Chapter 5

Accounting for Merchandising Operations

Preview of Chapter 5

Merchandising Operations
Merchandising Companies
Buy and Sell Goods

Wholesaler Retailer Consumer

The primary source of revenues is referred to as sales revenue or sales.

 Income Measurement
Not used in a
Service
Sales Less business.
Revenue

Cost of Equals Gross Less

Goods Sold Profit

Cost of goods sold is the total cost Operating Equals

of merchandise sold during the Expenses

period.
Net
Income
Operating Cycles
(Loss)

The operating cycle of a

merchandising company
ordinarily is longer than
that of a service company.
 Flow of Costs

Companies use either

a perpetual inventory
system or a periodic
inventory system to
account for
inventory.

Perpetual System
◆ Maintain detailed records of the cost of each inventory purchase and sale.
◆ Records continuously show inventory that should be on hand for every
item.
◆ Company determines cost of goods sold each time a sale occurs.

Periodic System
◆ Do not keep detailed records of the goods on hand.
◆ Cost of goods sold determined by count at the end of the accounting
period.
◆ Calculation of Cost of Goods Sold:
Beginning inventory $ 100,000
Add: Purchases, net 800,000

Goods available for sale 900,000

Less: Ending inventory 125,000

Cost of goods sold. $ 775,000

Advantages of the Perpetual System

◆ Traditionally used for merchandise with high unit values.
◆ Shows the quantity and cost of the inventory that should be on hand at any
time.
◆ Provides better control over inventories than a periodic system.
 Recording Purchases of Merchandise
◆ Made using cash or credit (on account).
◆ Normally record when goods are received from the seller.
◆ Purchase invoice should support each credit purchase.
 Illustration: Sauk Stereo (the buyer) uses as a purchase invoice the sales
invoice prepared by PW Audio Supply, Inc. (the seller). Prepare the journal
entry for Sauk Stereo for the invoice from PW Audio Supply.

May 4 Inventory 3,800

Accounts Payable 3,800
 Freight Costs – Terms of Sale

Ownership of the
goods passes to the
buyer when the
public carrier accepts
the goods from the
seller.

Ownership of the
goods remains with
the seller until the
goods reach the
buyer.

Freight costs incurred by the seller are an operating expense.

 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:

May 6 Inventory 150

Cash 150

Assume the freight terms on the invoice in Illustration 5-6 had

required PW Audio Supply to pay the freight charges, the entry by
PW Audio Supply would have been:

Freight-Out 150
May 4

Cash 150

Purchase Returns and Allowances

Purchaser may be dissatisfied because goods are damaged or
defective, of inferior quality, or do not meet specifications.

Purchase Return Purchase Allowance

Return goods for credit if the sale was May choose to keep the merchandise if
made on credit, or for a cash refund if the the seller will grant a reduction of the
purchase was for cash. purchase price.

Illustration: Assume Sauk Stereo returned goods costing $300 to

PW Audio Supply on May 8.

May 8 Accounts Payable 300

Inventory 300
 Purchase Discounts

Credit terms may permit buyer to claim a cash discount for prompt
payment.
Example: Credit terms may read
Advantages: 2/10, n/30.
◆ Purchaser saves money.
◆ Seller shortens the operating cycle by converting the accounts
receivable into cash earlier.

Purchase Discounts - Terms

2/10, n/30 1/10 EOM n/10 EOM

2% discount if 1% discount if Net amount due

paid within 10 paid within first within the first 10
days, otherwise 10 days of next days of the next
net amount due month. month.
within 30 days.

Illustration: Assume Sauk Stereo pays the balance due of $3,500

(gross invoice price of $3,800 less 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.
May Accounts Payable 3,500
14
Inventory 70

Cash 3,430
(Discount = $3,500 x 2% = $70)
Illustration: If Sauk Stereo failed to take the discount, and instead
made full payment of $3,500 on June 3, the journal entry would be:

June 3 Accounts Payable 3,500

Cash 3,500

Purchase Discounts
Should discounts be taken when offered?

Discount of 2% on $3,500 $ 70.00

$3,500 invested at 10% for 20 days 19.18
Savings by taking the discount $ 50.82

Example: 2% for 20 days = Annual rate of 36.5%

$3,500 x 36.5% x 20 ÷ 365 = $70
 Summary of Purchasing Transactions

Inventory
Debit Credit

4th - Purchase 3,800 300 8th - Return

th
6th – Freight-in 150 70 14 - Discount

Balance 3,580

Recording Sales of Merchandise

◆ Made using cash or credit (on account).
◆ Sales revenue, like service revenue, is recorded when the performance
obligation is satisfied.
◆ Performance obligation is satisfied when the goods are transferred from
the seller to the buyer.
◆ Sales invoice should support each credit sale.
 Journal Entries to Record a Sale

#1 Cash or Accounts receivable XXX

Selling
Sales revenue XXX Price

#2 Cost of goods sold XXX

Cost
Inventory XXX

Illustration: PW Audio Supply records the sale of $3,800 on May 4 to

Sauk Stereo on account (Illustration 5-6) as follows (assume the
merchandise cost PW Audio Supply $2,400).

