Accounting For Merchandising Businesses

Accounting for Merchandising Businesses
Chapter 6
Prepared by: C. Douglas Cloud
Professor Emeritus of Accounting
Pepperdine University
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Learning Objectives
Distinguish between the activities and financial

statements of service and merchandising
businesses.
Describe and illustrate the financial statements of
a merchandising business.
Describe and illustrate the accounting for
merchandise transactions including: sale of
merchandise; purchase of merchandise; freight;
sales taxes and trade discounts; dual nature of
merchandising transactions.
Describe the adjusting and closing process for a
merchandising business.
Learning Objectives
5. Describe and illustrate the use of the ratio of net
sales to assets in evaluating a company’s
operating performance.
Learning Objective 1

businesses.
LO 1
Nature of Merchandising Businesses
Service Business
Fees earned
$XXX
Operating expenses
–XXX
Net income
$XXX
LO 1
Merchandising Business
Sales $XXX
Cost of Merchandise Sold –XXX
Gross Profit $XXX
Operating Expenses –XXX
Net Income $XXX
LO 1
When merchandise is sold, the revenue is reported

as sales, and its cost is recognized as an expense
called cost of merchandise sold.
Gross
Profit
LO 1

 The cost of merchandise sold is subtracted from
sales to arrive at gross profit. It is the profit
before deducting operating expenses.
Gross
Profit
LO 1
Merchandise on hand (not sold) at the end of an

accounting period is called merchandise inventory.
EE 6-1
LO 1

businesses.
LO 2
Multiple-Step Income Statement
The multiple-step income statement contains

several sections, subsections, and subtotals.
LO 2
Revenue from Sales
LO 2
Revenue from Sales
Sales is the total amount charged customers for

merchandise sold, including cash sales and sales
on account.
LO 2
Revenue from Sales
Sales returns and allowances are granted by the

seller to customers for damaged or defective
merchandise.
LO 2
Revenue from Sales
Sales discounts are granted by the seller to

customers for early payment of amounts owed.
LO 2
Revenue from Sales
Net sales is determined by subtracting sales

returns and allowances and sales discounts from
sales.
LO 2
Cost of Merchandise Sold
The cost of merchandise sold is the cost of the

merchandise sold to customers. Merchandise costs
consist of all the costs of acquiring the
merchandise and readying it for sale, such as
purchase and freight costs.
LO 2
LO 2
The buyer may return merchandise to the seller

(purchase return), or the buyer may receive a
reduction in the initial price at which the
merchandise was purchased (purchase
allowance).
LO 2
You have seen that sellers may offer customers

sales discounts for early payment of their bills.
From the buyer’s perspective, such discounts are
referred to as purchase discounts.
LO 2
If merchandise inventory at the end of the period

is determined by taking a physical count of
inventory on hand, a periodic inventory system is
being used.
LO 2
Under the perpetual inventory system, the

amounts of inventory purchased, available for
sale, and sold are continuously (perpetually)
updated in the inventory records.
LO 2
Gross Profit
 Gross profit is computed by subtracting the cost
of merchandise sold from net sales.
Gross
Profit
LO 2
LO 2
Income from Operations
Selling expenses are  Sales salaries

incurred directly in the  Store supplies used
selling of merchandise.
 Depreciation of store
equipment
 Delivery expense
 Advertising expense
LO 2
Income from Operations
Administrative  Office salaries

expenses, sometimes  Depreciation of
called general expenses,
office equipment
are incurred in the
administration or  Office supplies used
general operations of the
business.
LO 2
LO 2
Income from operations, sometimes called

operating income, is determined by subtracting
operating expenses from gross profit.
LO 2
LO 2
Other Income and Expense
Other income is revenue from sources other than

the primary operating activity of a business.
Other expense is an expense that cannot be traced
directly to the normal operations of the business.
LO 2
LO 2
Single-Step Income Statement
An alternative form of income statement is the

single-step income statement. As shown in the next
slide, the income statement for NetSolutions
deducts the total of all expenses in one step from
the total of all revenues.
LO 2
Single-Step Income Statement
LO 2
Statement of Owner’s Equity
LO 2
Balance Sheet
The form of balance sheet with the assets on the

left-hand side and the liabilities and owner’s
equity on the right-hand side is called the account
form.
LO 2
Balance Sheet
 When the balance sheet is presented in a
downward sequence in three sections, it has been
prepared using the report form. This is the form
used in the next two slides.
LO 2
Balance Sheet
(continued)
LO 2
Balance Sheet

