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CHAPTER 5 ACCOUNTING FOR MERCHANDISE OPERATIONS C HAPTER O UTLINE

Chapter Preview
§ Merchandising is one of the largest and most influential
industries in the world. It is likely that a number of you will
work for a merchandiser. Therefore, understanding the
financial statements of merchandising companies is
important. In this chapter, you will learn the basics about
reporting merchandising transactions. In addition, you will
learn how to prepare and analyze a commonly used form of
the income statement.

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LEARNING O BJECTIVE 5.1 INCOME MEASUREMENT
DESCRIBE MERCHANDISING OPERATIONS AND INVENTORY SYSTEMS
q Merchandising Companies
q Buy and Sell Goods

Retailer

Wholesaler Consumer
q Cost of goods sold is the
q The primary source of revenues is referred to as sales revenue or sales. total cost of merchandise
sold during the period.

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TRANSACTIONS IN A MERCHANDISING COMPANY
1. Merchandise inventory is purchased 2. Payments are made for
for cash or on credit/On Account purchases on credit

Purchase for cash

OPERATING CYCLES
Payment Accounts Purchase Merchandise
Cash
of cash Payable on credit Inventory

Sales for cash

Collection Accounts Sales

of cash Receivable on credit
3. Merchandise is sold for 4. Cash is collected from
cash or on credit credit sales

Goods
Transfer ownership of
goods and money
Money

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FLOW OF COSTS PERPETUAL INVENTORY SYSTEM VS PERIODIC INVENTORY SYSTEM
q Perpetual System q Periodic System
• Maintain detailed records § Does not keep detailed
of the cost of each records of goods on hand
inventory purchase and
§ Cost of goods sold
sale
determined by count
• Records continuously
§ Calculation of Cost of
show inventory that Goods Sold:
should be on hand for
every item
Beginning inventory €100,000
• Company determines Add: Purchases, net 800,000
cost of goods sold each
time a sale occurs Goods available for sale 900,000
q Companies use either a perpetual inventory system or
Less: Ending inventory 125,000
a periodic inventory system to account for inventory. Cost of goods sold €775,000

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PERPETUAL INVENTORY SYSTEM VS PERIODIC INVENTORY SYSTEM
Advantages of the
Perpetual System
§ Traditionally used for
merchandise with high
unit values
§ Shows quantity & cost
of inventory on hand at
any time
§ Provides better control
over inventories than a
periodic system
DO IT! 1 MERCHANDISING OPERATIONS AND INVENTORY SYSTEMS
Indicate whether the following statements are true or false. If false, indicate
how to correct the statement.
1. Theprimarysourceofrevenueforamerchandisingcompanyresultsfromperform
ingservices for customers.
2. The operating cycle of a service company is usually shorter than that of a
merchandising company.
3. Sales revenue less cost of goods sold equals gross profit.
4. Ending inventory plus the cost of goods purchased equals cost of goods
available for sale.

Solution
ACTION PLAN
•1.Review
False. merchandising
The primary source of revenue for a service company results from
concepts.
performing services for customers. 2. True. 3. True. 4. False. Beginning
• Understand the flow of costs in a merchandising company.
inventory plus the cost of goods purchased equals cost of goods available for
sale.

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LEARNING O BJECTIVE 5.2 PURCHASE INVOICE – JOURNAL ENTRIES
RECORD PURCHASES UNDER A PERPETUAL SYSTEM
Illustration: Sauk Stereo (the buyer) uses as a
• Made using cash or credit (on account) purchase invoice the sales invoice prepared by
PW Audio Supply, Inc. (the seller). Prepare the
journal entry for Sauk Stereo for the invoice from
• Normally record when goods are received from the seller PW Audio Supply.

• Purchase invoice should support each credit purchase

Journal entry:

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FREIGHT COSTS FREIGHT COSTS - ILLUSTRATION

Assume upon delivery of the goods on May 6, Sauk Stereo pays Public Freight
Company €150 for freight charges, the entry on Sauk Stereo’s books is:

q Ownership of the goods passes to q Ownership of the goods

the buyer when the public carrier remains with the seller until the Assume the freight terms on the invoice on slide number 13 had required PW Audio
accepts the goods from the seller. goods reach the buyer. Supply to pay the freight charges, the entry by PW Audio Supply would be:

q Freight costs incurred by the seller are an operating expense.

