Is Merchandise Inventory a Debit or Credit?
Master core accounting principles to understand how business assets, like inventory, are recorded and affect your financials.
Accounting provides a structured way to record and summarize financial activities. At its core is the double-entry accounting system, where every financial transaction impacts at least two accounts. This system ensures financial records remain balanced. Understanding debits and credits within this system is foundational for interpreting financial statements.
Understanding Debits and Credits
For every debit, there must be an equal and opposite credit. Debits are entries on the left side of an account, while credits are entries on the right side. The effect of a debit or credit depends entirely on the type of account involved. This consistent application ensures the accounting equation—Assets equal Liabilities plus Equity—always remains in balance.
Accounts are categorized into five types: Assets, Liabilities, Equity, Revenues, and Expenses. Assets represent what a business owns, such as cash or property, and increase with a debit. Liabilities are what a business owes and increase with a credit. Equity reflects the owner’s stake and increases with a credit.
Revenue accounts increase with a credit. Conversely, expense accounts increase with a debit. Each account type has a “normal balance,” the side that increases that account. For instance, an asset account’s normal balance is a debit, meaning a debit increases its balance, and a credit decreases it.
Merchandise Inventory as an Asset
Merchandise inventory refers to the goods that a retailer, wholesaler, or distributor acquires from suppliers with the intention of reselling them to customers. This includes all finished goods ready for sale, whether they are on display, in storage facilities, or even in transit.
Merchandise inventory is classified as a current asset on a company’s balance sheet. This classification indicates that these goods are expected to be sold and converted into cash within one year, or within the normal operating cycle of the business. Because merchandise inventory is an asset, its normal balance is a debit. When merchandise inventory increases, the inventory account is debited, and when it decreases, the account is credited.
Recording Inventory Transactions
When a business purchases merchandise inventory, the inventory account is debited to increase its balance, reflecting the new goods acquired. If the purchase is made using cash, the cash account is credited. If the purchase is on credit, the accounts payable account, a liability, is credited, indicating an increase in what the business owes. For example, a $1,000 purchase of inventory on credit would involve a $1,000 debit to Inventory and a $1,000 credit to Accounts Payable.
When merchandise inventory is sold, two journal entries are typically required to reflect the transaction accurately. The first entry records the sale itself: cash or accounts receivable (if on credit) is debited, and sales revenue is credited. The second entry accounts for the cost of the goods that were sold, known as Cost of Goods Sold (COGS).
This involves debiting the Cost of Goods Sold account, which is an expense, and crediting the Merchandise Inventory account. This credit reduces the inventory balance, reflecting the goods that have left the business. For instance, if goods that cost $600 were sold for $1,000, the inventory account would be credited for $600, and the Cost of Goods Sold account would be debited for $600.