Merchandising business have inventory. An inventory is an item you buy for the sole purpose of reselling it. An inventory is an asset and appears under the current assets section of the balance sheet.
Cost of goods sold
We learned that the matching principle aims to match expenses with revenue. In honor of the matching principle, when inventory is sold the cost of the inventory has to be matched with the corresponding revenue. So therefore, when inventory is sold, we have to move inventory from the asset section of the balance sheet (inventory) to the expense section of the income statement (costs of goods sold). The expense account inventory is moved to (expensed) is called cost of goods sold.
Here is how it works
When a merchandise business buys products for resale it is an asset. The journal entry to record the initial purchase is:
Debit Merchandise inventory ( increase the merchandise inventory account by debiting it)
Credit Cash/ Accounts payable (decrease the cash account if cash was used or increase the accounts payable otherwise)
When a merchandise business sells the product, the revenue has to be matched with the expense as follows:
Debit cost of goods sold (increase the expense account cost of goods sold.)
Credit inventory (when we sell an item, the inventory account decreases)