Note: FOB = Free on Board

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PURCHASE RETURNS AND ALLOWANCES PURCHASE DISCOUNTS
q Purchaser may be dissatisfied because goods are
q Credit terms may permit buyer to claim a cash discount for prompt payment.
damaged or defective, of inferior quality, or do not meet
q Advantages:
specifications.
q Purchase Return • Purchaser saves money
q Return goods for credit if the sale was made on credit, or for • Seller shortens the operating cycle by converting the accounts receivable into
a cash refund if the purchase was for cash. cash earlier
q Purchase Allowance Example: Credit terms may read 2/10, n/30.
Review Question
q May choose to keep the merchandise if the seller will grant a
In a perpetual inventory
reduction of the purchase price.
system, a return of
defective merchandise by 2/10, n/30: 2% discount if paid within 10 days, otherwise net amount
Illustration: Assume Sauk Stereo returned goods a purchaser is recorded by due within 30 days.
costing €300 to PW Audio Supply on May 8. crediting:
1/10 EOM: 1% discount if paid within first 10 days of next month.
a. Purchases
n/10 EOM: Net amount due within the first 10 days of the next month.
May 8 Accounts Payable 300 b. Purchase Returns
EOM = End of Month
Inventory 300 c. Purchase Allowance

d. Inventory

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PURCHASE DISCOUNTS - ILLUSTRATION EXAMPLE OF TRADING TERMS
Assume Sauk Stereo pays the balance due of €3,500 (gross invoice price of €3,800 less
Catalog price
Catalog price 100 Not in bookeeping
100
purchase returns and allowances of €300) on May 14, the last day of the discount period.
Prepare the journal entry Sauk Stereo makes on May 14 to record the payment. Trade discount
Trade discount 20%
20% 20
20 system Seller
Seller Buyer
Buyer
Sales price
Sales price 80 Sales Purchases
(3,800 – 300 = 3,500)
Returns
Returns 10 Sales Returns Purchases Returns
(3,500*98% = 3,430)
(3,500*2% = 70) 70
Credit Discount
Credit Discount 2%
2% 1.4 Sales Discounts Purchases Discounts
Cash 68.6 Cash Receipts Cash Payments
Cash

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SUMMARY OF PURCHASING TRANSACTIONS DO IT! 2 PURCHASE TRANSACTIONS
On September 5, Zhu Company buys merchandise on account from Gao Company.
The purchase price of the goods paid by Zhu is ¥15,000, and the cost to Gao
Company is ¥8,000. On September 8, Zhu– returns defective goods with a selling
price of ¥2,000. Record the transactions on the books of Zhu– Company.
ACTION PLAN
• Purchaser records goods at cost.
• When goods are returned, purchaser reduces Inventory.

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LEARNING O BJECTIVE 5.3
RECORD SALE UNDER A PERPETUAL SYSTEM J OURNAL E NTRIES
• Sales may be made on credit or for cash TO R ECORD A S ALE
• Sales revenue, like service revenue, is recorded when the performance obligation
is satisfied Illustration: PW Audio
• Performance obligation is satisfied when goods are transferred from seller to buyer Supply records its May
• Sales invoice should support each credit sale 4 sale of €3,800 to
Sauk Stereo (see
Illustration 5.6) as
Output voucher Cash follows (assume the
Warehouse merchandise cost PW
Accounts
Audio Supply €2,400).
Invoice Receivable
Transfer ownership of
goods for money

Costs of Sales Revenues

goods sold
Revenue deduction

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JOURNAL ENTRIES TO RECORD A SALE SALES RETURNS AND ALLOWANCES

Goods => Costs of goods sold

Transfer ownership • “Flip side” of purchase returns and allowances
of goods for money • Contra revenue account to Sales Revenue (debit)
Money => Sales Revenues
• Sales Revenue is not reduced (debited) because:
§ Would obscure importance of sales returns and allowances as
a percentage of sales
§ Could distort comparisons

