Merchandising

Operations

Chapter 5

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Learning Objectives
1. Describe merchandising operations
and the two types of merchandise
inventory systems
2. Account for the purchase of
merchandise inventory using a
perpetual inventory system
3. Account for the sale of merchandise
inventory using a perpetual
inventory system

© 2k015 Pearson Education, Limited. 5-2

Learning Objectives
4. Adjust and close the accounts of a
merchandising business
5. Prepare a merchandiser’s financial
statements
6. Use the gross profit percentage to
evaluate business performance
7. Account for the purchase and sale
of merchandise inventory using a
periodic inventory system (Appendix
5A)
© 2k015 Pearson Education, Limited. 5-3
Learning Objective 1

Describe
merchandising
operations and the
two types of
merchandise
inventory systems

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• Almost every business sells goods or
services. When a business sells goods, we
refer to that business as a “merchandiser.”
• Although most of the operations in any
business can be similar, in a
merchandising business, there are some
special kinds of processes that are unique.
The first of those unique processes is the
Merchandiser Operating Cycle.
© 2k015 Pearson Education, Limited. 5-5
 The Operating Cycle
1- The company purchase inventory from an
individual or business called vendor.
2- The company sells the inventory to a
customer.
3- Finally the company collects cash from
the customer.

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What Are Merchandising
Operations?
• Seller of goods
• Can be wholesaler
or retailer
• Inventory is a very
important asset
• Managing A/R is
critical to success

© 2k015 Pearson Education, Limited. 5-7

 Merchandiser Financial Statements

Me rc ha nd ising Co mp a ny • Income Statement

Inc o me Sta te me nt
Ye a r End e d De c e mb e r 31, 2015 differs from a
Sales Revenue $ 230,000 service company
Cost of Goods Sold (100,000)
Gross Profit 130,000 • Cost of Goods
Operating Expenses
Salaries Expense $ 80,000
Sold
Rent Expense 24,000 • Gross Profit
Depr Exp—Furniture 9,000
Utilities Expense 3,000
Total expenses (116,000)
Net income $ 14,000

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 Merchandiser Financial Statements

Me rc ha nd ising Co mp a ny
Inc o me Sta te me nt
Largest
Ye a r End e d De c e mb e r 31, 2015 expense for
Sales Revenue $ 230,000
Cost of Goods Sold (100,000)
merchandisers
Gross Profit 130,000
Operating Expenses
Salaries Expense $ 80,000
Rent Expense 24,000
Depr Exp—Furniture 9,000
Utilities Expense 3,000
Total expenses (116,000)
Calculated as:
Net income $ 14,000 Net Sales—COGS

© 2k015 Pearson Education, Limited. 5-9

 Merchandiser Financial Statements
Merchandising Company
Balance Sheet - Partial
• Merchandise December 31, 2015
Assets
Inventory is Current Assets:
usually the only Cash
Accounts Receivable
$ 34,000
10,800
type of inventory. Merchandise Inventory 60,000
Office Supplies 800
– (There is no raw Prepaid Rent 2,100
materials or Total Current Assets $ 107,700

work-in-progress.)
• Merchandise Inventory is usually purchased
on credit, so Accounts Payable may also be
higher than a Service Company.

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Learning Objective 2

Account for the

purchase of
merchandise
inventory using a
perpetual inventory
system

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 Inventory System
• Businesses must have a way to determine
the value of merchandise inventory on
hand and the value sold.

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Types of Inventory Systems

Perpetual

Periodic
 Periodic

As computer Inventory is
technology takes physically
over more and counted
more accounting,
the Periodic Inexpensive
Method is used inventory
less and less.
Small shops without
opscan capability
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 Perpetual

When items are

Every inflow and scanned in the
outflow is tracked receiving dock or
in real time at the cash
register, the
inventory is
Merchandising and automatically
purchase systems are updated on a
integrated with the continuous basis.
accounting system

© 2k015 Pearson Education, Limited. 5-15

© 2k015 Pearson Education, Limited. 5-16
 Purchase of Inventory
Assume that Smart Touch Learning pays
for the inventory at the point of sale.

