CH 6 Accounting For Merchandising Businesses

Accounting for Merchandising Businesses
Chapter 6
Student Version
Prepared by: C. Douglas Cloud
Professor Emeritus of Accounting
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Learning Objective 1
Distinguish between the activities and financial

statements of service and merchandising
businesses.
LO 1
Nature of Merchandising Businesses
Most service businesses, such as plumbing repair

and accounting services, have no merchandise.
Merchandising businesses, such as a department
store or sandwich shop, generate revenue by
selling a product.
Merchandise on hand (not sold) at the end of an
accounting period is called merchandise inventory.

businesses.
Describe and illustrate the financial statements of
a merchandising business.
LO 2
Multiple-Step Income Statement
The multiple-step income statement contains

several sections, subsections, and subtotals. The
first segment reports revenue from sales.
LO 2

 Sales is the total amount charged customers for
merchandise sold, including cash sales and sales on
account.
 Sales returns and allowances are granted by the seller to

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

early payment of amounts owed.
 Net sales is determined by subtracting sales returns and

allowances and sales discounts from sales.
LO 2

The second segment of the multiple-step income
statement is the cost of merchandise sold section.
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

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).
 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.
 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

Selling expenses are incurred directly in the
selling of merchandise.
 Administrative expenses, sometimes called
general expenses, are incurred in the
administration or general operations of the
business.
 Income from operations, sometimes called
operating income, is determined by subtracting
operating expenses from gross profit.
LO 2

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.
Subtracting other income and expenses from
“income from operations” provides the net income
or loss.
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.
 When the balance sheet is presented in a
downward sequence in three sections, it has been
prepared using the report form.

businesses.
Describe and illustrate the accounting for
merchandising transactions including: sale of
merchandise; purchase of merchandise; freight;
sales taxes and trade discounts; dual nature of
merchandising transactions.
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
Credit Terms
To encourage the buyer to pay before the end of

the credit period, the seller may offer a discount,
such as 2/10, n/30. These terms indicate that a two
percent discount can be taken if the invoice is paid
within ten days. After ten days the full amount is
due by the thirtieth day from the invoice date.
LO 3
Receipts on Account
On January 22, 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.
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.
LO 3
Purchase Transactions
On January 3, NetSolutions purchased merchandise

for cash.
NOTE: 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
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.
 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. NetSolutions
records the return of the merchandise 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.
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.
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.
 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
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
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
Sales Taxes
On August 12, merchandise is sold on account to Lemon
Company, $100. The state has a 6% sales tax.
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

businesses.
Describe and illustrate the accounting for
merchandising 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.
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.
 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
At the end of the accounting period, Merchandise

Inventory has a balance of $63,950. A physical
count indicates that only $62,150 in inventory is
on hand. This inventory shrinkage of $1,800 is
recorded by the following adjusting entry:
LO 4
Step 1: Closing Entries
1. Debit each temporary account with a credit

balance, such as Sales, for its balance and credit
Income Summary.
LO 4
Step 2: Closing Entries
2. Credit each temporary account with a debit

balance, such as an expense, for its balance and
debit Income Summary.
LO 4
Steps 3 and 4: Closing Entries
3. Debit Income Summary for the amount of its

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

of the drawing account and credit the drawing
account.
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
Ratio of Net Sales to Assets

 The ratio of net sales to assets (in millions) for
Dollar Tree, Inc. for each year are as follows:
Accounting for Merchandising Businesses
The End
Student Version
Prepared by: C. Douglas Cloud
Professor Emeritus of Accounting
Pepperdine University

CH 6 Accounting For Merchandising Businesses

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CH 6 Accounting For Merchandising Businesses

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Accounting for Merchandising Businesses

Distinguish between the activities and financial

Most service businesses, such as plumbing repair

Distinguish between the activities and financial

The multiple-step income statement contains

Multiple-Step Income Statement

 Sales returns and allowances are granted by the seller to

 Sales discounts are granted by the seller to customers for

 Net sales is determined by subtracting sales returns and

Multiple-Step Income Statement

Multiple-Step Income Statement

Multiple-Step Income Statement

Multiple-Step Income Statement

Multiple-Step Income Statement

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 22, 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: Assume a perpetual

On January 4, NetSolutions purchased merchandise

A buyer may receive a discount from the seller

Alpha Technologies issues an invoice for $3,000 to

Alpha Technologies issued an invoice for $3,000 to

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

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

On a regular basis, the seller pays to the taxing authority

When wholesalers offer special discounts to

 Each merchandising transaction affects a buyer

Dual Nature of Merchandise Transactions

July 1. Scully Company sold merchandise on

Scully Company (Seller)

Cost of Merchandise Sold 4,500

July 2. Burton Company paid

Scully Company (Seller)

Burton Company (Buyer)

July 5. Scully Company sold merchandise on

Scully Company (Seller)

Cost of Merchandise Sold 3,500

July 7. Scully Company paid transportation

Scully Company (Seller)

Burton Company (Buyer)

July 13. Scully Company issued Burton

Scully Company (Seller)

Merchandise Inventory 700