A merchandising business is one that buys and sells goods in order to make a profit

The goods that a company buys in order to resell are known as merchandise.
Nature of Merchandising Businesses
The activities of a service business differ from those of a merchandising business. These differences are
illustrated in the following condensed income statements

Service Business

Fees Earned P XX
Less: Operating Expenses (XX)
Net Income P XX

The revenue activities of a service business involve providing services to customers. On the income
statement for a service business, the revenues from services are reported as fees earned. The operating

Merchandising

Sales P XX
Less: Cost of merchandise sold (XX)
Gross profit XX
Less: Operating expenses (XX)
Net income P XX

expenses incurred in providing the services are subtracted from the fees earned to arrive at net income.
In contrast, the revenue activities of a merchandising business involve the buying and selling of
merchandise. A merchandising business first purchases merchandise to sell to its customers. When this
merchandise is sold, the revenue is reported as sales, and its cost is recognized as an expense .This
expense is called the cost of merchandise sold. The cost of merchandise sold is subtracted from sales to
arrive at gross profit. This amount is called gross profit because it is the profit before deducting
operating expenses. Merchandise on hand (not sold) at the end of an accounting period is called
merchandise inventory. Merchandise inventory is reported as a current asset on the balance sheet.

The Operating Cycle

The operations of a merchandising business involve the purchase of merchandise for sale (purchasing),
the sale of the products to customers (sales), and the receipt of cash from customers (collection). This
overall process is referred to as the operating cycle. Thus, the operating cycle begins with spending cash,
and it ends with receiving cash from customers. The operating cycle for a merchandising business is
shown to the right. Operating cycles for retailers are usually shorter than for manufacturers because
retailers purchase goods in a form ready for sale to the customer. Of course, some retailers will have
shorter operating cycles than others because of the nature of their products.

Accounting for Merchandise

Merchandise may be accounted for under one of two inventory methods:
•Perpetual Inventory
•Periodic Inventory
For this presentation, we will assume a perpetual inventory system.

CHART OF ACCOUNTS FOR A MERCHANDISING COMPANY

Account Title Type of Account Normal Balance Purpose
Merchandise Inventory Asset Debit To account for the value
of merchandise held for
sale
Sales Revenue Credit To account for the sale
of merchandise at the
sales price
Sales Returns and Contra-Revenue Debit To account for returned
Allowances or damaged
merchandise
Sales Discounts Contra-Revenue Debit To account for
discounts offered to
customers for prompt
payment
Cost of Goods Sold Expense Debit To account for the cost
of merchandise sold
Shipping Expense Expense Debit To account for the cost
of shipping
merchandise to
customers

•Purchase of Merchandise
Before it can be sold, Merchandise must be purchased. The seller of merchandise is more commonly
known as the vendor. The source document for a purchase of merchandise is the purchase invoice.
Journal Entry for a Purchase of Merchandise Jones Career Consulting purchased 24 books from XYZ
Publishing about developing a resume to resell to clients. The total purchase cost, including shipping,
was $265. The books were purchased on account. The journal entry to record this transaction in a
perpetual inventory system is as follows.
Merchandise Inventory 265 Accounts Payable-XYZ Pub 265
•Sale of Merchandise
Purchase Returns & Allowances
Sometimes merchandise must be returned to the vendor or an adjustment is made to the amount due
for the merchandise (allowance). The source document for a purchase return or allowance is the debit
memorandum.
Effect of Purchase Returns & Allowances
When a return is made or an allowance is granted for merchandise bought on account, the effect of the
transaction is to reduce the amount due to the Vendor (Accounts Payable) and to reduce the value of
Merchandise Inventory.
Journal Entry for a Purchase Return Jones Career Consulting returned 4 damaged books to XYZ
Publishing. The total value of the merchandise returned was $50. The journal entry to record this
transaction in a perpetual inventory system is as follows.
Accounts Payable-XYZ Pub 50
Merchandise Inventory 50
Journal Entry for a Purchase Allowance The most typical reason for a purchase allowance is damaged
merchandise. The journal entry to record a purchase allowance is the same as the entry to record a
purchase return. Assume that JCC discarded the 4 damaged books and received an allowance from the
vendor. The journal entry would be the same as the previous transaction as shown below.
Accounts Payable-XYZ Pub 50
Merchandise Inventory 50
•Purchase Return
Effect of Purchase Returns & Allowances
When a return is made or an allowance is granted for merchandise bought on account, the effect of the
transaction is to reduce the amount due to the Vendor (Accounts Payable) and to reduce the value of
Merchandise Inventory.
Journal Entry for a Purchase Return Jones Career Consulting returned 4 damaged books to XYZ
Publishing. The total value of the merchandise returned was $50. The journal entry to record this
transaction in a perpetual inventory system is as follows.
Accounts Payable-XYZ Pub 50 Merchandise Inventory 50
Journal Entry for a Purchase Allowance The most typical reason for a purchase allowance is damaged
merchandise. The journal entry to record a purchase allowance is the same as the entry to record a
purchase return. Assume that JCC discarded the 4 damaged books and received an allowance from the
vendor. The journal entry would be the same as the previous transaction as shown below.
Accounts Payable-XYZ Pub 50
Merchandise Inventory 50
 Purchase Discounts
Merchandise is often purchased on account. When this occurs, the business and the vendor must agree
on the credit terms. The credit terms determine when the invoice must be paid. Many vendors offer a
discount if the invoice is paid within a specified period of time that is less than the full credit term. When
you are the buyer receiving a discount, it is known as a purchase discount.