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 Purchase on Account
If we had received the inventory, but
chosen to pay later . . .

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Purchase Returns and Allowances
• When all or a portion of a purchase is returned
to the seller, it is recorded as a reduction of the
merchandise inventory account.
• Assume Smart Touch Learning returns $7,000 of
the June 3 purchase on June 4.

© 2k015 Pearson Education, Limited. 5-19

 Recording Transportation Costs

• Transportation costs are the cost of

moving inventory from seller to buyer.
• FOB stands for Free on Board and
governs the passing of title of the goods.
• Selling/buying agreements usually specify
FOB terms.
Recording Transportation Costs

FOB Shipping Point

FOB Destination
 Transportation Costs
While goods are in transit, rules are necessary
to determine who bears the risk of loss.

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 FOB Shipping Point
• The buyer takes ownership to the goods
after the goods leave the seller’s place of
business

• In most cases the buyer pays the freight

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 FOB Destination
• The buyer takes ownership to the goods at
the delivery destination point

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 Freight In
• With FOB shipping point, the freight cost is paid
by the buyer and is part of the inventory cost.
• Assume Smart Touch Learning pays a $60
freight charge on the June 3 purchase.

© 2k015 Pearson Education, Limited. 5-25

 Purchase Discounts
Invoices that accompany credit purchases
often indicate “credit terms,” which offer the
buyer discount if they pay early.

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 Purchase Discounts
The amount of the discount is determined by the
“credit terms” indicated on the invoice.
Discount Period
Total Credit Period
Discount
Percent

3/15, NET 30 DAYS

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 Purchase Discounts
If Smart Touch Learning pays within the
15 day period, they get a 3% discount.

© 2k015 Pearson Education, Limited. 5-28

 A Look at the Merchandise Inventory
Account . . .

Merchandise The
Inventory merchandise
June 3 35,000 7,000 June 4 inventory
June 3 60 840 June 15 account will
27,220 reflect the net
results of all the
transactions for
the period.

© 2k015 Pearson Education, Limited. 5-29

Learning Objective 3

Account for the sale

of merchandise
inventory using a
perpetual inventory
system

© 2k015 Pearson Education, Limited. 5-30

© 2k015 Pearson Education, Limited. 5-31
• When we sell items to customers, we must
record the sale in the books. In this case,
we see that Smart Touch Learning sold 2
Touch Screen Tablet Computers to a
customer for a total of $1,000. However,
having an invoice does not mean that we
do not have to record the transaction in
the books. A journal entry must be
prepared.
© 2k015 Pearson Education, Limited. 5-32
 Recording a Sale
• In a perpetual system, two entries must be
made for every sale:
1- will record the sale and the related
receipt of cash or account receivable.
2- will record the reduction of inventory
and the related Cost of Goods Sold for this
particular transaction.

© 2k015 Pearson Education, Limited. 5-33

 Recording a Cash Sale
Smart Touch Learning sold 2 tablets for $1,000
cash. The cost of those tablets was $700.

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 Recording a Credit Sale
Smart Touch Learning sold 10 tablets for $500
each on account. Sales terms are 2/10, n/30.
The cost of those tablets was $3,500.

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 Sales Returns
• Requires an entry to Sales Returns and
Allowances and to Merchandise Inventory.
Inventory
• A customer returns 3 tablets that sold for $1,500
and originally cost $1,050.

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 Sales Allowances
• Requires an entry to Sales Returns and
Allowances.
• Smart Touch Learning grants a customer $100
for goods damaged in transit.

• There is no inventory to receive or record.

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 Sales Discounts
The customer pays Smart Touch Learning on
June 30, 9 days after the invoice date, and after
the return and the allowance.

