At the end of the trading period, it may be possible that some of the merchandise purchased have not been sold and are still on hand. The stock in hand at the end of the trading period is known as closing stock or ending inventory. The closing stock should be very carefully evaluated because the amount of closing stock or ending inventory would materially affect the trading results of the business. In order to get the correct result of the income statement, we must take into account the value of closing inventory of merchandise. The value of merchandise remaining unsold represents an asset of the business.
Suppose unsold stock at the end of the year is valued at $20,000.
The unsold stock has the following two-fold aspects:
- Firstly this unsold stock is left out of that opening stock and purchases which have already been recorded on the debit side of Trading Account. Therefore, to match the cost price and sales revenue of the same number of units the unsold stock will be recorded on the credit side of the Trading Account.
- Secondly, this unsold stock will be sold in next year, in other words, its benefit will be available in next year, therefore, it will be treated as an asset of the current year and will be recorded on the assets side of the Balance Sheet.
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 the income statement and the same amount will be recorded as a current asset in the balance sheet. This adjustment will affect the income statement and balance sheet as follows: