Merchandise inventory is goods that have been acquired by a distributor, wholesaler, or retailer from suppliers, with the intent of selling the goods to third parties. This can be the single largest asset on the balance sheet of some types of businesses. If these goods are sold during an accounting period, then their cost is charged to the cost of goods sold, and appears as an expense in the income statement in the period when the sale occurred. If these goods are not sold during an accounting period, then their cost is recorded as a current asset, and appears in the balance sheet until such time as they are sold.
If the market value of merchandise inventory declines below its recorded cost, then you must reduce the recorded cost down to its market value and charge the difference to expense, under the lower of cost or market rule.
Merchandise inventory may be located in three areas: in transit from suppliers (under FOB shipping point terms), in the company's storage facilities, or on consignment in locations owned by third parties. When compiling the total cost of inventory for recordation at month end in the company's accounting records, you need to include all of the merchandise in all three of these locations. Doing so is easiest with a perpetual inventory system, which maintains up-to-date balances of all unit quantities. A less reliable method is the periodic inventory system, under which a period-end physical count is needed to verify quantities on hand.