Sales discounts is a contra account to Sales.

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 Freight Out
• The freight in is part of the inventory cost.
• The freight out is a selling expense.
• Smart Touch Learning pays $30 to ship the June
21 sale to the customer.

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 Net Revenue
For the year, Smart Touch Learning sells
$297,500 of merchandise inventory. They
process $11,200 of sales returns and
allowances, and they award $5,600 of sales
discounts.

What is Net Sales Revenue for the year?

Sales Returns
Net Sales Sales Sales
= - and - Discounts
Revenue Revenue
Allowances

© 2k015 Pearson Education, Limited. 5-40

 Net Revenue
For the year, Smart Touch Learning sells
$297,500 of merchandise inventory. They
process $11,200 of sales returns and
allowances, and they award $5,600 of sales
discounts.

What is Net Sales Revenue for the year?

$280,700 = $ 297,500 - $11,200 - $5,600

© 2k015 Pearson Education, Limited. 5-41

 Gross Profit
• The difference between Net Sales Revenues
and Cost of Goods Sold
• Indicates the amount available to cover
operating expenses

© 2k015 Pearson Education, Limited. 5-42

Learning Objective 4

Adjust and close the

accounts of a
merchandising
business

© 2k015 Pearson Education, Limited. 5-43

 Adjusting Merchandise Inventory
• Actual inventory at the end of the period
may differ from what is expected from the
accounting records
– Theft
– Damage
– Errors
• Inventory must be adjusted at the end of
the period

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Closing the Accounts of a Merchandiser

1. Close revenues to
Income Summary
2. Close expenses and
contra-revenues to
Income Summary
3. Close Income
Summary to Capital
4. Close Withdrawals
to Capital

© 2k015 Pearson Education, Limited. 5-45

Closing the Accounts of a Merchandiser

© 2k015 Pearson Education, Limited. 5-46

 Closing the Accounts of a
Merchandiser
• At this point, Income Summary
Dec. 31 272,300 297,500 Dec. 31
the Income 25,200 Balance
Summary
account has a
$25,200 balance.
• Next, we need to close Income
Summary to the Capital account.

© 2k015 Pearson Education, Limited. 5-47

Learning Objective 5

Prepare a
merchandiser’s
financial statements

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 Merchandiser’s Financial
Statements
• There are two basic formats for the
statement of financial performance:
1 Multi-step
2 Single-step
 Single-Step Income Statement
SMART TOUCH LEARNING
Inc o me Sta te me nt
Ye a r End e d De c e mb e r 31, 2015
Revenues
Revenues and Net Sales Revenue $ 280,700
Expenses
Expenses are Cost of Goods Sold
Salaries Expense
$ 199,500
15,000
separated into Rent Expense
Utilities Expense
13,000
11,300
two reported Insurance Expense
Depreciation Expense
6,500
3,300

sub- Advertising Expense

Interest Expense
2,400
2,300

groupings. Delivery Expense

Supplies Expense
1,600
600
Total expenses 255,500
Net income $ 25,200

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 Multi-Step Income Statement
SMART TOUCH LEARNING
Inc o me Sta te me nt
Ye a r End e d De c e mb e r 31, 2015
Sales Revenue $ 297,500
Includes Less: Sales Returns & Allowances
Sales Discounts
(11,200)
(5,600)
several Net Sales Revenue
Cost of Goods Sold
$ 280,700
(199,500)
important Gross Profit 81,200

subtotals
before the Let's look at the rest of the Multi-Step
Income Statement
Net Income
line.

