How to Find Ending Merchandise Inventory

Merchandise inventory represents the goods a business holds for sale to customers. Accurately determining the value of ending merchandise inventory is fundamental for understanding a company’s financial position and making informed operational decisions. This value directly impacts a business’s reported assets and its overall financial health.

Physical Inventory Counting

The most direct approach to finding ending inventory involves a physical count of all goods on hand. This process typically occurs at the close of an accounting period, requiring a systematic enumeration of every item held by the business. Businesses often organize storage areas, use pre-numbered inventory tags, and deploy teams to count and verify quantities to enhance accuracy. Each tag specifies the item, quantity, and a unique identifier, ensuring no items are double-counted or missed.

A second team may verify a sample of counts to reduce discrepancies. While verifying inventory records, a complete physical count can be time-consuming and resource-intensive, especially for businesses with large and diverse inventories. The process remains susceptible to human error, such as miscounts or improper tagging. This method provides a tangible verification of goods but requires subsequent valuation and reconciliation with financial records.

Costing and Valuation Methods

Once the quantity of ending inventory is established, its monetary value must be assigned for financial reporting. This valuation often begins with the cost of goods sold (COGS) formula: Beginning Inventory + Purchases – Cost of Goods Sold = Ending Inventory. When specific costs fluctuate, different costing methods determine which costs are assigned to the goods remaining in inventory.

First-In, First-Out (FIFO)

The First-In, First-Out (FIFO) method assumes that the first goods purchased are the first ones sold. Consequently, the inventory remaining at the end of a period is assumed to consist of the most recently acquired items. This method generally aligns with the physical flow of most businesses, especially for perishable goods. During periods of rising costs, FIFO results in a higher reported ending inventory value and a lower cost of goods sold, which can lead to higher reported profits.

Last-In, First-Out (LIFO)

Conversely, the Last-In, First-Out (LIFO) method assumes that the last goods purchased are the first ones sold. Under LIFO, ending inventory consists of the earliest purchased items. This method is permitted for financial reporting in the United States but not under International Financial Reporting Standards (IFRS). The Internal Revenue Service (IRS) imposes a LIFO conformity rule: if a company uses LIFO for tax purposes, it must also use it for financial reporting. In an environment of rising costs, LIFO typically results in a lower reported ending inventory value and a higher cost of goods sold, which can lead to lower taxable income.

Weighted-Average

The Weighted-Average method calculates an average cost for all goods available for sale. This average cost is then applied to both the cost of goods sold and the ending inventory. To determine the weighted-average cost, the total cost of goods available for sale is divided by the total number of units available for sale. This method smooths out price fluctuations, as it does not prioritize any specific purchase order. It often results in an ending inventory value between FIFO and LIFO, especially during periods of volatile prices.

Perpetual and Periodic Inventory Systems

The choice of inventory tracking system influences how and when ending inventory is determined.

Perpetual Inventory System

A perpetual inventory system continuously updates records with every purchase and sale. Each time an item is bought, its quantity and cost are added; each time an item is sold, its quantity and cost are removed. This system allows a business to know its inventory levels and cost of goods sold at any moment, without needing a separate calculation for ending inventory.

While a perpetual system provides real-time data, a physical count is still necessary periodically to reconcile recorded inventory with actual stock. This helps identify discrepancies due to damage, theft, or counting errors. Continuous tracking makes it suitable for businesses with high-value items or those needing precise, up-to-the-minute inventory information. Technology, such as barcode scanners and inventory management software, often facilitates this system.

Periodic Inventory System

In contrast, a periodic inventory system does not maintain continuous records. Inventory is updated and determined only at specific intervals, typically at the end of an accounting period. Under this system, the cost of goods sold is calculated only after a physical inventory count determines the ending inventory. The formula for calculating cost of goods sold is Beginning Inventory + Purchases – Ending Inventory.

Businesses using a periodic system rely on the accuracy of the physical count to establish their ending inventory value. This system is simpler and less costly to implement than a perpetual system, making it suitable for businesses with a large volume of low-value items where continuous tracking might not be cost-effective. However, it provides less real-time insight into inventory levels and product profitability.

Determining What to Include in Inventory

Determining what items belong in a company’s ending inventory involves specific considerations beyond physical location. Goods in transit require examination of shipping terms to ascertain ownership. If terms are Free On Board (FOB) shipping point, ownership transfers to the buyer as soon as goods leave the seller’s dock; the buyer includes these goods in their inventory. Under FOB destination terms, ownership transfers only when goods reach the buyer’s location, so the seller retains ownership until delivery.

Consigned goods also present a unique situation. When a company holds goods on consignment, it sells them on behalf of another party (the consignor) without taking ownership. These goods should not be included in the consignee’s inventory. If a company sends its own goods to another party on consignment, those goods remain part of the original company’s inventory until sold by the consignee.

Items sent to customers on approval are still considered part of the seller’s inventory. Ownership does not transfer until the customer accepts them or a specified return period expires. These scenarios highlight that physical possession does not always equate to ownership for inventory accounting.