Chapter-5: Accounting for

Merchandising Operations

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 Merchandising Operations
Merchandising Companies
Buy and Sell Goods

Wholesaler Retailer Consumer

The primary source of revenues is referred to as

sales revenue or sales.
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 Merchandising Operations
Income Measurement
Not used in a
Service business.

Cost of goods sold is the total cost

of merchandise sold during the
period.

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 Merchandising Operations
Operating
Cycles
The operating
cycle of a
merchandising
company
ordinarily is
longer than that
of a service
company.

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 Merchandising Operations
Flow of Costs

Companies use either a perpetual inventory system or a periodic inventory

system to account for inventory.

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 Merchandising Operations
Flow of Costs
Perpetual System
Maintain detailed records of the cost of each
inventory purchase and sale.
Records continuously show inventory that should be
on hand.
Company determines cost of goods sold each time a
sale occurs.
Periodic System
Do not keep detailed records of the goods on hand.

Cost of goods sold determined by count at the end of the

accounting period.

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Merchandising Operations
Calculation of COGS
Beginning inventory $ 100,000
Add: Purchases, net 800,000
Goods available for sale 900,000
Less: Ending inventory 125,000
Cost of goods sold $ 775,000

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Merchandising Operations
Additional Consideration
Perpetual System:
Traditionally used for merchandise with high unit
values.
Provides better control over inventories.
Requires additional clerical work and additional cost
to maintain inventory records.
Nowadays fully computerized system makes it easier
to record

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Recording Purchases of
Merchandise (Perpetual system)
Companies purchase inventory using
cash or credit (on account).

Normally recorded when goods are

received.

Purchase invoice should support

each credit purchase.

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 Recording Purchases of
Merchandise
Example: Sauk Stereo (the buyer)
uses as a purchase invoice, the
sales invoice prepared by PW
Audio Supply, Inc. (the seller).
Prepare the journal entry for
Sauk Stereo for the invoice from
PW Audio Supply.

May 4 Inventory (or, Merchandise Inventory) 3,800

Accounts payable 3,800
(to record goods purchased on account from PW Audio Supply) 10
 Recording Purchases of
Merchandise
Freight Costs FOB Shipping Point

Seller places goods Free On

Board the carrier, and buyer
pays freight costs.

Example: Assume upon delivery of the goods on May 6, Sauk

Stereo pays Acme Freight Company $150 for freight charges,
the entry on Sauk Stereos books is:

May 6 Inventory 150

Cash 150
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 Recording Purchases of
Merchandise
Freight Costs FOB Destination
Seller places goods Free On
Board to the buyers place of
business, and seller pays
freight costs.

Example: Assume the freight terms on the invoice in Illustration

5-5 had required PW Audio Supply to pay the freight charges, the
entry by PW Audio Supply would have been:

May 4 Freight-out (or, Delivery Expense) 150

Cash 150
Freight costs incurred by the seller are an operating expense.
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 Recording Purchases of
Merchandise
Purchase Returns and Allowances
Purchaser may be dissatisfied because goods are
damaged or defective, of inferior quality, or do not meet
specifications.
Purchase Return Purchase Allowance
Return goods for credit if the sale May choose to keep the
was made on credit, or for a cash merchandise if the seller will
refund if the purchase was for grant an allowance (deduction)
cash. from the purchase price.

Example: Assume that on May 8 Sauk Stereo returned to PW

Audio Supply goods costing $300.

May 8 Accounts payable 300

Inventory 300
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 Recording Purchases of
Merchandise
Purchase Discounts
Sellers may permit buyer to claim a cash discount for prompt
payment through Credit Terms.

Credit terms specify the amount of cash discount and time

period in which discount is offered.

Advantages:

Purchaser saves money.

Seller shortens the operating cycle.

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 Recording Purchases of
Merchandise
Purchase Discounts: Examples of Credit Terms

2/10, n/30 1/10 EOM n/10 EOM

2% discount if 1% discount if Net amount due

paid within 10 paid within first 10 within the first 10
days, otherwise days of next days of the next
net amount due month. month.
within 30 days.

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Recording Purchases of
Merchandise
Purchase Discounts
Example: Assume Sauk Stereo pays the balance due of
$3,500 (gross invoice price of $3,800 less purchase returns
and allowances of $300) on May 14, the last day of the
discount period. Prepare the journal entry Sauk Stereo
makes to record its May 14 payment. (terms: 2/10, n/30)

May 14 Accounts payable 3,500

Inventory 70
Cash 3,430
(Discount = $3,500 x 2% = $70)

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Recording Purchases of
Merchandise
Purchase Discounts

Should discounts be taken when offered?

If cash is sitting idle and not generating

any return then discount should be taken

If cash is generating a return then

compare the income with the discount
amount and take the one with higher
advantage.
Examples of returns: Bank interests, Stock
profits, Bond interests etc.
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Recording Purchases of
Merchandise
Example:

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 Recording Purchases of
Merchandise
Summary of Purchasing Transactions

4th - Purchase $3,800 $300 8th - Return

6th Freight-in 150 70 14th - Discount

Balance $3,580

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Recording Sales of
Merchandise (Perpetual system)
Made using cash or credit (on account).