Purchase Discounts Discount terms are stated in the following way 2/10, n/30 This term is read “Two
ten, net thirty” and means that the buyer will receive a 2 percent discount on the purchase price if the
invoice is paid within ten days of the invoice date, else the total (net) is due within thirty days. Other
discount terms include 1/15, n/30 and 3/10, n/45
Examine this Invoice
Invoice Date: 6/15/03
Purchase of 20 books at $12.50 ea. $250.00
Shipping 15.00
Total Due $265.00
Terms: 2/10, n/30
The credit terms for this invoice indicate that if this invoice is paid by June 25 (10 days after the invoice
date), the buyer may take a 2% discount on the merchandise price. Otherwise, the total amount due
($265.00) must be paid by July 15. NOTE: Discounts are calculated on the merchandise cost only. If this
invoice is paid on June 15, the amount due would be $260.00. The discount of $5.00 ($250.00 * .02) is
deducted from the total due in determining the amount to pay.

Journal Entry for Payment with a Purchase Discount A compound entry is required to journalize the
entry to record payment of an invoice when the discount is taken. Assume that JCC pays the invoice of
6/15/03 on 6/22/03. Further assume that no merchandise has ever been returned or granted an
allowance. The journal entry to record the payment of the invoice is as follows.
Accounts Payable-XYZ Pub 265
Cash 260
Merchandise Inventory 5

Affect of Discount on Accounts Payable Notice that Accounts Payable is debited for $265 even though
the company was paid only $260. If Accounts Payable were not debited for the full amount of the
invoice, a balance of $5 would remain in this account. When a discount is granted, the purchaser pays
the amount of the invoice less the discount but is given credit by the creditor for the full amount.
Accounts Payable-XYZ Pub 265
Cash 260
Merchandise Inventory 5

Affect of Discount on Merchandise Inventory

Notice that the purchase discount is deducted directly from the Merchandise Inventory account. The
affect of a purchase discount is to reduce the cost of the merchandise purchased. This is accomplished
in the journal entry by crediting Merchandise Inventory.
Accounts Payable-XYZ Pub 265
Cash 260
Merchandise Inventory 5

Journal Entry for Payment with a Purchase Discount Now examine the journal entry when the allowance
for the four books is taken into account. Notice that the discount cannot be calculated on the amount of
the returned merchandise, and the balance of Accounts Payable has been reduced by the amount of the
return. (See the slide for Journal Entry for a Purchase Allowance if you need a reminder.)
Accounts Payable-XYZ Pub 215
Cash 211
Merchandise Inventory 4

Explanation of the Calculation of the Payment amount with a Purchase Discount and Allowance
Next, deduct the shipping cost in order to determine the amount of the discount.
Original Invoice Less Allowance Net Due $265 - $50 = $215
In order to calculate the amount due on the invoice, first deduct the amount of the purchase allowance.
Net Due Less Shipping Times Discount Rate Discount $215 - $15 X .02 = $4
The total due to XYZ is $211 ($215 less the $4 discount).
•Sales Return
Sale of Merchandise
The purpose of buying merchandise is to resell it, generally at a profit. The source document for a sale of
merchandise is the sales invoice.

