At the end of the trading period, some merchandise purchased earlier in the year may not have 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 evaluated carefully because the amount of closing stock or ending inventory materially affects the trading results of the business. In order to ensure that the income statement is correct, we must consider the value of the closing inventory of merchandise.
The value of merchandise remaining unsold at the end of the trading period represents an asset of the business.
Suppose that a firm’s unsold stock at the end of the year is valued at $20,000.
The unsold stock has the following aspects:
Firstly, the unsold stock is left out of the opening stock and purchases that have already been recorded on the debit side of the trading account.
Therefore, to match the cost price and sales revenue of the same number of units, the unsold stock is recorded on the credit side of the trading account.
Secondly, the unsold stock will be sold in the next year. That’s to say, its benefit will be available in the next year, which means that it should be treated as an asset of the current year. As a result, it is recorded on the assets side of the balance sheet.
To reduce the expense on the merchandise inventory, the income statement should receive credit and a corresponding debit should be made to an asset merchandise inventory.
Effect on Financial Statement
The amount of closing merchandise inventory is deducted from the cost of goods available for sale in the income statement. Also, the same amount is recorded as a current asset in the balance sheet. This adjustment affects the income statement and balance sheet as follows: