Chapter
5
McGraw-Hill/Irwin
Accounting for
Merchandising
Operations
© The McGraw-Hill Companies, Inc., 2005
Learning objective
1.
2.
3.
4.
5.
6.
Specialty of merchandising activities
Accounting for merchandise purchasing
Accounting for merchandise sales
Completing Accounting cycle
Financial statement format
Decision Analysis:
•
•
•
•
McGraw-Hill/Irwin
Current Ratio
Acid-test ratio
Gross margin ratio
Case: Walmart & Target
© The McGraw-Hill Companies, Inc., 2005
1. Specialties of Merchandising Activities
Merchandising companies sell goods to earn revenue.
Example: supermarket
Revenues
McGraw-Hill/Irwin
Minus
Expenses
Equals
Net
income
© The McGraw-Hill Companies, Inc., 2005
Merchandising Activities
Merchandising Companies
Manufacturer
McGraw-Hill/Irwin
Wholesaler
Retailer
Customer
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Reporting Income for a Merchandiser
Merchandising companies sell products to earn revenue.
Examples: sporting goods, clothing, and auto parts
stores
Net
Sales
Minus
Cost of Equals
Goods Sold
Gross
Profit
Minus
Expenses
Equals
Net
Income
Merchandising Company
Income Statement
For Year Ended December 31, 2005
Sales revenues
Cost of goods sold
Gross profit
Operating expenses
Net income
McGraw-Hill/Irwin
$ 150,000
80,000
$ 70,000
46,500
$ 23,500
© The McGraw-Hill Companies, Inc., 2005
Operating Cycle for a Merchandiser
Begins with the purchase of merchandise and ends
with the collection of cash from the sale of
merchandise.
Credit Sale
Cash Sale
Purchases
Purchases
Merchandise
inventory
Account
receivable
Cash
sales
Merchandise
inventory
McGraw-Hill/Irwin
Cash
collection
Credit sales
© The McGraw-Hill Companies, Inc., 2005
Inventory Systems
Beginning
inventory
Net cost of
purchases
+
= Merchandise
available for sale
Ending Inventory
McGraw-Hill/Irwin
+
Cost of Goods
Sold
© The McGraw-Hill Companies, Inc., 2005
Inventory Systems
 Perpetual inventory system continuously
updates accounting records for merchandising
transactions — specifically, for those records of
inventory available for sale and inventory sold.
 Periodic inventory system updates the
accounting records for merchandise
transactions only at the end of a period. What
are the disadvantages of periodic inventory
system?
McGraw-Hill/Irwin
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2. Accounting for Merchandise Purchases
 Trade discounts vs. purchase discounts
 Purchase returns and allowances
 Transportation costs
McGraw-Hill/Irwin
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
Main Source, Inc.
614 Tech Avenue
Nashville, TN 37651
S
o
l
d
T
o

P.O. 167
Item
AC417


Name: Barbee, Inc.
Attn: Tom Bell
Address: One Willow Plaza
Cookeville, Tennessee
38501

Sales: 25 Terms 2/10,n/30
Description
250 Backup System

We appreciate your business!
McGraw-Hill/Irwin
Invoice
Date
5/4/05
Number
358-BI
Seller Invoice date
Purchaser Order number
Credit terms Freight terms
Goods Invoice amount

Ship: FedEx Prepaid
Quanity
Price
Amount
500 $ 54.00 $ 27,000
Sub Total
Ship Chg.
Tax
Total
$
27,000
27,000