Recording the Sale of Merchandise Two journal entries are required to record the sale of merchandise in
a PERPETUAL INVENTORY SYSTEM-1. The first entry records the sale of the merchandise and either the
receipt of cash or the account receivable. The amount used in this transaction is the sales price of the
merchandise. 2. The second entry records the reduction in merchandise and the recognition of an
expense for the cost of merchandise sold. The amount used in this transaction is the cost of the
merchandise.

Journal Entry for a Sale of Merchandise Jones Career Consulting sold 2 books to Harry Minor on account
for a total of $50. The total cost of the books sold was $25. The journal entries to record this
transaction in a perpetual inventory system are as follows.
Accounts Receivable-H. Minor 50
Sales 50

Cost of Merchandise Sold 25

Merchandise Inventory 25

 Sales Returns & Allowances

Just as merchandise is sometimes returned to the vendor or an adjustment is made to the amount due
for the merchandise (allowance), the seller must sometimes account for a sales return or allowance. The
source document for a sales return or allowance is the credit memorandum.

Recording a Sales Return or Allowance Recall that two journal entries are required to record the sale of
merchandise in a perpetual inventory system. Two journal entries are also required to record a sales
return or allowance.

1. The first entry recognizes the sales return or allowance and either the payment of cash or the
reduction of the account receivable. The amount used in this transaction is the sales price of the
merchandise returned or adjusted.

2. The second entry records the replacement of the merchandise in inventory and the reduction of the
expense for the cost of merchandise sold. The amount used in this transaction is the cost of the
merchandise.
Recording a Sales Return or Allowance
The essential affect of the journal entries to record a sales return or allowance is to reverse the original
entry to record the sale—it is as if the merchandise was never sold. The only difference is that instead of
reducing the Sales account, the amount of returns and allowances are kept up with in the Sales Returns
& Allowances account.
Journal Entry for a Sales Return or Allowance Harry Minor returned one book. The book had been sold
by JCC for $25. The cost of the book was $12.50. The journal entries to record this transaction in a
perpetual inventory system are as follows.
Sales Returns & Allowances 25.00 Accounts Receivable-Minor 25.00
Merchandise Inventory 12.50 Cost of Merchandise Sold 12.50
•Payment on Account
•Receipt on Account

 FOB – KRENZEL

KLEINT AND KRENZEL – DISCUSS PA NATIN NORMAL BALANCES

AND DIFF AND SIM OF PERIODIC AND PERPETUAL
CY AND JANICE – PREPARE NG PROBLEM NA MEDYO CHILL LANGSXZS

Contra-revenue account An account that is offset against a revenue account on the income statement.
Cost of goods sold The total cost of merchandise sold during the period
FOB destination Freight terms indicating that the seller places the goods free on board to the buyer’s
place of business,and the seller pays the freight.(p.205).
FOB shipping point Freight terms indicating that the seller places goods free on board the carrier, and
the buyer pays the freight costs.(p.205).
Gross profit The excess of net sales over the cost of goods sold.(p.214).
Gross profit rate Gross profit expressed as a percentage,by dividing the amount of gross profit by net
sales.(p.215).
Income from operations Income from a company’s principal operating activity; determined by
subtracting cost of goods sold and operating expenses from net sales.(p. 215).
Multiple-step income statement An income statement that shows several steps in determining net
income.(p. 214).
Net sales Sales less sales returns and allowances and less sales discounts.(p.214).
Nonoperating activities Various revenues,expenses,gains, and losses that are unrelated to a company’s
main line of operations.(p.215).
Operating expenses Expenses incurred in the process of earning sales revenues.(p.215).
Other expenses and losses A nonoperating-activities section of the income statement that shows
expenses and losses unrelated to the company’s main line of operations. (p.216).
Other revenues and gains A nonoperating-activities section of the income statement that shows
revenues andgains unrelated to the company’s main line of operations. (p.216).
Periodic inventory system An inventory system under which the company does not keep detailed
inventory records throughout the accounting period but determines the cost of goods sold only at the
end of an accounting period.(p.202).
Perpetual inventory system An inventory system under which the company keeps detailed records of
the cost of each inventory purchase and sale and the records continuously show the inventory that
should be on hand.(p. 201).