Introduction to Inventory and Cost of Goods Sold

Inventory is merchandise purchased by merchandisers (retailers, wholesalers, distributors) for the purpose of being sold to customers. The cost of the merchandise purchased but not yet sold is reported in the account Inventory or Merchandise Inventory.

Inventory is reported as a current asset on the company's balance sheet. Inventory is a significant asset that needs to be monitored closely. Too much inventory can result in cash flow problems, additional expenses (e.g., storage, insurance), and losses if the items become obsolete. Too little inventory can result in lost sales and lost customers. 

Because of the cost principle, inventory is reported on the balance sheet at the amount paid to obtain (purchase) the merchandise, not at its selling price.

Inventory is also a significant asset of manufacturers. However, in order to simplify our explanation, we will focus on a retailer. 

Cost of Goods Sold

Cost of goods sold is the cost of the merchandise that was sold to customers. The cost of goods sold is reported on the income statement when the sales revenues of the goods sold are reported. 

A retailer's cost of goods sold includes the cost from its supplier plus any additional costs necessary to get the merchandise into inventory and ready for sale. For example, let's assume that Corner Shelf Bookstore purchases a college textbook from a publisher. If Corner Shelf's cost from the publisher is $80 for the textbook plus $5 in shipping costs, Corner Shelf reports $85 in its Inventory account until the book is sold. When the book is sold, the $85 is removed from inventory and is reported as cost of goods sold on the income statement.