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Inventory Accounting
Put systems in place to track the flow of inventory into and out of your store every day.
Track the quantity and cost of all incoming shipments, as well as the quantity and sales
price of each item sold. Make regular adjustments for spoiled, stolen or damaged goods
to keep your records in line with your actual inventory on hand. Inventory is the most
important asset of a retail store, and it often comprises the largest investment that store
owners make, so it is crucial to know exactly where your inventory accounts stand at
any time.
Income
Track all of your income as it comes in, and compare your records to bank statements
regularly to spot any discrepancies. Sales revenue is the largest driver of income for a
store, but you may have other sources of income, such as after-sale service fees,
extended warranty sales or even consignment commissions. If you have an electronic
point-of-sale, or POS, system that ties into your accounting system, perform regular
audits to ensure the integrity of your records, and be sure to manually add all income
that does not flow through the POS. Otherwise, keep detailed receipts of all income and
transfer the totals into your accounting system as often as possible.
Expenses
Track your expenses the same as your income, and compare your records against bank
statements regularly. Automate as many recurring expenses as possible, including rent
and lease payments, and set your accounting system to automatically record these
expenses each period. Record all variable expenses in their appropriate double-entry
bookkeeping accounts, including cost of goods sold, labor expenses, fees, taxes and
purchases. Include large one-time capital investments, such as display cases or lighting
fixtures, in their own account so you can easily separate them to calculate your normal
operating profit.
Merchandise Inventory
Merchandise inventory is the cost of goods on hand and available for sale at any
given time. Merchandise inventory (also called Inventory) is a current asset with a
normal debit balance meaning a debit will increase and a credit will decrease.
To determine the cost of goods sold in any accounting period, management needs
inventory information. Management must know:
its cost of goods on hand at the start of the period (beginning inventory)
the net cost of purchases during the period
and the cost of goods on hand at the close of the period (ending inventory).
Since the ending inventory of the one period is the beginning inventory for the next
period, management already knows the cost of the beginning inventory. Companies
record purchases, purchase discounts, purchase returns and allowances, and
transportation-in throughout the period. Therefore, management needs to determine
only the cost of the ending inventory at the end of the period in order to calculate cost of
goods sold.
Cost of goods sold is the inventory cost to the seller of the goods sold to
customers. Cost of Goods Sold is an EXPENSE item with a normal debit balance (debit
to increase and credit to decrease). Even though we do not see the word Expense this
in fact is an expense item found on the Income Statement as a reduction to Revenue.
Accountants must have accurate merchandise inventory figures to calculate cost of
goods sold. Accountants use two basic methods for determining the amount of
merchandise inventory—perpetual inventory procedure and periodic inventory
procedure.
When discussing inventory, we need to clarify 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. The difference between perpetual and
periodic inventory procedures is the frequency with which the Merchandise Inventory
account is updated to reflect what is physically on hand.
Merchandising companies selling low unit value merchandise (such as nuts and bolts,
nails, Christmas cards, or pencils) that have not computerized their inventory systems
often find that the extra costs of record-keeping under perpetual inventory procedure
more than outweigh the benefits. These merchandising companies often use periodic
inventory procedure.
Under periodic inventory procedure, companies do not use the Merchandise Inventory
account to record each purchase and sale of merchandise. Instead, a company corrects
the balance in the Merchandise Inventory account as the result of a physical inventory
count at the end of the accounting period. Also, the company usually does not maintain
other records showing the exact number of units that should be on hand. Although
periodic inventory procedure reduces record-keeping, it also reduces control over
inventory items. Firms assume any items not included in the physical count of inventory
at the end of the period have been sold. Thus, they mistakenly assume items that have
been stolen have been sold and include their cost in cost of goods sold.
Financial statement of a merchandising business
Merchandising companies sell products but do not make them. Therefore, these
companies will have cost of goods sold but the calculation is much easier than for a
manufacturing company. Expenses for a merchandising company must be broken down
into product costs (cost of goods sold) and period costs (selling and administrative).
Just like all income statements, the first line is revenue. In the case of a business that
sells a product, we refer to revenue as Sales or Sales Revenue. This lets the reader
know that the company generates its revenue from the sale of products rather than the
delivery of services.
Merchandising is the promotion of goods and/or services that are available for retail sale.
Merchandising includes the determination of quantities, setting prices for goods and services,
creating display designs, developing marketing strategies, and establishing discounts or coupons.
More broadly, merchandising may refer to retail sales itself, that is the provision of goods to end-
user consumers.
A merchandising business sells products referred to as merchandise. This is one of the
most common business types. A merchant buys already-made products and sells them for a
profit. The business could have a storefront or the owner could sell his products as a street
vendor or even as a door-to-door business. The internet has made merchandising businesses easy
to establish, and with little capital risk.