May 4 Accounts Receivable 3,800

Sales Revenue 3,800

May 4 Cost of Goods Sold 2,400

Inventory 2,400
Sales Returns and Allowances
◆ “Flip side” of purchase returns and allowances.
◆ Contra-revenue account to Sales Revenue (debit).
◆ Sales not reduced (debited) because:
► Would obscure importance of sales returns and allowances as a
percentage of sales.
► Could distort comparisons.

Illustration: Prepare the entry PW Audio Supply would make to

record the credit for returned goods that had a $300 selling price
(assume a $140 cost). Assume the goods were not defective.

May 8 Sales Returns and Allowances 300

Accounts Receivable 300

May 8 Inventory 140

Cost of Goods Sold 140

Illustration: Assume the returned goods were defective and had a

scrap value of $50, PW Audio would make the following entries:

May 8 Sales Returns and Allowances 300

Accounts Receivable 300

May 8 Inventory 50

Cost of Goods Sold 50

Sales Discount
◆ Offered to customers to promote prompt payment of the balance due.
◆ Contra-revenue account (debit) to Sales Revenue.

Illustration: Assume Sauk Stereo pays the balance due of $3,500

(gross invoice price of $3,800 less purchase returns and allowances
of $300) on May 14, the last day of the discount period. Prepare the
journal entry PW Audio Supply makes to record the receipt on May
14.

May 14 Cash 3,430

Sales Discounts 70 *

Accounts Receivable 3,500

* [($3,800 – $300) X 2%]

 Completing the Accounting Cycle

Adjusting Entries
◆ Generally the same as a service company.
◆ One additional adjustment to make the records agree with the actual
inventory on hand.
◆ Involves adjusting Inventory and Cost of Goods Sold.

Illustration: Suppose that PW Audio Supply has an unadjusted

balance of $40,500 in Merchandise Inventory. Through a physical
count, PW Audio determines that its actual merchandise inventory
at year-end is $40,000. The company would make an adjusting entry
as follows.

Cost of Goods Sold 500

Inventory 500
Closing Entries
 Forms of Financial Statements
Multiple-Step Income Statement
◆ Shows several steps in determining net income.
◆ Two steps relate to principal operating activities.
◆ Distinguishes between operating and non-operating activities.

Key Items:

Net sales

Gross profit

Operating
expenses

Nonoperating
activities

Net income
Single-Step Income Statement

◆ Subtract total expenses from total revenues

◆ Two reasons for using the single-step format:
1. Company does not realize any profit until total revenues exceed total
expenses.
2. Format is simpler and easier to read.
Classified Balance Sheet

Determining Cost of Goods Sold Under a Periodic System

◆ No running account of changes in inventory.
◆ Ending inventory determined by physical count.
◆ Cost of goods sold not determined until the end of the period.
Recording Merchandise Transactions
◆ Record revenues when sales are made.
◆ Do not record cost of merchandise sold on the date of sale.
◆ Physical inventory count determines:
► Cost of merchandise on hand and
► Cost of merchandise sold during the period.
◆ Record purchases in Purchases account.
◆ Purchase returns and allowances, Purchase discounts, and Freight costs are
recorded in separate accounts.

Recording Purchases of Merchandise

Illustration: On the basis of the sales invoice (Illustration 5-6) and

receipt of the merchandise ordered from PW Audio Supply, Sauk
Stereo records the $3,800 purchase as follows.

May 4 Purchases 3,800

Accounts Payable 3,800

Freight Costs

Illustration: If Sauk pays Public Freight Company $150

for freight charges on its purchase from PW Audio Supply on May 6,
the entry on Sauk’s books is:

May 6 Freight-in (Transportation-In) 150

Cash 150
Purchase Returns and Allowances

Illustration: Sauk Stereo returns $300 of goods to PW Audio Supply

and prepares the following entry to recognize the return.

May 8 Accounts payable 300

Purchase Returns and Allowances 300

Purchase Discounts

Illustration: On May 14 Sauk Stereo pays the balance due on account

to PW Audio Supply, taking the 2% cash discount allowed by PW
Audio for payment within 10 days. Sauk Stereo records the payment
and discount as follows.

May 14 Accounts Payable 3,500

Purchase Discounts 70

Cash 3,430

Recording Sales of Merchandise

Illustration: PW Audio Supply, records the sale of $3,800 of

merchandise to Sauk Stereo on May 4 (sales invoice No. 731,
Illustration 5-6) as follows.
May 4 Accounts Receivable 3,800

Sales Revenue 3,800

No entry is recorded for cost of

goods sold at the time of the sale
under a periodic system.
Sales Returns and Allowances

Illustration: To record the returned goods received from Sauk Stereo

on May 8, PW Audio Supply records the $300 sales return as follows.

May 8 Sales Returns and Allowances 300

Accounts Receivable 300

Sales Discounts

Illustration: On May 14, PW Audio Supply receives payment of

$3,430 on account from Sauk Stereo. PW Audio honors the 2% cash
discount and records the payment of Sauk’s account receivable in
full as follows.

May Cash 3,430

14
Sales Discounts 70

Accounts Receivable 3,500

Comparison of Entries
Worksheet for merchandising company—periodic inventory
system