ACCOUNTING FOR MERCHANDISING OPERATIONS

LECTURE 18 & 19

Maliha Rabeta
Lecturer
Department of Business Administration in
Finance and Banking
BUP

02 & 11 October 2022

MERCHANDIZING OPERATIONS

 Companies like Wal-Mart, and Amazon.com are called merchandising companies because they buy and
sell merchandise rather than perform services as their primary source of revenue.
 Merchandising companies that purchase and sell directly to consumers are called retailers.
 Merchandising companies that sell to retailers are known as wholesalers.
 The primary source of revenues for merchandising companies is the sale of merchandise, often
referred to simply as sales revenue or sales.
 A merchandising company has two categories of expenses: cost of goods sold and operating expenses.
 Cost of goods sold is the total cost of merchandise sold during the period. This expense is directly
related to the revenue recognized from the sale of goods.
INCOME MEASUREMENT PROCESS FOR A MERCHANDISING COMPANY

Not used in a Service

business.
OPERATING CYCLES

 The operating cycle of a merchandising company ordinarily is longer than that of a service company.
The purchase of merchandise inventory and its eventual sale lengthen the cycle.
FLOW OF COSTS
PERPETUAL SYSTEM
In a perpetual inventory system, companies keep detailed records of the cost of each inventory
purchase and sale. In a perpetual inventory system, companies keep detailed records of the cost of
each inventory purchase and sale.

▪ Purchases increase Merchandise Inventory.

▪ Freight costs, Purchase Returns and Allowances and Purchase Discounts are included in
Merchandise Inventory.
▪ Cost of Goods Sold is increased and Merchandise Inventory is decreased for each sale.
▪ Physical count done to verify Merchandise Inventory balance.

The perpetual inventory system provides a continuous record of Merchandise Inventory and Cost
of Goods Sold. Under a perpetual inventory system, a company determines the cost of goods sold
each time a sale occurs.
PERIODIC SYSTEM
In a periodic inventory system, companies do not keep detailed inventory records of the goods on hand
throughout the period. Instead, they determine the cost of goods sold only at the end of the accounting
period—that is, periodically. At that point, the company takes a physical inventory count to determine the
cost of goods on hand.
1. Purchases of merchandise increase
Purchases.
To determine the cost of goods sold under a 2. Ending Inventory determined by physical
periodic inventory system, the following steps count.
are necessary: 3. Calculation of Cost of Goods Sold:
1. Determine the cost of goods on hand at
the beginning of the accounting period. Beginning inventory $ 100,000
Add: Purchases, net + 800,000
2.Add to it the cost of goods purchased. Goods available for sale 900,000
Less: Ending inventory - 125,000
3. Subtract the cost of goods on hand at the
end of the accounting period. Cost of goods sold $ 775,000
RECORDING PURCHASES OF MERCHANDISE

 Made using cash or credit (on account).

 Normally recorded when goods are received.
 Purchase invoice should support each credit purchase.
RECORDING PURCHASES OF MERCHANDISE
Under the perpetual inventory system, companies record in the Merchandise Inventory account the
purchase of goods they intend to sell.

Illustration: From INVOICE NO. 731 (Illustration 5-5) record the journal entry Sauk Stereo (Pembeli)
would make to record its purchase from PW Audio Supply.

May 4 Merchandise inventory 3,800

Accounts payable 3,800
FREIGHT COSTS – TERMS OF SALE
The sales agreement should indicate who (i.e. the seller or the buyer) is to pay for transporting the goods to the buyer’s
place of business. When a common carrier such as a railroad, trucking company, or airline transports the goods, the
carrier prepares a freight bill in accord with the sales agreement. Freight terms are expressed as either FOB shipping
point or FOB destination.

Seller places goods Free On

Board the carrier, and buyer
pays freight costs.

Seller places goods Free On

Board to the buyer’s place of
business, and seller pays freight
costs.
Illustration: Assume upon delivery of the goods on May 6, Sauk Stereo pays Acme Freight Company
€150 for freight charges, the entry on Sauk Stereo’s (Pembeli) books is:

May 6 Merchandise inventory 150

Cash 150

2. Now, 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 (Penjual) Supply would have been:

May 4 Freight-out (or Delivery Expense) 150

Cash 150
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 May choose to keep the
sale was made on credit, or for a merchandise if the seller will
cash refund if the purchase was grant an allowance (deduction)
for cash. from the purchase price.

Illustration: Assume that on May 8 Sauk Stereo (Pembeli) returned to PW

Audio Supply goods costing €300.

May 8 Accounts payable 300

Merchandise inventory 300

 PURCHASE DISCOUNT

Credit terms may permit buyer to claim a cash discount for prompt payment.
Advantages:
▪ Purchaser saves money.
▪ Seller shortens the operating cycle.

Example: Credit terms of ‘2/10, n/30’, is read “two-ten, net thirty.” 2% cash discount if payment is made
within 10 days.
PURCHASE DISCOUNT TERMS

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

2% discount if paid 1% discount if paid Net amount due

within 10 days, within first 10 days of within the first 10
otherwise net next month. days of the next
amount due within month.
30 days.
Illustration: 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
(Pembeli) makes to record its May 14 payment.

May 14 Accounts payable 3,500

Cash 3,430
Merchandise Inventory 70
Illustration: 2. If Sauk Stereo failed to take the discount, and instead made full payment of €3,500 on June 3,
the journal entry would be:

June 3 Accounts payable 3,500

Cash 3,500
RECORDING SALES OF MERCHANDISE

 Made for cash or credit (on account).

 Normally recorded when earned, usually when
goods transfer from seller to buyer.
 Sales invoice should support each credit sale.
 RECORDING SALES OF MERCHANDISE

Two Journal Entries to Record a Sale

#1 Cash or Accounts receivable XXX Selling

Sales XXX Price

#2 Cost of goods sold XXX Cost

Merchandise inventory XXX
RECORDING SALES OF MERCHANDISE

Illustration: Assume PW Audio Supply (Penjual) records its May 4 sale of €3,800 to Sauk
Stereo (Illustration 5-5) as follows. Assume the merchandise cost PW Audio Supply €2,400.

May 4 Accounts receivable 3,800

Sales 3,800

4 Cost of goods sold 2,400

Merchandise inventory 2,400
SALES RETURNS AND ALLOWANCES

▪ “Flipside” of purchase returns and allowances.

▪ Contra-revenue account (debit).
▪ Sales not reduced (debited) because:

✓ would obscure importance of sales returns and allowances as a percentage of sales.

✓ could distort comparisons between total sales in different accounting periods.

RECORDING SALES OF MERCHANDISE

Illustration: 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 Merchandise inventory 140

Cost of goods sold 140
RECORDING SALES OF MERCHANDISE

Illustration: 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 Merchandise inventory 50
Cost of goods sold 50
SALES DISCOUNT
 Offered to customers to promote prompt payment.
 “Flipside” of purchase discount.
 Contra-revenue account (debit).
Illustration: 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 * [(€3,800 – €300) X 2%]

Accounts receivable 3,500

 ADJUSTING ENTRIES

▪ Generally the same as a service company.

▪ One additional adjustment to make the records agree with the actual inventory on hand.
▪ Involves adjusting Merchandise Inventory and Cost of Goods Sold.

Illustration: 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

Merchandise inventory 500
INCOME STATEMENT PRESENTATION OF SALES

 Primary source for evaluating a company’s performance.

 Format designed to differentiate between the various sources of income and expense.
GROSS PROFIT
FORMS OF FINANCIAL STATEMENTS

IFRS allows presentation by nature and

presentation by function.

Operating Expenses
FORMS OF FINANCIAL STATEMENTS

Various revenues and gains and expenses and

losses that are unrelated to the company’s
main line of operations.

Other Income and Expense

FORMS OF FINANCIAL STATEMENTS

Interest expense, if
material, must be
disclosed on the face of
the income statement.

Interest Expense
FORMS OF FINANCIAL STATEMENTS: CLASSIFIED STATEMENT OF FINANCIAL
POSITION
 PERIODIC INVENTORY SYSTEM

▪ Separate accounts used to record purchases, freight costs, returns, and discounts.
▪ Company does not maintain a running account of changes in inventory.
▪ Ending inventory determined by physical count.

COMPARISON OF ENTRIES-PERPETUAL VS. PERIODIC

COMPARISON OF ENTRIES-PERPETUAL VS. PERIODIC
PERIODIC INVENTORY SYSTEM

Calculation of Cost of Goods Sold