Financial Accounting:
Tools for Business Decision Making, 2nd Ed.
Kimmel, Weygandt, Kieso
1
Chapter 5
Chapter 5
Merchandising Operations
After studying Chapter 5, you should
be able to:
 Identify the differences between a service
enterprise and a merchandising company.
 Explain the recording of purchases under a
perpetual inventory system.
 Explain the recording of sales revenues under a
perpetual inventory system.
 Distinguish between a single-step and a multi-step
income statement.
 Explain the factors affecting the profitability. 3
Service enterprises
perform services as
their primary source
of revenue
Merchandising
companies buy
and sell
merchandise
Differences Between a Service
Enterprise and a Merchandising Company
 In a merchandising company, the primary source of
revenues is the sale of merchandise, referred to as sales
revenue or sales.
 Unlike expenses for a service company, expenses for a
merchandising company are divided into two categories:
 Cost of goods sold - the total cost of merchandise sold
during the period.
 Operating expenses - selling and administrative
expenses.
5
Terms
 Sales revenue or sales = sale of
merchandise
 Cost of goods sold = total cost of
merchandise sold
6
Illustration
5-1
Page 202 in book
How Income is Measured in
a Merchandising Company
Sales
Revenue
Less
Cost of
Goods Sold
Equals
Gross
Profit
Less
Operating
Expenses
Equals
Net Income
(Loss)
7
Operating cycle of a
company is...
the average time it takes to
go from cash to cash in
producing revenues.
TO
8
Operating cycle of a
merchandising company is...
 ordinarily longer than than
that of a service company;
 purchase of merchandise and
its sale lengthens the cycle.
9
Illustration 5-2
Service Company
Receive Cash
Perform Services
Cash
Accounts
Receivable
Merchandising Company
Receive Cash
Cash
Buy Inventory
Sell Inventory
Accounts
Receivable
Merchandise
10
Inventory
Inventory Systems
 Perpetual - detailed inventory system in
which the cost of inventory is maintained
and the records continuously show the
inventory that should be on hand
 Periodic -inventory system in which
detailed records are not maintained and
the cost is goods sold is determined only
at end of accounting period
11
Illustration 5-3
Comparing Periodic and
Perpetual Inventory Systems
Inventory Purchased
Item Sold
Perpetual
Perpetual
End of
Period
No Entry
Record Purchase of Inventory
Inventory Purchased
Record Revenue and
Cost of Goods Sold
Item Sold
End of
Period
Periodic
Record Purchase of Inventory
Record Revenue Only
Compute Cost
12 Sold
of Goods
Computers
13
and
electronic
scanners
have
enabled
many
companies
to install
perpetual
inventory
systems
What Is Charged to
Merchandise Inventory?
 All Costs of getting the inventory to
company and ready to sell
 +Freight-In
 +Special Permits
 Only costs associated with merchandise
purchased for resale - not assets acquired
for use, such as supplies
15
Merchandise Purchases
On May 4 the company bought $ 3,800 worth of
merchandise from PW Audio Supply, Inc.
Task:Record the purchase by getting
information from the Purchase Invoice.
The Purchase Invoice is a copy of the
sales invoice.
16
•1. Seller
•2.Invoice Date
•3.Purchaser
•4.Salesperson
•5.Credit terms
•6.Freight
terms
•7.Goods sold:
catalog
no.,description,
quantity, price
per unit
•8.Total invoice
price
Illustration 5-4
Invoice No. 731
Firm Name: Sauk Stero
Attention o f James Hoover, Purchasing Agent
Address 125 Main Street
City Chelsea State Illinois Zip 60915
Date5/4/01 Salesperson Maone Terms 2/10,n/30 Freight Paid by Buyer
Catalog No. Description
A2547Z48
QTY
Production Model
Circuits
IMPORTANT: ALL RETURNS MUST BE MADE WITHIN 10 DAYS
8
Price
Amount
300
TOTAL
1,500
17
$3,800
Merchandise Purchases
On May 4 the company bought $ 3,800 worth of
merchandise from PW Audio Supply, Inc.
