Solution By Steps

Step 1: Definition of Merchandise Inventory

Merchandise inventory refers to the goods that a business has purchased for the purpose of resale to customers. It is considered an asset because it has a future economic benefit (i.e., the potential to generate revenue when sold).

Step 2: Reporting of Merchandise Inventory

Merchandise inventory is reported on the balance sheet under current assets. This is because it is expected to be converted into cash within the normal operating cycle of the business, typically within one year.

Step 3: Role of Merchandise Inventory in Financial Statements

The cost of merchandise inventory is not an expense until the goods are sold. Once sold, the cost of goods sold (COGS) is recorded as an expense on the income statement, which is then subtracted from net sales to determine gross profit.

Step 4: Incorrect Statements

Statement 1 is incorrect because merchandise inventory is not subtracted from net sales; rather, the cost of goods sold (COGS), which includes the cost of inventory sold, is subtracted.

Statement 3 is incorrect because merchandise inventory is not an expense account; it is an asset until the goods are sold.

Statement 4 is incorrect because merchandise inventory decreases when products are sold, not increases. The cost of the sold inventory is transferred to COGS.

Final Answer

The correct statement is: Merchandise inventory is an asset reported on the balance sheet and contains the cost of products purchased for sale.