Question

Discuss how the inventory of a merchandising company differs from that of a manufacturing company. What are the two inventory Control Systems. Why is one better than the other? Explain with examples.

Answer 1

Inventory of Merchandising vs Manufacturing Company

A merchandising company is one which buys goods from the manufactures and sells them to the customers. For them there is only one type of inventory which is their merchandise inventory.This inventory is in a ready for sale condition.

On the other hand in a manufacturing company, there are three types of inventory:-

a) Raw Materials

b) Work in process

c) Finished goods.

For example a company manufacturing office furniture, wood and glue are the raw materials. The completed chairs , tables, filing cabinets etc are the finished products. The products that are still not completed but hve to go through further processes before they become finsihed goods is called work in process.

Two Types of Inventory Control Systems

The two types of Inventory control systems are the perpetual inventory system and the periodic inventory system.

In the perpetual inventory system, the inventory records are updated real time or on a continuous basis. The company can know the inventory position at any given point of time. When goods are purchased it directly goes to the Inventory account. When a sale takes place the inventory accounted will be credited and the cost of goods sold will be debited. Thus the inventory is always up to date.

In the periodic inventory system, inventory is reported once every month or a quarter or some times even a year. When goods are purchased it does not go to the inventory account but purchases is debited. At the time of sale only the sales revenue is credited. No entry is made for the cost of goods sold.The inventory continues to be in purchases account. Only at the end of a certain period a count is done of the unsold inventory and cost is calculated and reduced from the previous months stock and purchases.

Perpetual inventory system is better than the periodic system due to following reasons

(1) Inventory is always updated

(2) Inventory reporting is more accurate

(3) More useful for management decision making because of real time records,

(4) Useful for large businesses where inventory is stored at many locations but managed centrally.

Periodic Inventory system is better than perpetual due to following reasons

(1) Does not requirement the large investment in computer systems and software and human resources required for managing a perpetual inventory system.

(2) This is more useful for small businesses

(3) Even if perpetual system is followed, a periodic physical count of inventory is necessary