Merchandise
Inventory
Accounts
Payable
May 4 3,800
Freight-out
May 4 3,800
GENERAL JOURNAL
May 4 Merchandise Inventory
Accounts Payable
Debit Credit
3,800
3,800
To record goods purchased on account
18
Purchases Returns and Allowances
On May 8 the company returned $300 worth of
merchandise to PW Audio Supply, Inc.
Merchandise
Inventory
May 4 3,800 May 8 300
Accounts
Payable
Freight-out
May 8 300 May 4 3,800
GENERAL JOURNAL
May 8 Accounts Payable
Merchandise Inventory
Debit Credit
300
300
To record goods returned that were purchased on account
19
Freight Costs - On Incoming
Inventory
20
Freight Costs - On Incoming Inventory
On May 6 the company paid $ 150 to have the
merchandise inventory delivered to them.
Merchandise
Inventory
Freight-Out
Cash
May 4 3,800 May 8 300
May 6
May 6 150
150
GENERAL JOURNAL
May 6 Merchandise Inventory
Cash
Debit Credit
150
150
To record payment of freight.
21
Freight Costs - On Outgoing
Inventory
22
Freight Costs-on outgoing inventory
On May 6 the seller company paid $ 150 to have
merchandise inventory delivered to the buyer.
Merchandise
Inventory
Freight-Out
May 6
Cash
150
GENERAL JOURNAL
May 6 Freight-Out
Cash
May 6 150
Debit Credit
150
150
To record payment of freight on goods sold.
23
Purchase Discounts
•Credit terms of a purchase on account may
permit the buyer to claim a cash discount for
prompt payment.
•Credit terms specify the amount of cash discounts
and the time period during which it is offered.
•2/10,n/30
•1/10 EOM
24
Purchases Discounts
Review - Company purchased $3800 of merchandise
and returned $300. The credit terms are 2/10, n/30
and the invoice was paid within the discount period
Original Invoice
-Returns
Amount due before discount
2% discount
Net due
$3,800
300
$3,500
70
$3,430
25
Purchases Discounts
Review - Company purchased $3800 of merchandise
and returned $300. The credit terms are 2/10, n/30
and the invoice was paid within the discount period.
Merchandise
Inventory
May 4 3,800 May 8 300 May 8
Accounts
Payable
Cash
300 May 4 3,800
May 14 70 May 14 3,500
GENERAL JOURNAL
May 14 Accounts Payable
Cash
Merchandise Inventory
To record payment within discount period.
May 14 3430
Debit Credit
3,500
3,430
70
Sales Invoice ...
a business document that provides
written evidence of a credit sale.
27
•1. Seller
•2.Invoice Date
•3.Purchaser
•4.Salesperson
•5.Credit terms
•6.Freight
terms
•7.Goods sold:
catalog
no.,description,
quantity, price
per unit
•8.Total invoice
price
Illustration 5-4
Invoice No. 731
Firm Name: Sauk Stero
Attention o f James Hoover, Purchasing Agent
Address 125 Main Street
City Chelsea State Illinois Zip 60915
Date 5/4/01 Salesperson Maone Terms 2/10,n/30 Freight Paid by Buyer
Catalog No. Description
A2547Z48
QTY
Production Model
Circuits
IMPORTANT: ALL RETURNS MUST BE MADE WITHIN 10 DAYS
8
Price
300
TOTAL
Amount
1,500
28$3,800
Sales Revenues Under a Perpetual System
 are recorded when earned-revenue
recognition principle
 must be supported by a business documentwritten evidence
 2 entries are made for each sale
 one to record sale
 one to record cost of merchandise sold
29
Sales - under a perpetual system
Assume a CASH sale of $ 2,200
For merchandise having a cost of $ 1,400
Cash
Accounts
Receivable
Merchandise
Inventory
May 4 2,200
May 4 1.400
Sales
May 4 2,200
Sales Returns &
Allowances
Cost of Goods
Sold
May 4 1.400
Sales Returns and
Allowances
Flip side of purchase returns and allowance
On buyer’s books
GENERAL JOURNAL
May 8 Accounts Payable
Merchandise Inventory
Debit Credit
300
300
To record goods returned that were purchased on account
On seller’s books
GENERAL JOURNAL
May 8 Sales Returns and Allowance
Accounts Receivable
Debit Credit
300
To record return of goods delivered to Sauk Stero
300
31
Sales - under a perpetual system
Assume a sale of $ 3,800 ON ACCOUNT
For merchandise having a cost of $2,400
Accounts
Merchandise
Receivable
Cash
Inventory
May 4 3,800
Sales
May 4 3,800
Sales Returns &
Allowances
May 4 2,400
Cost of Goods
Sold
May 2,400
What Is the Sales Returns
and Allowances Account?
