Introduction to the Merchandise Business

By Jeff Boulton



1. Congratulations
2. What is a Merchandise Business?
3. Supplies versus Inventory
4. Methods of Merchandise Accounting
5. The Significance of Inventory
6. The Concept of Cost of Goods Sold
7. Practice Question


















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You have finally made it through the entire accounting cycle (for a service business that is).


This however, is only the beginning. There are many types of businesses out there, and each of them could be formed under different forms of ownership too. This means the accounting cycle has a number of variations; one for each situation.


Your knowledge consists of the square below with the checkmark.


We will now learn how the accounting cycle varies for a merchandise business (the green circle above).


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What is a Merchandise Business?

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A merchandise business is a business that sells merchandise. In other words, instead of a service, a merchandise business sells goods.


At first it doesn’t sound like this would cause much of a difference in the way one performs accounting. In some ways you are correct. Almost everything is the same. However, because a merchandise business sells goods, we now have to track the purchase, cost, and sale of goods.


Essentially, the accounting system differs ONLY WHERE MERCHANDISE is concerned.


If it doesn’t involve merchandise, then there really is no difference between accounting for a service business and a merchandise business






















Supplies versus Inventory

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The first thing we have to clear up is the difference between supplies and merchandise.

Supplies are purchased for use in running a business (i.e. office supplies, cleaning supplies).

Merchandise Inventory is purchased for RE-SALE. This idea is you buy goods, and re-sell them for a higher price in order to make money.

Note: this doesn’t mean that pencils and paper can’t be inventory. If you are a stationary store, then these items ARE inventory. The key concept is “goods for re-sale”.











Methods of Merchandise Accounting

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There are two methods:

1. Periodic
2. Perpetual

They refer to how often the merchandise inventory account is verified and updated to reflect the current value of inventory on hand.



In the days before computerized accounting and inventory systems, larger companies would sell goods out of inventory with no intention of trying to keep inventory records up to date, especially with a high volume of sales.


Instead, much like a supplies adjustment, an inventory count would be made at the end of the period (periodically). This will show how much inventory was missing, all of which is assumed to have been sold.



Now thanks to technology, inventory systems can tell you exactly how much inventory (and what kind) is in the storeroom or on the floor (inventory is kept perpetually up to date). Every time a cashier scans a product, it records the sale, but also reduces the inventory level.


Now inventory counts are done much less frequently, and are usually just to catch discrepancies in the records and to account for theft.












The Significance of Inventory

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Inventory adds an entirely new dimension to running and evaluating a business.


Inventory can become obsolete (summer clothing not sold by fall, too many of the hottest toys from last Christmas). Inventory also takes up space for which you pay rent, needs to be stored, stocked, and counted, which takes labour, and inventory soaks up cash to sit there on the floor and do nothing, instead of paying the business’ bills. Not the least of which, inventory can be stolen.


Inventory values can also be “played” with to alter a business’ reported Net Income. How? This is because the cost of inventory eventually makes it to the income statement as an expense called Cost of Goods Sold. The more you sell, the higher your cost of goods sold expense.


The reason all this is significant, is because inventory is usually significant. The single largest expense for a merchandise business is usually the Cost of Goods Sold expense.















The concept of Cost of Goods Sold

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Since now we are selling goods, part of the cost of generating revenue is the cost of the items we are selling. This is called the Cost of Goods Sold.


This is how the Cost of Goods Sold is calculated (it would be wise to memorize this formula RIGHT NOW!):


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Practice Question

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A business with $20,000 of inventory on January 1st makes the following purchases:

Jan. 10th
Jan. 17th
Jan. 21st
return (900)

Note: when inventory was counted on January 31st, the business had $14,000 of inventory left.

Sales in January were $40,000 including Operating Expenses of $17,000.


1. Find the Cost of Goods Sold
2. Find Net Income









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Beginning Inventory
Add: Purchases
Less: Purchase Returns
Total Available
Less: Ending Inventory
Cost of Goods Sold
Less: Cost of Goods Sold
Gross Profit
Less: Operating Expenses
Net Income