© The McGraw-Hill Companies, Inc., 2005
Accounting for Merchandise Purchases
On November 2, Z-Mart, purchased $1200 of
Merchandise Inventory by paying cash.
Nov. 2 Merchandise Inventory . . . . . . . . 1,200
.
Cash . . . . . . . . . . . . . . . .
1,200
Purchase merchandise for cash
McGraw-Hill/Irwin
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Trade Discounts
Used by manufacturers and wholesalers to offer
better prices for greater quantities purchased.
Example
Matrix, Inc. offers a 30% trade
discount on orders of 1,000
units or more of their popular
product Racer. Each
Racer has a list price of $5.25.
McGraw-Hill/Irwin
Quantity sold
Price per unit
Total
Less 30% discount
Invoice price
1,000
$ 5.25
5,250
(1,575)
$ 3,675
© The McGraw-Hill Companies, Inc., 2005
Purchase Discounts
Credit term
2/10,n/30
Discount
Percent
McGraw-Hill/Irwin
Number of
Days
Discount Is
Available
Otherwise,
Net (or All)
Is Due
Credit
Period
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Purchase Discounts
A deduction from the invoice price granted to
induce early payment of the amount due.
Terms
Discount Period
Credit Period
Full amount
less discount
Full amount due
Time
Due
Purchase or Sale
McGraw-Hill/Irwin
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Purchase Discounts
On Nov 2, Z-Mart purchased $1200 of
Merchandise Inventory on account, credit
terms are 2/10, n/30.
Nov. 2
Merchandise Inventory
Accounts Payable
1,200
1,200
Purchase merchandise on account
McGraw-Hill/Irwin
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Purchase Discounts
On Nov. 12, Z-Mart paid the amount due on the
purchase of Nov. 2.
Nov. 12 Accounts Payable
1,200
Cash
Marchandise Inventory
1,176
24
Paid for the $1,200 purchase of Nov. 2 less the discount.
$1,200 × 2% = $24 discount
McGraw-Hill/Irwin
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Purchase Discounts
After we post these entries, the accounts
involved look like this:
Merchandise Inventory
11/02
1,200 11/12
Bal. 1,176
McGraw-Hill/Irwin
24
Accounts Payable
11/12 1,200 11/02 1,200
Bal.
0
© The McGraw-Hill Companies, Inc., 2005
Failure to Pay Within the Discount Period
If we fail to take a 2/10, n/30
discount, is it really expensive?
365 days ÷ 20 days × 2% = 36.5% annual rate
Days
in a
year
McGraw-Hill/Irwin
Number
of additional
days before
payment
Percent
paid to
keep
money
© The McGraw-Hill Companies, Inc., 2005
Purchase Returns and Allowances
Purchase Return: Merchandise returned by the purchaser
to the supplier.
Purchase Allowance: A reduction in the cost of defective
merchandise received by a purchaser from a supplier.
McGraw-Hill/Irwin
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Purchase Returns and Allowances
On Nov. 9, Z-Mart purchased $20,000 of
Merchandise Inventory on account, credit
terms are 2/10, n/30.
Nov. 9
Merchandise Inventory
Accounts Payable
20,000
20,000
Purchased merchandise on account
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2005
Purchase Returns and Allowances
On Nov. 10, Z-Mart returned $500 of defective
merchandise to the supplier.
Nov 10 Accounts Payable
500
Merchandise Inventory
500
Returned defective merchandise
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2005
Purchase Returns and Allowances
On Nov. 18, Z-Mart paid the amount owed for the
purchase of Nov 9.
Nov. 18 Accounts Payable
19,500
Cash
Merchandise Inventory
19,110
390
Paid account less discount
Purchase
Returns
Amount Due
Discount
Cash Paid
McGraw-Hill/Irwin
$ 20,000
(500)
19,500
(390)
$ 19,110
© The McGraw-Hill Companies, Inc., 2005
Transportation Costs
Buyer
Seller
FOB shipping point
(buyer pays)
Terms
FOB shipping point
FOB destination
McGraw-Hill/Irwin
Merchandise
FOB destination
(seller pays)
Ownership transfers
to buyer when goods
are passed to
Transportation
costs paid by
Carrier
Buyer
Buyer
Seller
© The McGraw-Hill Companies, Inc., 2005
Transportation Costs
On Nov. 12, Z-Mart purchased $8,000 of
Merchandise Inventory for cash and also paid
$100 transportation costs.
Nov. 12 Merchandise Inventory
Cash
8,100
8,100
Paid for merchandise and transportation
McGraw-Hill/Irwin
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Quick Check 
On July 6, 2005 Seller Co. sold $7,500 of
merchandise to Buyer, Co.; terms of 2/10,n/30. The
shipping terms were FOB shipping point. The
shipping cost was $100. Which of the following will
be part of Buyer’s July 6 journal entry?
a. Credit Sales $7,500
b. Credit Purchase Discounts $150
c. Debit Merchandise Inventory $100
d. Debit Accounts Payable $7,450
FOB shipping point indicates the buyer
ultimately pays the freight. This is recorded with
a debit to Merchandise Inventory.
McGraw-Hill/Irwin
