managing and accounting for merchandise inventory: Periodic and perpetual. Here’s a quick breakdown of each.
The periodic method
The periodic inventory method updates stock records periodically. Inventory is manually counted to determine stock-on-hand levels and COGS. This system offers an effective use of labour and administration but can be misrepresentative of the ups and downs of inventory movement in the intervening period.
The perpetual method
The perpetual inventory method constantly tracks and updates inventory levels and values as stock movements occur. This system helps you know exactly how much merchandise inventory you have available at any given time. However, the ongoing and set-up costs can be higher as you’ll need to invest in inventory management software and other technology.
How to calculate merchandise inventory
Understanding the value of your merchandise inventory is key to business success. Merchandise inventory, when sold, feeds into the COGS calculation, which is:
Opening Inventory + Purchases + Production Costs – Closing Inventory = Cost of Goods Sold
There are several methods for calculating the value of merchandise inventory. We’ll look at some of the main ones now.
First-in, First-out (FIFO)
FIFO is an inventory valuation system where the merchandise inventory that’s purchased first is the first to be resold. Items are sold in the order that they are acquired.
Last-in, first-out (LIFO)
LIFO is a strategic inventory valuation system where the most recently purchased merchandise inventory is the first to be sold. It helps businesses reduce the risk of rising inventory costs but is not permitted outside of the United States under the General Accepted Accounting Principles.
- Read more: FIFO vs LIFO – Advantages & Disadvantages
Weighted average cost is a merchandise inventory valuation method that measures the average cost of all your products based on their individual quantities and costs. This is the simplest method of the three, making it preferable to many product businesses.
Merchandise inventory accounting
Merchandise inventory accounting requires tracking the quantity, cost, and value of inventory items that are ready to be sold. Once they’re sold, the items contribute to the COGS formula which in turn gives you insights into business profitability.
Certain principles ensure that merchandise inventory accounting is accurate, comparable, and can be relied on for future forecasts. Let’s look at some of the basics.
Recording of merchandise
When a good is purchased, it is recorded as an asset and the cost of that purchase is debited from the company’s cash or accounts payable.
Knowing how to value your inventory is central to accounting. There are different ways of calculating value; whatever method you use, it’s important to be consistent over time to ensure you are comparing ‘apples to apples’ throughout. If you change accounting methods that will need to be recorded and adjustments made.
The Lower Cost or Market rule
This is an accounting rule that requires a business to record its inventory at the lowest cost of market value. It’s often leaned on if inventory may be reduced in cost for various reasons – such as consumables getting closer to their use-by date. It will make the overall inventory sum smaller than if goods are valued as an ‘average’ cost.
To ensure transparency around the datasets, financial books may require disclosures around certain rules in play, including the valuation method used. Doing so enables public scrutiny of inventory value compared to others in the market and prevents businesses from inflating their datasets.