businesses.
merchandising transactions including: sale of
merchandise; purchase of merchandise; freight;
sales taxes and trade discounts; dual nature of
LO 3
Chart of Accounts
LO 3
Cash Sales
On January 3, NetSolutions sold $1,800 of

merchandise for cash.
LO 3
Cash Sales
Using the perpetual inventory system, the cost

of merchandise sold and the decrease in
merchandise inventory are also recorded. The
cost of merchandise sold on January 3 is
$1,200.
LO 3
Cash Sales
Sales made to customers using credit cards are

recorded as cash sales. Assume that NetSolutions
paid credit card processing fees of $48 on
January 31.
LO 3
Sales on Account
On January 12, NetSolutions sold merchandise

on account for $510. The cost of merchandise
sold was $280.
LO 3
Sales Discounts
 The terms for when payments for merchandise

are to be made are called credit terms. If
payment is required on delivery, the terms are
cash or net cash. Otherwise, the buyer is allowed
an amount of time, known as the credit period,
in which to pay.
LO 3
Invoice
LO 3
Credit Terms
To encourage the buyer to pay before the end of

the credit period, the seller may offer a discount.
Credit terms of 2/10, n/30 are summarized in the
next slide (Exhibit 7).
LO 3
LO 3
Receipts on Account
On January 17, NetSolutions receives the amount

due within ten days, so the buyer deducted $30
($1,500 x 2%) from the invoice amount.
LO 3
Credit Memo
 A credit memorandum, often called a credit memo,

authorizes a credit to (decreases) the buyer’s
account receivable. An example of a credit memo
issued by NetSolutions is shown in Exhibit 8 (next
slide).
LO 3
Credit Memo
LO 3
Credit Memo
On January 13, issued Credit Memo No. 32 to Krier

Company for merchandise returned to NetSolutions.
Selling price, $225; cost to NetSolutions, $140.
EE 6-2
LO 3
Purchase Transactions
On January 3, NetSolutions purchased merchandise

for cash.
NOTE: We will assume a perpetual

inventory system is used.
LO 3
On January 4, NetSolutions purchased merchandise

on account from Thomas
* Corporation.
LO 3
Purchases Discounts
A buyer may receive a discount from the seller

(sales discount) for early payment of the amount
owed. From the buyer’s perspective, such
discounts are called purchases discounts.
LO 3
Alpha Technologies issues an invoice for
$3,000 to NetSolutions dated March 12, with
terms 2/10, n/30. NetSolutions is trying to
determine if it should pay the invoice within
the discount period.
LO 3
If NetSolutions can borrow cash at an annual
interest rate of 6%, should the firm borrow cash
to pay the invoice within the discount period?
Discount of 2% on $3,000 $60.00

Interest for 20 days at the rate
of 6% on $2,940 – 9.80
Savings from borrowing $50.20
YES
LO 3
Alpha Technologies issued an invoice for

$3,000 to NetSolutions dated March 12, with
terms 2/10, n/30. Based on the calculation in
the previous slide, NetSolutions pays the
amount due, less the discount, on March 22.
LO 3
Discount Not Taken
Assume that, instead of paying the invoice within

the discount period, NetSolutions pays the invoice
on April 11.
LO 3
Purchases Returns and Allowances
A purchases return involves actually returning

merchandise that is damaged or does not meet the
specifications of the order. From a buyer’s
perspective, such returns are called purchases
returns and allowances.
LO 3
Debit Memo
 A debit memorandum, often called a debit memo,

informs the seller of the amount the buyer
proposes to debit to the account payable due the
seller.
LO 3
Debit Memo
NetSolutions receives a delivery from Maxim

Systems and determines that $900 of the items are
not the merchandise ordered. Debit memorandum
#18 is issued to Maxim Systems.
LO 3
Debit Memo
LO 3
Debit Memo
NetSolutions records the return of the merchandise

indicated in the debit memo in Exhibit 9 as follows:
LO 3
Merchandise Purchased
On May 2, NetSolutions purchased $5,000 of

merchandise on account from Delta Data Link,
terms 2/10, n/30.
LO 3
Merchandise Returned
On May 4 , NetSolutions returned $3,000 of the

merchandise purchased from Delta Data Link.
LO 3
Invoice Paid
On May 12, NetSolutions paid for the purchase of

May 2 less the return and discount.
EE 6-3
LO 3
Freight
If ownership of the merchandise passes to the

buyer when the seller delivers the merchandise to
the freight carrier, the terms are said to be FOB
(free on board) shipping point.
LO 3
Freight
On June 10, NetSolutions buys merchandise from
Magna Data on account, $900, terms FOB shipping
point and pays the shipping cost of $50.
LO 3
Freight
If ownership of the merchandise passes to the

buyer when the buyer receives the merchandise,
the terms are said to be FOB (free on board)
destination.
LO 3
Sale Plus Freight Cost
On June 15, NetSolutions sells merchandise to Kranz