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SALES RETURNS AND ALLOWANCES SALES DISCOUNTS
Illustration: Prepare the entry PW Audio Supply would make to record the credit for returned •Offered to customers to promote prompt payment of balance due
goods that had a €300 selling price (assume a €140 cost). Assume the goods were not defective •Contra-revenue account (debit) to Sales Revenue
Assume Sauk Stereo pays the balance due of €3,500 (gross invoice price of €3,800 less
May 8 Sales Returns and Allowance 300
purchase returns and allowances of €300) on May 14, the last day of the discount period.
Accounts Receivable 300
Prepare the journal entry PW Audio Supply makes to record the receipt on May 14.
May 8 Inventory 140
May 14 Cash 3,430
Cost of Goods Sold 140
Sales Discounts *[(€3,800 − €300) × 2%] 70*
Illustration: Assume the returned goods were defective and had a Accounts Receivable 3,500
scrap value of €50, PW Audio would make the following entries:

May 8 Sales Returns and Allowance 300

Accounts Receivable 300

May 8 Inventory 50
Cost of Goods Sold 50

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DO IT! 3 SALES TRANSACTIONS LEARNING O BJECTIVE 5.4
On September 5, Zhu Company buys merchandise on account from Gao Company. The selling price of the
goods is ¥15,000, and the cost to Gao Company was ¥8,000. On Sep. 8, Zhu returns defective goods with a
selling price of ¥2,000 and a fair value of ¥300. Record the transactions on the books of Gao Company.
APPLY THE STEPS IN THE ACCOUNTING CYCLE TO A MERCHANDISING COMPANY
ACTION PLAN
• Seller records both
the sale and the cost • Each of the required steps described in Chapter 4 for service
of goods sold at the companies apply to merchandising companies.
time of the sale.
• the seller records
the return in a contra • A merchandising company generally has the same types of adjusting
account, Sales entries as a service company.
Returns and
Allowances, and
reduces Accounts • However, a merchandiser using a perpetual system will require one
Receivable. additional adjustment to make the records agree with the actual
• Any goods
inventory on hand.
returned increase
Inventory and
reduce Cost of
Goods Sold.

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ADJUSTING ENTRIES CLOSING ENTRIES
• Generally same as a service company Close R/E accounts having Credit Balances
• One additional adjustment to make records agree with actual inventory on hand
Dec. 31 Sales Revenue 480,000
• Involves adjusting Inventory and Cost of Goods Sold
Income Summary 480,000
(Close credit balance accounts)
Illustration: Suppose that PW Audio Supply has an unadjusted balance of €40,500 in
Inventory. Through a physical count, PW Audio Supply determines that its actual merchandise 31 Income Summary 450,000
inventory at December 31 is €40,000. The company would make an adjusting entry as follows. Cost of Goods Sold 316,000
Salaries and Wages Expense 64,000
Dec. 31 Cost of Goods Sold 500 Utilities Expense 17,000
Inventory (€40,500 − €40,000) 500 Advertising Expense 16,000
Sales Returns and Allowances 12,000
Inventory Cost of Goods Sold Sales Discounts 8,000
Unadj. Bal. 40,500 Unadj. Bal. xx Depreciation Expense 8,000
Adjustment 500 Adjustment 500 Freight-Out 7,000
Adjusted Bal. 40,000 Adjusted Bal. xx+500 Insurance Expense 2,000
(Close debit balance accounts)

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CLOSING ENTRIES DO IT! 4 CLOSING ENTRIES
The trial balance of Celine’s Sports Wear Shop at December 31 shows Inventory €25,000, Sales Revenue
€162,400, Sales Returns and Allowances €4,800, Sales Discounts €3,600, Cost of Goods Sold €110,000, Rent
Revenue €6,000, Freight-Out €1,800, Rent Expense €8,800, and Salaries and Wages Expense €22,000.
Dec. 31 Income Summary 30,000 Prepare the closing entries for the above accounts.
Retained Earnings 30,000 ACTION PLAN
(To close net income to retained earnings) • Close all
temporary
31 Retained Earnings 15,000 accounts with
credit balances to
Dividends 15,000 Income Summary
(To close dividends to retained earnings) by debiting these
accounts.
• Close all
temporary
accounts with debit
balances, except
Dividends, to
Income Summary
by crediting these
accounts.

