At the end of trading period, it may be possible that some of the merchandise purchased have not been sold and are still on hand. In order to get correct result of income statement, we must take into account the value of closing inventory of merchandise. The value of merchandise remaining unsold represents asset of the business.
In order to reduce the expense on the merchandise inventory, income statement should be given a credit and a corresponding debit to an asset “merchandise inventory”.
Effect on financial statement
The amount of closing merchandise inventory will be deducted from the cost of goods available for sale in income statement and the same amount will be recorded as current asset in the balance sheet. This adjustment will affect income statement and balance sheet as follows: