Financial Accounting

MGCR 211

Chapter 5
Merchandising Operations

Prof. Jingjing Zhang

 The Rest of the Semester

Chapter 10
Chapter 7
Chapter 12
Chapter 8
Chapter 8
Chapters 5&6

Chapter 12 Chapter 11
Chapter 9
Chapter 9
Chapter 9

Statement of cash flows Chapter 13

Performance measurement Chapter 14

Midterm 2
Overview of Chapter 5
5.1 Merchandising 5.2 Recording
operations and purchases of
inventory systems merchandise

5.3 Recording 5.4 Statement of

sales of income
merchandise presentation

5.5 Evaluating
profitability

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 5.1 Types of Businesses

Inventory: raw materials, work

No inventory Inventory
in process, finished goods
Focus of
Chapters 5 & 6 Managerial & Cost Accounting

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5.1 Income Measurement Process

The difference between

sales revenue and COGS

The total cost of merchandise

sold during the period

The expenses incurred in the

process of earning sales revenue
(e.g., salaries, insurance, utilities,
depreciation)

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5.1 Flow of Costs and Inventory Systems

Inventory
Beginning Inventory
Cost of Goods
Available for Sale Cost of Goods Purchased Cost of Goods Sold Statement of Income

Ending Inventory

Statement of Financial Position The equation: BI + P – COGS = EI

• Inventory system is used to determine what goods are available for sale (inventory) and
what goods have been sold (COGS)
• Companies use either a perpetual inventory system or a periodic inventory system to
account for inventory and COGS
• We focus on perpetual inventory systems

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 5.2 Cost of Goods Purchased
• Purchases are recorded in the Inventory account
• Costs of the inventory purchased
– Purchase price
– Freight costs incurred by the buyer
– Handling costs Debit Inventory
– Insurance costs
• Purchase costs are reduced by
– Purchase returns and allowances
Credit Inventory
– Discounts

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 5.2 Purchase Price
Sauk Communications Ltd. (the buyer), which sells radio communication products,
purchased 13 radios on May 2 from PW Technologies Inc. (the seller). Sauk
Communications received the related invoice in the amount of $3,900 on the same day.

May 2 Inventory 3,900

Accounts Payable 3,900
(To record goods purchased on account from PW Technologies)

Inventory Accounts Payable

Purchase price May 2 3,900 May 2 3,900

May 2 3,900 May 2 3,900

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 5.2 Freight Costs
• Ownership of the goods remains
with the seller until the goods reach
the buyer
• The seller pays the freight costs and
is responsible for any loss or
damage that occurs during transit
• The goods are included in the
seller’s inventory until they are
delivered
* FOB means “free on board” until the point where ownership is transferred
• Ownership of the goods passes to the
buyer when the public carrier accepts
the goods from the seller
• The buyer pays the freight costs and
is responsible for any loss or damage
that occurs during transit
• The goods become part of the buyer’s
inventory at the point of shipping
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 5.2 Freight Costs
The terms of the sale of the radios from PW Technologies to Sauk Communications are FOB
shipping point. PW Technologies shipped the merchandise to Sauk Communications on May 2.
Upon delivery of the goods on May 4, Sauk Communications pays CanTruck Ltd. $150 for
freight charges.
May 4 Inventory 150
Cash 150
(To record payment of freight on goods purchased)

Inventory Accounts Payable

Purchase price May 2 3,900 May 2 3,900

Freight costs May 4 150
May 4 4,050 May 2 3,900

What if the terms were FOB destination?

• Sauk Communications would have no entry to record for freight
• Sauk Communications would record the purchase of these goods on May 4 instead of May 2
• PW Technologies would record the freight cost it paid on outgoing merchandise

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 5.2 Purchase Returns and Allowances

Purchase Return
Return goods for credit if the sale was made on credit, or for a cash
refund if the purchase was for cash

Purchase Allowance
May choose to keep the merchandise if the seller will grant a reduction
of the purchase price

In both cases, the result is a decrease (credit) to the Inventory account

to reflect the decrease in the cost of goods purchased

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 5.2 Purchase Returns and Allowances
Assume that Sauk Communications returned one of the radio it purchased to PW
Technologies on May 8. The returned radio had cost Sauk Communications $300.
Because these goods were originally sold on account, Sauk Communications received a
credit from PW Technologies for the return of this merchandise.

May 8 Accounts Payable 300

Inventory 300
(To record return of goods to PW Technologies)

Inventory Accounts Payable

Purchase price May 2 3,900 May 8 300 Purchase return May 8 300 May 2 3,900
Freight costs May 4 150
May 8 3,750 May 8 3,600

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 5.2 Discounts
• A quantity discount gives a price
reduction according to the volume of the
purchase
– Not recorded separately
– Discounted price is recorded as cost of
purchase
• A purchase discount is offered to
encourage early payment of a balance
due
– Recorded separately when payment made
Net: invoice price less any
– Results in a decrease (credit) to Inventory returns or allowances

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 5.2 Quantity Discount
Sauk Communications Ltd. (the buyer), which sells radio communication products,
purchased 13 radios on May 2 from PW Technologies Inc. (the seller). Sauk
Communications received the related invoice in the amount of $3,900 on the same day.

May 2 Inventory 3,900

Accounts Payable 3,900
(To record goods purchased on account from PW Technologies)

If PW Technologies offers a 10% price discount on orders of five or more pieces of

equipment.

Price costs $3,510 = $3,900 × (1 – 10%)

May 2 Inventory 3,510
Accounts Payable 3,510
(To record goods purchased on account with a quantity discount from PW Technologies)

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 5.2 Purchase Discounts
Assume that the credit terms were 2/10, n/30. If Sauk Communications wanted to settle its
payable on May 12, the last day of the discount period, the entry to record the payment would be:

May 12 Accounts Payable 3,600

Cash 3,528
Inventory 72
(To record payment to PW Technologies)

(1) 3,900 Gross invoice price

(2) 300 Purchase returns
(3) = (1) – (2) 3,600
(4) 98% After the 2% discount
(5) = (3) × (4) 3,528

Inventory Accounts Payable

Purchase price May 2 3,900 May 8 300 Purchase return May 8 300 May 2 3,900
Freight costs May 4 150 May 12 72 Purchase discount May 12 3,600
May 12 3,678 May 12 0

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 5.2 Purchase Discounts
If Sauk Communications failed to take the discount and instead made full payment of
$3,600 on June 1 (30 days after the date of sale), Sauk Communications would make
the following entry:

June 1 Accounts Payable 3,600

Cash 3,600
(To record payment to PW Technologies)

To take or not to take the discount?

• Passing up the discount, Sauk Communication would be paying 2% for the use of $3,600 for 20 days,
equivalent to a 0.1% per day (2% ÷ 20) or an annual interest rate of 36.5% (0.1% × 365)
• Customer usually pay within the discount period because the savings are substantial

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5.2 Summary of Purchase Transactions
Inventory
Purchase price May 2 3,900 May 8 300 Purchase return
Freight costs May 4 150 May 12 72 Purchase discount
May 31 3,678

Represents the cost of the goods purchased

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 5.2 Adjusting Entry at Period End
• For control purposes, a physical inventory count is always taken at least
once a year
• Compare the inventory amount actually on hand with the inventory records
• Any differences that are found can be investigated and adjusted
• To adjust for inventory shortages

Cost of Goods Sold XX

Inventory XX

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 5.2 Adjusting Entry at Period End
Assume that PW Technologies’ physical inventory count on December 31, 2024, its
year end, determines that the cost of its goods on hand, or ending inventory, is $40,000.
However, its inventory records indicate that there should be goods with a cost of
$42,000 on hand. This $2,000 difference likely represents the theft. The following entry
would be made to adjust inventory assuming that PW Technologies records adjusting
entries annually:

Dec. 31 Cost of Goods Sold 2,000

Inventory 2,000
(To adjust inventory to physical count)

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 In-Class Exercise 5-1
At the beginning of the year, Point Claire Shipping Ltd., a company that has a perpetual inventory
system, had $55,000 of inventory. During the year, inventory costing $220,000 was purchased. Of
this, $26,000 was returned to the supplier and a 5% discount was taken on the remainder. Freight
costs incurred by the company for inventory purchases amounted to $2,700. The cost of goods
sold during the year was $218,000.
a. Determine the balance in the Inventory account at the end of the year.

b. Prepare the adjusting entry that would be required if the inventory count determined that Point
Claire Shipping had inventory with a cost of $21,000 at the end of the year.

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 In-Class Exercise 5-1
At the beginning of the year, Point Claire Shipping Ltd., a company that has a perpetual inventory
system, had $55,000 of inventory. During the year, inventory costing $220,000 was purchased. Of
this, $26,000 was returned to the supplier and a 5% discount was taken on the remainder. Freight
costs incurred by the company for inventory purchases amounted to $2,700. The cost of goods
sold during the year was $218,000.
a. Determine the balance in the Inventory account at the end of the year.

Inventory

Beg. Bal. 55,000 26,000 Purchase return

Purchase 220,000 9,700* Purchase discount
Freight costs 2,700 218,000 Cost of goods sold
End. Bal. 24,000
* (220,000 – 26,000) × 5% = 9,700

b. Prepare the adjusting entry that would be required if the inventory count determined that Point
Claire Shipping had inventory with a cost of $21,000 at the end of the year.

Cost of Goods Sold 3,000

Inventory 3,000

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 Midterm 1 Exam
• The solutions and grading criteria will be posted on myCourses (in the
“Exams” folder) after today’s lecture
• Exam problems will be explained in Tutorial Session 3 (this Friday)
• For those who did better than expected
– Keep up the good work!
– But don’t get overconfident
– Midterm 2 WILL BE harder
• For those who did worse than expected
– Midterm 1 only accounts for 20%
– Take it as a practice for the more important exams (Midterm 2: 25%; Final: 45%)
– Don’t give up on accounting yet!