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SUMMARY OF MERCHANDISING ENTRIES SUMMARY OF MERCHANDISING ENTRIES

To close net income to retained Income Summary X

earnings) Retained Earnings X

(To close dividends to retained Retained Earnings X

earnings) Dividends X

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LEARNING O BJECTIVE 5.5 INCOME STATEMENT

PREPARE FINANCIAL STATEMENTS FOR A Gross Profit

MERCHANDISING COMPANY On the basis of the sales data for PW Audio Supply (net sales of €460,000)
and cost of goods sold under the perpetual inventory system (assume
Income Statement Presentation of Sales €316,000), PW Audio Supply’s gross profit is €144,000, computed as shown.
The income statement begins by presenting sales revenue. It then
deducts contra revenue accounts—sales returns and allowances
and sales discounts—from sales revenue to arrive at net sales.

We also can express a company’s gross profit as a percentage, called the gross profit rate.

Gross Profit ÷ Net Sales = Gross Profit Rate

€144,000 ÷ €460,000 = 31.3%

Analysts generally consider the gross profit rate to be more useful than the gross profit amount.

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INCOME STATEMENT INCOME STATEMENT
Other Income and Expense
Operating Expenses Incurred in the process of earning sales revenue.
Operating expense for PW Audio Supply include the following. Various revenues and gains and expenses and losses that are unrelated to
the company’s main line of operations.
(including Selling Expense and Administrative Expense) Other Income
• Interest revenue from notes receivable and marketable securities
Operating expenses • Dividend revenue from investments in capital stock
Salaries and wages expense € 64,000 • Rent revenue from subleasing a portion of the store
• Gain from the sale of property, plant, and equipment
Utilities expense 17,000
Advertising expense 16,000 Other Expense
• Casualty losses from such causes as vandalism and accidents
Depreciation expense 8,000
• Loss from sale or abandonment of property, plant, and equipment
Freight-out 7,000 • Loss from strikes by employees and suppliers
Insurance expense 2,000
Total operating expenses €114,000 Interest expense, if material, must be disclosed on the face of the income statement.

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COMPREHENSIVE INCOME STATEMENT
INCOME STATEMENT
q Presents items not included in the determination of net income.
q Items included in comprehensive income are either reported in a
combined statement of net income and comprehensive income, or
in a separate comprehensive income statement.

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CLASSIFIED STATEMENT OF FINANCIAL POSITION DO IT! 5 FINANCIAL STATEMENT CLASSIFICATIONS
ACTION PLAN You are presented with the following list of accounts from the adjusted trial balance for
merchandiser Gorman Company. Indicate in which financial statement (income statement, IS;
• Review the major statement of financial position, SFP; or retained earnings statement, RES) and under what
sections of the income classification each of the following would be reported.
statement: sales, cost of
goods sold, operating
expenses, other income
and expense, and
interest expense.
• Add net income to
beginning retained
earnings and deduct
dividends to arrive at
ending retained earnings
in the retained earnings
statement.
• Review the major
sections of the statement
of financial position,
income statement,
and retained earnings
statement.

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DO IT! 5 FINANCIAL STATEMENT CLASSIFICATIONS
ACTION PLAN You are presented with the following list of accounts from the adjusted trial balance for
merchandiser Gorman Company. Indicate in which financial statement (income statement,
• Review the major IS; statement of financial position, SFP; or retained earnings statement, RES) and under what
sections of the income classification each of the following would be reported.
statement: sales, cost of
goods sold, operating
expenses, other income
and expense, and
interest expense.
• Add net income to
beginning retained
earnings and deduct
dividends to arrive at
ending retained earnings
in the retained earnings
statement.
• Review the major
sections of the statement
of financial position,
income statement,
and retained earnings
statement.

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