 Contra Revenue Account to sales
 Used to show how much came in on returns
and allowances
Excessive returns and allowances suggest:
 inferior merchandise
 inefficiencies in filing orders
 errors in billing customers
 mistakes in delivery or shipment of goods
33
What Is the Sales
Discount Account?
 Contra Revenue Account to sales
 Used to disclose amount of cash
discounts taken by customers
34
Sales Discounts
Flip side of purchase discounts
On buyer’s books
GENERAL JOURNAL
May 14 Accounts Payable
Cash
Merchandise Inventory
Debit Credit
3,500
3,430
70
To record payment within discount period
On seller’s books
GENERAL JOURNAL
Debit Credit
May 14 Cash
Sales Discounts
Accounts Receivable
3,430
70
To record collection within discount period
3500
35
Two Forms Of
Income Statements
 Single-step income statement
 Multiple-step income statement
36
Single-Step Income
Statement
One step… subtract total
expenses from total revenues
Revenues $10,000
Expenses
3,000
Net income $ 7,000
37
PW AUDIO, Inc.
Illustration 5-9
Single-step Income Statement
For the Year Ended December 31, 2001
Sales
Interest Revenue
Gain on Sale of equipment
Total Revenues
Expenses
Cost of goods sold
Selling expenses
Administrative expenses
Interest expense
Casualty Loss from vandalism
Income tax expense
Total expenses
Net income
$460,000
3,000
600
$463,600
$316,000
76,000
38,000
1,800
200
10,100
442,100
$ 21,500
Illustration 5-9
PW AUDIO SUPPLY, INC.
Multi-step Income Statement For the Year Ended
December 31, 2001
Sales revenues
Sales
Less: Sales returns and allowance
Sales discounts
Net sales
Cost of goods sold
Gross profit
Operating expenses
Selling expenses:
Store salaries expense
Advertising expense
Depreciation expense
Freight-out
Total selling expenses
Administrative expenses
Salaries expense
Utilities expense
Insurance Expense
Total administrative expenses
Total operating expenses
Income from operations
$ 480,000
$12,000
8,000
20,000
460,000
316,000
$ 144,000
$45,000
16,000
8,000
7,000
$76,000
$19,000
17,000
2,000
38,000
114,000
$ 30,000
PW AUDIO SUPPLY, INC.
Multi-step Income Statement
For the Year Ended December 31, 2001
Income from operations (continued)
Other revenues and gains
Interest revenue
Gain on sale of equipment
Illustration 5-9
$ 30,000
$ 3,000
600
$ 3,600
Other expenses and losses
Interest expense
Casualty loss from vandalism
$ 1,800
200
2,000
Income before income income taxes
Income tax expense
Net Income
1,600
31,600
10,100
$21,500
Gross Profit Rate=
Gross Profit
Net Sales
Company’s gross profit expressed as a
percentage
41
Operating Expenses To
Sales Ratio=
Operating Expenses
Net Sales
Many companies have improved the
efficiency of their operations, thus
reducing the ratio of operating
expenses to sales.
42
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