Many businesses with merchandise have storefronts that maintain inventory. These brick-
and-mortar stores vary in size, merchandise and price points. A toy store is a merchandising
business. A computer reseller is a merchandising business. Clothing, housewares and pet supply
stores are all types of merchandising businesses that you probably encounter regularly.
Drop-shipping is the latest trend in which the wholesale distributor establishes a program
where an online vendor sells merchandise he hasn't yet purchased. When the consumer buys the
product, the business then places an order on demand, the drop-ship wholesaler then fulfills the
order directly to the consumer. This means that the business doesn't need to hold inventory,
which reduces costs for storage and insuring items held in stock against potential loss. Being
online further reduces many needs for physical office space and brick-and-mortar stores.
Merchandise: This is what you sell. You buy the goods from the product manufacturer or you
obtain them from a wholesale supply company or distributor. Merchandise is purchased with the
strict intent of reselling the items to consumers.
Cost of Goods Sold: This is also referred to as COGS, and will be listed in the abbreviated form
on most financial statements. The COGS for a manufacturing company is the cost of materials,
plus the supplies and labor to create the product. Since a merchandiser is usually buying already
made products, the COGS is the price paid to acquire merchandise.
Periodic Inventory System: This inventory accounting system records inventory at specified
periods of time, such as at the end of a quarter.
Perpetual Inventory System: This inventory accounting system records inventory with every
transaction. This is very popular with automated and software-driven point-of-sale and
warehouse management systems.
End of Month: This is also seen as EOM on financial reports and purchase invoices. EOM
describes the credit extended by the seller to the buyer, requiring that payment be made by the
end of the month.
Free on Board: The FOB refers to the moment the buyer takes ownership; thus, the
responsibility of the merchandise from the wholesaler or distributor. The two parties must
determine who pays for the freight and when the buyer accepts ownership, risk and potential
damage. This is called the FOB point. If the agreement is FOB Shipping Point, then the buyer
accepts responsibility and pays all shipping costs from the seller's location. FOB Destination
means the seller maintains responsibility and shipping costs until the goods are received at the
buyer's location - at that point the seller records the sale.
Total Revenues: This refers to the amount of money collected when selling merchandise. It does
not consider any costs associated with obtaining products or running the company.
Gross Margin: This is a preliminary indicator of profitability. The gross margin subtracts the
COGS from the revenues. This is often further translated into a ratio, taking the gross margin and
dividing it by revenues expressed as a percentage. The higher the percentage the more profitable
you are with merchandise pricing.
Net Margin: Net margin goes further that gross margin, subtracting the operating costs, interest
and taxes paid to run the business from the gross margin. The net profit is the bottom line of your
company.
Credit Terms: When buying from distributors or wholesalers, a merchandiser can get credit
extended for the inventory. The terms include the time and interest due. Merchandisers get a
discount if paid within a designated period of time before the credit terms expire. The equation
n/10 = EOM determines this where EOM is usually 30 days. This means there is a discount if the
balance is paid within 10 days.
Credit Period: The credit period is the duration of the credit terms. Invoices are usually due in
30 days. Other credit periods exist, some that extend out to 90 days. Penalties are assessed if
payments are not made timely and you may lose the ability to buy on credit with the distributor.
Cash Discount: A cash discount is a term referring to discounts given to customers making
payments in cash. There are fewer fees for the merchant to accept cash, it demonstrates timely
and total payment and encourages customers to purchase with cash for the discount. This is a
sales discount not a purchase discount between the merchant and the wholesaler.
Shrinkage: This term refers to a reduction in inventory numbers in a perpetual inventory system.
Theft, breakage, spoilage, and transit issues all contribute to shrinkage. If a company is not
updating inventory records with manual numbers, it may not realize shrinkage is occurring and
be at risk of not being able to fulfill orders.
An inventory recording system has to deal with the recording of physical quantities of
stock and its valuation. Now there are two principal systems for determining the inventory of a
firm – the perpetual inventory system and the periodic inventory system. Let us learn about
them both.
Opening Stock (Value known) + Purchases during the year (known) – COGS (known) = Closing
Stock (Balancing Figure)
Net sales revenue – total amount of sales less discount and returns and allowances (for
cash and on account).
Cost of sales (cost of goods sold) – cost of merchandise sold during the period.
Other income – income from sources other than the principal line of service rendered or
activity of the business.
Distribution expenses – expenses that are incurred directly in the selling of merchandise.
Other expenses – any other normal costs that are not significant enough to be reported
separately or expenses that cannot be traced directly to operations.
Under the merchandising concern, current asset section has the account Merchandise
Inventory, representing the cost of unsold goods.