Merchandising involves purchasing products t also called merchandise inventory or just inventory t to
resell to customers. The operating cycle t the time it takes to go from cash to cash in producing
revenues t is usually longer for a merchandising company than it is for a service company.
Unlike expenses for a service company, merchandising companies divide them into two categories: cost
of goods sold and operating expenses. The cost of goods sold is the total cost of the merchandise that
was sold during the period of time. This expense is directly related to the revenue that is recognized
from the sale of goods. Sales revenue less the cost of goods sold is called gross profit.
After gross profit is calculated, operating expenses are deducted to determine earnings before income
tax. Operating expenses are expenses that are incurred in the process of earning sales revenue.
Sales revenue t Costs of Goods Sold = Gross Profits
Gross profits t operating expenses = earnings before income taxes
Earnings before income taxes t income taxes = net earnings
A merchandising company keeps track of its inventory to determine what is available for sale (inventory)
and what has been sold (cost of goods sold). Goods available for sale are reported as merchandise
inventory, a current asset on the balance sheet. There are two types of systems used for merchandising
companies: perpetual or periodic.
Perpetual inventory system details records that are maintained for the cost of each product that is
purchased and sold. These records are perpetual; they show the quantity and cost of the inventory
purchased, sold, and on hand. When inventory is purchased, it is recorded by debiting the inventory
account. When merchandise is sold, the costs of the goods that have just been sold (the original cost of
the merchandise) are obtained from the inventory records. This cost is transferred from the
merchandise inventory (asset) to the cost of goods sold (expense).
For control purposes, a physical inventory count is always taken at least once a year. This system allows
the company to monitor merchandise availability and maintaining optimal inventory level.
In a periodic inventory, detailed inventory records of the merchandise on hand are not kept throughout
the period. As a result, the cost of goods sold is determined only at the end of the accounting period,
which is periodically. To determine the cost of goods sold under this system, the following steps are
Beginning inventory + Costs of Goods purchased = Costs of good available for sale
Costs of goods available for sale t ending inventory = costs of goods sold
This is the same method used in perpetual, however, costs of goods sold is calculated and recorded at
the same time of each sale.