Accounting for a Merchandising Business
In this lesson, we examine the accounting for merchandising operations -- those that sell products. The products held for sale are called inventory, or more specifically, merchandise inventory. Inventory is a current asset that will be sold to yield a profit--and the adage "buy low, sell high" is a succinct way to state a merchandiser's profit strategy.
In addition to introducing a new asset, we also introduces a new cost category, and a new name for the revenue account. The cost is called Cost of Merchandise Sold (also called Cost of Goods Sold by some companies), and represents the cost of the inventory that was sold during the period. If John purchases 100 units of product for $5 each and sells 20 of them for $10 each, John earns $200 of sales revenue. The cost of the units sold is 20 * $5 = $100, and would be the Cost of Goods Sold. The difference between the revenue earned and the cost of merchandise sold is called gross profit. Here is a very basic income statement that computes the gross profit: John's Products | | Partial Income Statement | | For Month Ended 1/31/2013 | | | | Sales (20 units * $10) | $200 | Cost of Merchandise Sold (20 units * $5) | $100 | Gross Profit | $100 | Expenses | 0 | Net Income | $100 |
Note that 20 units of product were sold for $10 each. The ones that were sold cost $5 each, resulting in gross profit of $100. The balance sheet for John's Products will show an Inventory account, which is located in the current assets, after Cash and Accounts Receivable. John's Products | | Partial Balance Sheet | | 1/31/2013 | | | | Assets | | Cash | ... | Accounts Receivable | ... | Inventory (80 units * $5) | 400 | ... | ... |
If John originally purchased 100 units, the sale of 20 units leaves 80 units remaining, at a cost of $5 each.
The cost