Normally recorded when earned, usually

when goods transfer from seller to buyer.

Sales invoice should support each credit

sale.

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 Recording Sales of
Merchandise
Journal Entries to Record a Sale

#1 Cash or Accounts receivable XXX Selling

Sales revenue XXX Price

#2 Cost of goods sold XXX

Cost
Inventory XXX

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Recording Sales of
Merchandise
Example: Assume PW Audio Supply records its May 4 sale
of $3,800 to Sauk Stereo on account (Illustration 5-5) as
follows. Assume the merchandise cost PW Audio Supply
$2,400.

May 4 Accounts receivable 3,800

Sales revenue 3,800

4 Cost of goods sold 2,400

Inventory 2,400

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 Recording Sales of
Merchandise
Sales Returns and Allowances
Flipside of purchase returns and allowances.

Customer/Client may be dissatisfied because goods are

damaged or defective, of inferior quality, or do not meet
specifications.

Contra-revenue account (Sales returns and allowances ) (debit).

Sales not reduced (debited) because:

Would obscure importance of sales returns and allowances

as a percentage of sales.

Could distort comparisons.

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 Recording Sales of
Merchandise
Example: Prepare the entry PW Audio Supply would make to
record the credit for returned goods that had a $300 selling
price (assume a $140 cost). Assume the goods were not
defective.

May 8 Sales returns and allowances 300

Accounts receivable 300

8 Inventory 140
Cost of goods sold 140

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 Recording Sales of
Merchandise
Example: Assume the returned goods were defective and
had a scrap value of $50, PW Audio would make the following
entries:

May 8 Sales returns and allowances 300

Accounts receivable 300

8 Inventory 50
Cost of goods sold 50

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 Recording Sales of
Merchandise
Sales Discount
Offered to customers to promote prompt payment.

Flipside of purchase discount.

Contra-revenue account (Sales discounts) (debit).

*(3800-300-70=3430)

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 Recording Sales of
Merchandise
Example: Assume Sauk Stereo pays the balance due of
$3,500 (gross invoice price of $3,800 less purchase returns
and allowances of $300) on May 14, the last day of the
discount period. Prepare the journal entry PW Audio Supply
makes to record the receipt on May 14.

May 14 Cash 3,430

Sales discounts 70*
Accounts receivable 3,500

* [($3,800 $300) X 2%]

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 Completing the Accounting
Cycle
Adjusting Entries
Generally the same as a service company.

One additional adjustment to make the records agree with

the actual inventory on hand.
In perpetual inventory system adjustment is required
only when records are incorrect due to recording errors,
theft or waste.

Involves adjusting Inventory and Cost of Goods Sold.

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 Completing the Accounting
Cycle
Example: Suppose that PW Audio Supply has an unadjusted
balance of $40,500 in Merchandise Inventory. Through a
physical count, PW Audio determines that its actual
merchandise inventory at year-end is $40,000. The company
would make an adjusting entry as follows.

Cost of goods sold 500

Inventory
500

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 Completing the Accounting
Cycle

Closing
Entries

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 Completing the Accounting
Cycle
Closing Entries

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 Forms of Financial
Statements
Multiple-Step Income Statement
Shows several steps in determining net income.

Two steps relate to principal operating activities.

Distinguishes between operating and non-operating activities.

The multi-step income statement involves the use of multiple sub-totals within
the income statement, which makes it easier for readers to aggregate selected
types of information within the report.

The usual subtotals are for the gross margin, operating expenses, and other
income, which allow readers to determine how much the company earns just
from its manufacturing activities (the gross margin), what it spends on supporting
operations (the operating expense total) and what component of its results do
not relate to its core activities (the other income total).

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 Forms of Financial
Statement
Multiple
Step Income
Statement
Key Items:
Net sales
Gross profit
Gross profit
rate

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 Forms of Financial
Statement
Multiple Step
Income
Statement
Key Items:
Net sales
Gross profit
Operating
expenses:
Operating expenses are
those expenditures that
a business incurs to
engage in any activities
not directly associated
with the production of
goods or services.
(Selling, general &
administrative exp)
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 Forms of Financial
Statement
Multiple-Step Income Statement
Key Items:
Net sales
Gross profit
Operating
expenses
Non-
operating
activities
Net income

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 Forms of Financial
Statement

Multiple-
Step
Income
Statement

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 Forms of Financial
Statement
Single-Step Income Statement
Subtract total expenses from total revenues

Two reasons for using the single-step format:

1. Company does not realize any profit until total

revenues exceed total expenses.

2. Format is simpler and easier to read.

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 Forms of Financial
Statement
Single-Step Income Statement

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 Forms of Financial
Statement
Classified Balance Sheet

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