Company on account, $700, terms FOB destination.
The cost of the merchandise sold is $480.
LO 3
Sale Plus Freight Cost

On June 15, NetSolutions pays freight of $40 on the
sale of June 15.
LO 3
Seller Prepays Freight

On June 20, NetSolutions sells merchandise to
Planter Company on account, $800, terms FOB
shipping point. NetSolutions paid freight of $45,
which was added to the invoice. The cost of the
merchandise sold is $360.
LO 3
Seller Prepays Freight
LO 3
Freight Terms
LO 3
Freight Terms
EE 6-4
LO 3
Summary: Recording Merchandise Inventory
LO 3
Sales Taxes
On August 12, merchandise is sold on account to

Lemon Company, $100. The state has a 6% sales
tax.
LO 3
Sales Taxes
On a regular basis, the seller pays to the taxing

authority (state) the amount of the sales taxes
collected.
LO 3
Trade Discounts
When wholesalers offer special discounts to

certain classes of buyers who order large
quantities, these discounts are called trade
discounts.
LO 3
Dual Nature of Merchandise Transactions
 Each merchandising transaction affects a buyer

and a seller. In the following illustrations, we
show how the same transactions would be
recorded by both the seller and the buyer.
LO 3
July 1. Scully Company sold merchandise on

account to Burton Co., $7,500, terms
FOB shipping point, n/45. The cost of the
merchandise sold was $4,500.
LO 3

Scully Company (Seller)
Accounts Receivable—Burton Co. 7,500
Sales 7,500
Cost of Merchandise Sold 4,500

Merchandise Inventory 4,500
Burton Company (Buyer)
Accounts Payable—Scully Co. 7,500
LO 3
July 2. Burton Company paid

transportation charges of $150 on
the July 1 purchase from Scully
Company.
LO 3

No entry.

Merchandise Inventory 150
Cash 150
LO 3
July 5. Scully Company sold merchandise on

account to Burton Co., $5,000, terms
FOB destination, n/30. The cost of the
merchandise sold was $3,500.
LO 3

Sales 5,000

Merchandise Inventory. 5,000
LO 3
July 7. Scully Company paid transportation

costs of $250 for delivery of
merchandise sold to Burton Company
on July 5.
LO 3

Delivery Expense 250
Cash 250

No entry.
LO 3
July 13. Scully Company issued Burton

Company a credit memorandum for
merchandise returned, $1,000. The
cost of the merchandise returned was
$700.
LO 3

Sales Returns and Allowances 1,000

Cost of Merchandise Sold 700
LO 3
July 15. Scully Company received payment

from Burton Company for purchase
of July 5.
LO 3

Cash 4,000

Cash 4,000
LO 3
July 18. Scully Company sold merchandise

on account to Burton Company,
$12,000, terms FOB shipping point,
2/10, n/eom. Scully prepaid
transportation costs of $500, which
were added to the invoice. The cost
of the merchandise sold was $7,200.
LO 3

Sales 12,000
Accounts Receivable—Burton Co. 500
Cash 500
LO 3
July 28. Scully Company received payment

from Burton Company for purchase
of July 18, less discount (2% ×
$12,000).
LO 3

Cash 12,260
Sales Discounts 240

Cash 12,260
EE 6-5

businesses.
merchandising transactions including: sale of
merchandise, purchase of merchandise; freight,
sales taxes, and trade discounts; dual nature of
Describe the adjusting and closing process for a
merchandising business.
LO 4
Adjusting Entry for Inventory Shrinkage
Merchandising businesses may experience some

loss of inventory due to shoplifting, employee
theft, or errors in recording or counting inventory.
LO 4
Adjusting Entry for Inventory Shrinkage
 If the balance of the Merchandise Inventory

account is larger than the total amount of the
merchandise count, the difference is often called
inventory shrinkage or inventory shortage.
LO 4
Inventory Shrinkage
NetSolutions’ inventory records indicate the

following on December 31, 2013:
Dec. 31, 2013
Account balance of Merchandise Inventory $63,950
Physical merchandise inventory on hand 62,150
Inventory shrinkage $ 1,800
LO 4
Inventory Shrinkage
At the end of the accounting period, inventory

shrinkage is recorded by the following adjusting
entry:
EE 6-6
LO 4
Step 1: Closing Entries
Debit each temporary account with a credit balance,

