Chapter 6
Accounting for
Merchandising Activities
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Remaining course context
Balance Sheet
Current Assets
Cash
Chapter
9, 19
Current Liabilities
10000
Accounts Payable
Chapter
6, 13
5000
Accounts Receivable
10
20000
Wages Payable
11
25000
Notes Receivable
10
15000
Utilities Payable
3
2000
Marketable Securities
18
25000 Long-Term Debt
Inventory
6, 7
120000
Capital Assets
Notes Payable
13,17
Bonds Payable
17
600000
15, 16
300000
Equipment
4,12
250000 Owner’s Equity
Buildings
4,12
500000
12
60000
Goodwill
Total Assets
Common Stock
Retained Earnings 5
1000000 Total Liabilities + OE
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
20000
48000
1000000
In this chapter…
Balance Sheet
Current Assets
Cash
Chapter
Current Liabilities
10000
Accounts Payable
Accounts Receivable
20000
Wages Payable
Notes Receivable
15000
Utilities Payable
Marketable Securities
25000 Long-Term Debt
Inventory
6, 7
120000
Capital Assets
2000
Bonds Payable
600000
Buildings
500000
Total Assets
25000
20000
250000 Owner’s Equity
60000
5000
Notes Payable
Equipment
Goodwill
Chapter
6, 13
Common Stock
Retained Earnings
1000000 Total Liabilities + OE
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
300000
48000
1000000
Merchandising Activities
• Until now we have most examined the activities of a
services based company.
• Now we will consider how companies which engage in
the resale of goods track, record and report on matters
relating to their inventory
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Merchandising vs. Services
• A merchandiser may earn net income by buying and
selling goods to end customers.
– They may deliver goods in addition to services
– They may add services to raw materials to produce finished goods
which they sell.
• The cost of the goods is an expense used to generate
revenue – Cost of Goods Sold (CGS)
– CGS includes the cost of the raw material, plus other costs needed
to bring the product to market (shipping, handling, etc)
• Sales – a word used to generically describe revenue from
the sale of goods
• Gross Margin (aka Gross Profit = Sales – CGS) is the
amount remaining after sales used to cover operating
expenses
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Inventory
• Merchandise Inventory, or Inventory, is a current asset
balance sheet account used to hold the value of the
inventory
• As we will see in future chapters, there are several ways to
determine the value of the Inventory
• Two general inventory accounting conventions
– Perpetual inventory – provides a continuous record of the amount
of inventory on hand. At any time, a reader can examine the
inventory account to determine the value of inventory on hand.
• The remainder of the chapter concerns Perpetual inventory
– Periodic inventory – requires updating the inventory account only
at the end of a period to reflect the quantity and cost of both goods
on hand and goods sold. The Inventory account is only accurate
after adjustments are made at the end of the period
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Accounting for Merchandise Purchases
• Inventory is a current asset balance sheet account
• When purchasing inventory, the following journal entry
would be made:
– Inventory is debited (increased)
– Either cash or Accounts Payable is credited depending on whether
buying on cash or credit
• The cost is includes the actual cost of the material, plus
shipping, handling, discounts, allowances for returns, etc
Date
Account Titles and explanation
Jan 1
Inventory
PR
Debit
1000
Cash
Jan 2
Credit
1000
Inventory
750
Accounts Payable
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
750
Accounting for Merchandise Purchases
• Purchase returns are merchandise received by a purchaser
but returned to the supplier.
• A purchase allowance is a reduction in the cost of the
merchandise to accommodate for defects, even though the
inventory is still sellable
• The purchaser can inform the seller of the defects by
issuing a Debit Memorandum. This would trigger the
seller and the buyer each reducing their respective
accounts for the inventory. From the purchaser’s
perspective:
Date
Account Titles and explanation
Jan 2
Accounts Payable
PR
Debit
Credit
100
Inventory
100
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Accounting for Merchandise Purchases
• Trade Discounts – a certain percentage reducing the price
of inventory when sold to trade partners, or channel
partners
– when a manufacturer sells on volume to a distributor/wholesaler,
or when a wholesaler sells to a retailer
– A manufacturer may offer a percentage discount off of list price to
a wholesaler who buys 50000 or more of their product
– Bic sells pens to Grand & Toy at $0.001 per pen. If G&T buys a
million or more pens they may get 25% off list = $750
(.001*1,000,000 – (.25*.001*1,000,000))
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Accounting for Merchandise Purchases
• Purchase Discounts - a certain percentage reducing the
price for adhering to credit terms
– Credit Terms – are a listing of amounts and timing of payments
between buyer and seller.
– It is a reward system used by sellers to encourage early payment
• Examples
– 2% 10, net 30 – means purchaser gets a 2% discount if they pay
within 10 days of invoice date, or pays the full amount before 30
days
– So say someone purchases $1000 worth of pens, on terms of 2%
10, net 30.
– Look how powerful the incentive is: 2% discount over the
remaining 20 days = 36.5% annual interest (365/20 x 2%)
– Lets look at the transactions on the next slide….
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Accounting for Merchandise Purchases
• First, the inventory is purchased on credit in full
• Second, payment is made within 9 days
–
–
–
–
AP is debited the full amount (the credit is completely honoured)
But cash is not credited at the full amount (the discount is desired)
Inventory value is reduced to show the impact of the discount
Lets look at it through the T-account view….
Date
Account Titles and explanation
Jan 5
Inventory
PR
Debit
1000
Accounts Payable
Accounts Payable
Jan 14
Credit
1000
1000
Inventory
20
Cash
980
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Accounting for Merchandise Purchases
• Through T-accounts we see the result is that
– the Payable is completely exhausted
– The inventory is reduced to reflect the discount
– The actual cash paid reflects the value of the inventory
Inventory
Jan 5
Accounts Payable
(a) 1000
Jan 14
1000 (a)
20 (b)
(b) 1000
Balance 980
0
Cash
Jan 14
980 (b)
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Transfer of Ownership
• The point where ownership transfers from seller to buyer is
important as it determines who must pay transportation and
other shipping related costs.
• FOB (Free On Board) – the point of transfer
– FOB factory means the buyer is responsible for shipping
– FOB destination means the seller is responsible for shipping
• Transportation-In Costs – are shipping costs paid on
purchases
• Transportation-Out Costs – are costs paid on sales. If the
seller sells on FOB destination terms, the Delivery
Expense account is debited to cover these costs
• Example…
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Transportation costs
• Company purchases raw materials for $1000 from supplier
• Supplies are FOB factory (purchaser covers costs)
• So, on the purchaser’s books, the value of the inventory is
the cost of the purchase plus what it cost to get the goods
to the purchaser’s site.
Inventory
Cash
Original
Purchase
(a) 1000
1000 (a)
Shipping
(b) 50
50 (b)
Balance
1050
1050
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Accounting for Merchandise Sales
• So now we’ve bought raw materials, how do we sell
them…
• The sales transactions for a merchandiser are similar to
those of a service company
– Below, the first transaction is a sale on credit
– The second is a sale on cash
– We’ve seen this many times before…
Date
Account Titles and explanation
Apr 1
Accounts Receivable
PR
Debit
1000
Sales
Apr 2
Credit
1000
Cash
750
Sales
750
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Accounting for Merchandise Sales
• But what about the expense side. How do we recognize
the Cost of Goods Sold?
• Cost of Goods Sold (CGS) is an expense account used to
monitor the cost of the goods sold
– The transaction below reduces the inventory to acknowledge the
goods that were just sold
Date
Account Titles and explanation
Apr 2
Cost of Goods Sold
PR
Inventory
Debit
Credit
980
980
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Sales Discounts
• Just like what we saw earlier, we can not only buy on
terms (say 1% 15, net 60), we can also sell on them.
• When our customer takes advantage of the terms we offer,
we must reduce the revenue to acknowledge the discount
– The Sales Discount account is a “contra revenue” account, which
will be used to reduce inventory on the Income Statement
Date
Account Titles and explanation
Apr 1
Accounts Receivable
PR
Debit
Credit
1000
Sales
1000
Apr 14 Cash
990
Sales Discounts
10
Accounts Receivable
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
1000
Sales Returns and Allowances
• Sales returns refer to merchandise that customers return to
the seller after a sale.
• Sales allowances refer to reductions in price to reflect
damage or some dissatisfaction on the part of the customer
• We can use the Sales Returns and Allowances “contra
revenue” account to reduce Sales Revenue
Date
Account Titles and explanation
Apr 1
Accounts Receivable
PR
Debit
Credit
1000
Sales
1000
Apr 14 Sales Returns and Allowances
Accounts Receivable
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
500
500
Sales Returns and Allowances
• If the merchandise is still sellable, the merchandise can be
put back into inventory
Date
Account Titles and explanation
Apr 2
Inventory
PR
Debit
Credit
490
Cost of Goods Sold
490
• Or, if the goods are not sellable, they should be scrapped.
This can be done by just leaving them on COGS account
or to a Loss from Defective Merchandise account
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Mid-chapter Demo Problem
• Lets look at the Mid-chapter demo problem
– Consider the transactions
– Complete the journal entries
– What do these look like from the T-account perspective
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Adjusting Entries
• Similar to the service company we studied earlier,
merchandising companies will have adjusting entries at the
end of period
– (you know, to reflect amortization, reduction in prepaid assets,
accrued expenses, accrued revenues, etc)
• Merchandising companies may also see a adjustment for
shrinkage
• Shrinkage reflects a loss due to
– Deterioration of goods (food, weatherable items)
– Theft
– Damage while in storage
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Adjusting Entries
• To adjust for shrinkage, the company will debit COGS and
credit Inventory
– In a perpetual inventory system shrinkage can really only be
assessed through a physical count/assessment of the inventory
Date
Account Titles and explanation
Apr 2
Cost of Goods Sold
PR
Inventory (shrinkage)
Debit
Credit
80
80
• Once the adjustment to inventory is complete, the ending
inventory balance for period 1 becomes the beginning
inventory balance for period 2
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Closing Entries
• Closing entries for a merchandising company are the same
as those for a service company.
• We must close the additional temporary accounts used by a
merchandising company
– Sales Discounts
– Sales Returns and Allowances
– Cost of Goods Sold
• Exhibit 6.21 shows a good example of the closing process
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Financial Statements
• The financial statements for a merchandiser are similar to
those of a service company
– The Balance Sheet has an additional asset account for Inventory
– The Income Statement will show Sales, COGS that produce a
Gross Profit (Sales – COGS).
– The Income Statement may also break out selling expenses from
operating expenses
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Sample Problems
• Try Exercise 6-3 and 6-5
– Complete the journal entries
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD
Demonstration Problem
• Lets try the demonstration problem
–
–
–
–
–
Calculate the total cost of merchandise inventory purchases
Complete the Multi-Step Income Statement
Complete the Single Step Income Statement
Enter the closing entries
Bonus
• Complete the Statement of Owner’s Equity
• Classified Balance Sheet
• Chapter 7
Financial Accounting
Dave Ludwick, P.Eng, MBA, PMP, PhD