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 SMART TOUCH LEARNING
Inc o me Sta te me nt
Ye a r End e d De c e mb e r 31, 2015
Gross Profit $ 81,200
Operating Expenses
Selling Expenses
Salaries Expense - Selling 8,100
We break Rent Expense - Selling 7,300

our Advertising Expense

Depreciation Expense - Selling
2,400
2,200

Operating Delivery Expense

Total Selling Expenses
1,600
21,600
Expenses Administrative Expenses
Utilities Expense 11,300
into Selling Salaries Expense - Admin
Insurance Expense
6,900
6,500
Expenses & Rent Expense - Admin 5,700
Depreciation Expense - Admin 1,100
Admin Supplies Expense 600
Total Administrative Expense 32,100
Expenses. Total Expenses (53,700)
Operating Income 27,500

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 SMART TOUCH LEARNING
Inc o me Sta te me nt
Ye a r End e d De c e mb e r 31, 2015
Operating Income $ 27,500
Other Revenues & Expenses

• Finally, Interest Expense

Total Other Revenue & Expenses
(2,300)
(2,300)
Net Net Income $ 25,200

Income
is determined by subtracting Other
Revenues and Expenses from
Operating
Income.
• Most companies will use a multi-step
income statement.

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Learning Objective 6

Use the gross profit

percentage to
evaluate business
performance

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 Gross Profit Percentage

Gross Profit Gross Net Sales

= ÷
Percentage Profit Revenue

• Measures the profitability of each sales

dollar.
• When this number is trending downward, it
can indicate a significant problem.

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Gross Profit Percentage—Example

Gross Profit Net Sales

= Gross Profit ÷
Percentage Revenue

34.1% = $904,625 ÷ $2,650,899

© 2k015 Pearson Education, Limited. 5-56

Learning Objective 7

Account for the

purchase and sale of
merchandise
inventory using a
periodic inventory
system (Appendix 5A)

© 2k015 Pearson Education, Limited. 5-57

Purchasing Merchandise Inventory in a
Periodic System
• Inventory-related expenses are recorded
in separate accounts DURING the year,
and combined at the end of the period.
– Purchases
– Purchase Discounts
– Purchase Returns and Allowances
– Freight-In

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© 2k015 Pearson Education, Limited. 5-59
 Journal Entries in a Periodic System

On June 3, Smart Touch Learning

acquires inventory on account for $35,000.

© 2k015 Pearson Education, Limited. 5-60

 Journal Entries in a Periodic System

On June 3, Smart Touch Learning

acquires inventory on account for $35,000.

Note that Purchases is debited instead of

Merchandise Inventory.
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 Journal Entries in a Periodic System

On June 3, Smart Touch Learning paid a

freight bill related to a receipt of
inventory.

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Journal Entries in a Periodic System

On June 4, Smart Touch Learning

returned $7,000 of the inventory
purchased on June 3rd for credit.

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 Journal Entries in a Periodic System

On June15, Smart Touch Learning pays the

remaining amount on the payable from
June 3, taking the purchase discount.

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 Closing the Accounts
Assume the following balances on the
December 31 Adjusted Trial Balance:
•Merchandise Inventory (beginning) = $0
•Merchandise Inventory (ending) = $31,290
•Purchases = $281,750
•Purchase Returns and Allowances = $61,250
•Purchase Discounts = $4,410
•Freight In = $14,700
© 2k015 Pearson Education, Limited. 5-65
 Closing the Accounts
Close the credit balance accounts (Purchase
Returns and Allowances and Purchase
Discounts)
Discounts to Income Summary and record
ending Merchandise Inventory.

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 Closing the Accounts
Close the debit balance accounts (Purchases
and Freight In)
In to Income Summary and
remove beginning Merchandise Inventory.

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 Reporting Cost of Goods Sold

Beginning Merchandise Inventory $0

Purchases $281,750
Less: Purchase Returns and Allowances 61,250
Less: Purchase Discounts 4,410
Net Purchases 216,090
Add: Freight In 14,700
Net Cost of Purchases 230,790
Cost of Goods Available for Sale 230,790
Less: Ending Merchandise Inventory 31,290
Cost of Goods Sold $199,500

© 2k015 Pearson Education, Limited. 5-68

End of Chapter 5

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