such as Sales, for its balance and credit Income
Summary.
LO 4

Credit each temporary account with a debit
balance, such as an expense, for its balance and
debit Income Summary.
LO 4
Debit Income Summary for the amount of its

balance (net income) and credit the owner’s capital
account.
LO 4
Debit the owner’s capital account for the balance of

the drawing account and credit the drawing
account.
LO 4
Closing Entries
NetSolutions’ Income Summary account after the

closing entries have been posted is as follows:
5. Describe and illustrate the use of the ratio of
net sales to assets in evaluating a company’s
operating performance.
LO 5
Ratio of Net Sales to Assets
The ratio of net sales to assets measures how

effectively a business is using its assets to generate
sales.
Ratio of Net
Net Sales
Sales to =
Assets Average Total Assets
LO 4

 The following data (in millions) were taken from
the annual reports of Dollar Tree, Inc.:
LO 4

 The ratio of net sales to assets for each year are as
follows:
EE 6-7
Appendix
The Periodic
Inventory
System Prepared by: C. Douglas Cloud
Appendix
Periodic Inventory System
App 1
Appendix
Recording Merchandise Transactions

Purchases. Purchases of inventory are recorded in
a purchases account rather than in the
merchandise inventory account.
Appendix

 Purchases Discounts. Purchases discounts are
normally recorded in a separate purchases
discounts account. The balance of the purchases
discounts account is reported as a deduction from
Purchases for the period.
Appendix

 Purchases Returns and Allowances. Purchases
returns and allowances are recorded in a similar
manner as purchase discounts.
Appendix

 Freight In. When merchandise is purchased FOB
shipping point, the buyer pays for the freight.
Under the periodic inventory system, freight paid
when purchasing merchandise FOB shipping
point is debited to Freight In.
Appendix
(continued)
Appendix
(concluded)
Appendix
Closing Entries
(continued)
Appendix
Closing Entries
(continued)
Appendix
Closing Entries
(concluded)
Accounting for Merchandising Businesses
The End
Prepared by: C. Douglas Cloud

Accounting For Merchandising Businesses

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Accounting For Merchandising Businesses

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Accounting for Merchandising Businesses

Distinguish between the activities and financial

Distinguish between the activities and financial

When merchandise is sold, the revenue is reported

Nature of Merchandising Businesses

Merchandise on hand (not sold) at the end of an

Nature of Merchandising Businesses

Distinguish between the activities and financial

The multiple-step income statement contains

Sales is the total amount charged customers for

Sales returns and allowances are granted by the

Sales discounts are granted by the seller to

Net sales is determined by subtracting sales

The cost of merchandise sold is the cost of the

The buyer may return merchandise to the seller

You have seen that sellers may offer customers

If merchandise inventory at the end of the period

Under the perpetual inventory system, the

Selling expenses are  Sales salaries

Administrative  Office salaries

Income from operations, sometimes called

Other income is revenue from sources other than

An alternative form of income statement is the

Single-Step Income Statement

Statement of Owner’s Equity

The form of balance sheet with the assets on the

Distinguish between the activities and financial

On January 3, NetSolutions sold $1,800 of

Using the perpetual inventory system, the cost

Sales made to customers using credit cards are

On January 12, NetSolutions sold merchandise

 The terms for when payments for merchandise

To encourage the buyer to pay before the end of

On January 17, NetSolutions receives the amount

 A credit memorandum, often called a credit memo,

On January 13, issued Credit Memo No. 32 to Krier

On January 3, NetSolutions purchased merchandise

NOTE: We will assume a perpetual

On January 4, NetSolutions purchased merchandise

A buyer may receive a discount from the seller

Discount of 2% on $3,000 $60.00

Alpha Technologies issued an invoice for

Assume that, instead of paying the invoice within

A purchases return involves actually returning

 A debit memorandum, often called a debit memo,

NetSolutions receives a delivery from Maxim

NetSolutions records the return of the merchandise

On May 2, NetSolutions purchased $5,000 of

On May 4 , NetSolutions returned $3,000 of the

On May 12, NetSolutions paid for the purchase of

If ownership of the merchandise passes to the

If ownership of the merchandise passes to the

On June 15, NetSolutions sells merchandise to Kranz

Sale Plus Freight Cost

Seller Prepays Freight

Seller Prepays Freight

Summary: Recording Merchandise Inventory

On August 12, merchandise is sold on account to

On a regular basis, the seller pays to the taxing

When wholesalers offer special discounts to

Dual Nature of Merchandise Transactions

 Each merchandising transaction affects a buyer

Dual Nature of Merchandise Transactions