Accounting for Merchandising

Companies
Merchandising Company
A merchandising business is one
that buys and sells goods in
order to make a profit.
Merchandise

The goods that a

company buys in order
to resell are known as
merchandise.
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
Additional accounts must be added to the Chart of Accounts for
a merchandising company.
Account Title Type of Account Normal Balance Purpose
Merchandise Asset Debit To account for the value of
Inventory 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 or
Allowances 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
Merchandise Transactions
Several types of transactions are common for
merchandising companies:

•Purchase of Merchandise
•Sale of Merchandise
•Purchase Return
•Sales Return
•Payment on Account
•Receipt on Account
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
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.
 PURCHASE RETURNS AND
ALLOWANCES
A purchaser may be dissatisfied with
merchandise received because the goods
1. are damaged or defective,
2. are of inferior quality, or
3. are not in accord with the
purchaser’s specifications.
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 RETURNS AND
ALLOWANCES

General Journal J1
Date Account Title and Explanation Ref Debit Credit
May 8 Accounts Payable 300
Merchandise Inventory 300
To record return of goods.

For purchases returns and allowances that were

originally made on account, Accounts Payable is
debited and Merchandise Inventory is credited.
For cash returns and allowances, Cash is debited
and Merchandise Inventory is credited.
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.
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
 Calculating a Purchase Discount
Examine this invoice. The credit terms for this invoice
indicate that if this invoice is paid
Invoice by June 25 (10 days after the invoice
Date: 6/15/03 date), the buyer may take a 2%
Terms: 2/10, n/30 discount on the merchandise price.
Purchase of Otherwise, the total amount due
20 books at ($265.00) must be paid by July 15.
$12.50 ea. $250.00
NOTE: Discounts are calculated
Shipping 15.00 on the merchandise cost only.
Total Due $265.00 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
Effect 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
Effect 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
In order to calculate the amount due on the invoice, first deduct
the amount of the purchase allowance.
Original Invoice Less Allowance Net Due
$265 - $50 = $215
Next, deduct the shipping cost in order to determine the
amount of the discount.

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).
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
 FREIGHT COSTS
• The sales agreement should indicate whether the seller or
the buyer is to pay the cost of transporting the goods to the
buyer’s place of business.
• FOB Shipping Point
1. Goods delivered to shipping point by seller
2. Buyer pays freight costs from shipping
point to destination
• FOB Destination
1. Goods delivered to destination by seller
2. Seller pays freight costs
 ACCOUNTING FOR
FREIGHT COSTS
• Merchandise Inventory is debited by the buyer, if the
buyer pays the freight bill (FOB shipping point).
• Freight Out (or Delivery Expense) is debited by the
seller, if the seller pays the freight bill (FOB
destination).
 ACCOUNTING FOR
FREIGHT COSTS

General Journal J1
Date Account Title and Explanation Ref Debit Credit
May 4 Merchandise Inventory 150
Cash 150
To record payment of freight.

When the purchaser directly incurs the freight

costs, the account Merchandise Inventory is
debited and Cash is credited.
 COMPLETING THE
ACCOUNTING CYCLE
• A merchandising company requires the same
types of adjusting entries as a service company,
with one additional adjustment for inventory to
ensure the recorded inventory amount agrees
with the actual quantity on hand.
• A physical count is an important control feature
since a perpetual system indicates what should be
there but a count will determine what is actually
there.
 COMPLETING THE
ACCOUNTING CYCLE
• A merchandising company also requires the same
types of closing entries as a service company.
• The additional accounts that need to be closed
out in a merchandising account include Sales,
Sales Returns and Allowances, Cost of Goods Sold,
and Freight Out.
• Merchandise Inventory is an asset account and is
not closed at the end of the period.
 ILLUSTRATION 5-9
STATEMENT PRESENTATION OF
SALES REVENUE SECTION
As contra revenue accounts, sales returns and
allowances (and sales discounts, if any) are
deducted from sales in the income statement to
arrive at Net Sales.

HIGHPOINT ELECTRONIC
Income Statement (Partial)
For the Year Ended December 31, 2002
Sales revenue
Sales $ 480,000
Less: Sales returns and allowances 20,000
Net sales $ 460,000
 ILLUSTRATION 5-10
CALCULATION OF GROSS PROFIT

Gross profit is calculated by deducting cost of goods

sold from net sales as follows:

Net
Net sales
sales $$ 460,000
460,000 100%
Cost
Cost of
of goods
goods sold
sold 316,000 69%
Gross
Gross profit
profit $ 144,000 31%

Gross profit is often expressed as a

percentage of sales.
 ILLUSTRATION 5-12
CALCULATION OF NET INCOME

Net income is calculated by deducting operating

expenses from gross profit as follows:

Gross profit $ 144,000

Operating expenses 114,000
Net income $ 30,000

Net income is the “bottom line” of a

company’s income statement.
 HIGHPOINT ELECTRONIC
Income Statement
ILLUSTRATION For the Year Ended December 31, 2002
Sales revenue
5-14 Sales $ 480,000
Less: Sales returns and allowances 20,000

This is the format Net sales

Cost of goods sold
460,000
316,000
of a multi-step Gross profit
Operating expenses
144,000

income statement Selling expenses

Salaries expense $ 45,000
that has both Advertising expense 16,000
Amortization expense 8,000
operating and non- Freight out 7,000

operating Total selling expenses

Administrative expenses
$ 76,000

activities. Rent expense

Utilities expense
$ 19,000
17,000
Insurance expense 2,000
Total administrative expenses 38,000
As shown, the non- Total operating expenses 114,000
Income from operations 30,000
operating activities Other revenue and gains
are reported Interest revenue
Gain on sale of equipment
$ 3,000
600
immediately after Total non-operating revenue and gain
Other expenses and losses
$ 3,600

the company’s Interest on expense $ 1,800

Casualty loss from vandalism 200
primary operating Total non-operating expense and loss 2,000
Net non-operating revenue 1,600
activities. Net income $ 31,600
 CLASSIFIED BALANCE SHEET
HIGHPOINT ELECTRONIC
Balance Sheet (partial)
December 31, 2002
Assets
Current assets On the balance sheet,
Cash merchandise inventory is $ 9,500
reported as a current asset
Accounts receivable 16,100
and appears immediately
Merchandise inventory below accounts receivable. 40,000
Prepaid insurance This is because current 1,800
Total current assets assets are listed in the 67,400
Capital assets order of their liquidity.
Store equipment $ 80,000
Less: Accumulated amortization 24,000 56,000
Total assets $ 123,400