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Itemized Cost of Merchandise Purchased
Z-Mart.
Total Cost of Merchandise Purchases
For Year Ended Dec 31, 2005
Invoice cost of merchandise purchases
$ 235,800
Less:
Purchase discounts
(4,200)
Purchase returns and allowances
(1,500)
Add:
Cost of transportation-in
2,300
Total cost of merchandise purchases
$ 232,400
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2005
3. Accounting for Merchandise Sales
 Sales of merchandise
 Sales discounts
 Sales returns and allowances
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2005
Accounting for Merchandise Sales
Z-Mart
Computation of Gross Profit
For Year Ended December 31, 2005
Sales
Less:
Sales discounts
Sales returns and allowances
Net sales
Cost of goods sold
Gross profit
$
$ 4,300
2,000
$
$
321,000
6,300
314,700
(230,400)
84,300
Sales discounts and returns and allowances are Contra Revenue accounts.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2005
Sales of Merchandise
On Nov. 3, Z-Mart sold $2,400 of merchandise on
credit. The merchandise was carried in inventory
at a cost of $1,600.
Nov. 3
Accounts Receivable
Sales
2,400
2,400
Sales of merchandise on credit
Cost of Goods Sold
Merchandise Inventory
1,600
1,600
To record cost of sales
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2005
Sales Discounts
On Nov. 12, Z-Mart sold merchandise costing
$600 for $1,000 on account. Credit terms were
2/10, n/60. Let’s prepare the journal entries.
Nov. 12 Accounts Receivable
Sales
1,000
1,000
Sales of merchandise on credit
Cost of Goods Sold
Merchandise Inventory
600
600
To record cost of sales
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2005
Sales Discounts
On Nov. 22, Z-Mart received a check for $980 in
full payment of the Nov. 12 sale.
Nov.22 Cash
Sales Discount
Accounts Receivable
980
20
1,000
Received payment less discount
Contra
Revenue
Account
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2005
Sales Returns and Allowances
On Nov. 3, Z-Mart sold merchandise costing
$4,000 for $7,500 on account The credit
terms were 2/10, n/30.
Nov.3
Accounts Receivable
Sales
7,500
7,500
Sales of merchandise on credit
Cost of Goods Sold
4,000
Merchandise Inventory
4,000
To record cost of sales
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2005
Sales Returns and Allowances
On Nov. 6, customer returns merchandises with
a sales price of $800 and a cost of $600. The
return is related to the Nov. 3 sale.
Nov. 6
Sales Returns and Allowances
Accounts Receivable
800
800
Customer returned merchandise
Merchandise Inventory
Cost of Goods Sold
600
600
Returned goods placed in inventory
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2005
Sales Returns and Allowances
Assume that $800 of merchandise Z-Mart sold on Nov.
3 is defective but the buyer decides to keep it
because Z-Mart offers a $100 price reduction.
Nov. 6
Sales Returns and Allowances
Accounts Receivable
100
100
To record sales allowance on Nov. 3 sale.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2005
4. Completing accounting cycle
 Prepare adjustments and close accounts for a
merchandising company.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2005
Shrinkage
 Compare a physical count of inventory with
recorded amounts.
 Z-Mart’s Merchandise Inventory account at the
end of year 2005 has a balance of $21,250,
but a physical count reveals that only $21,000
of inventory exists. The adjusting entry is:
12/31/2005 Dr. Cost of goods sold
250
Cr. Merchandise inventory
250
To adjust for $250 shrinkage.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2005
Completing the accounting cycle
Let’s complete the
accounting cycle
by preparing the
closing entries for
Z-Mart.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2005
Step 1: Close Credit Balances in Temporary Accounts
to Income Summary.
Dec. 31 Sales . . . . . . . . . . . . . . . . . . . . 321,000
Income summary . . . . . .
321,000
To close credit balance in temporary accounts
Income Summary
321,000
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2005
Step 2: Close Debit Balances in Temporary Accounts to
Income Summary.
Dec. 31
Incom e Sum m ary
308,100
Sales Discounts
4,300
Sales Returns and Allow ances
2,000
Cost of Goods Sold
230,400
Depreciation Expense-Store Eq
3,000
Depreciation Expense-Office Eq
700
Office Salaries Expense
25,300
Sales Salaries Expense
18,500
Insurance Expense
600
Rent Expense - Office Space
900
Rent Expense - Selling Space
8,100
Office Supplies Expense
1,800
Store Supplies Expense
1,200
Advertising Expense
11,300
To close debit balances in temporary accounts
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2005
Income Summary
308,100
321,000
Bal.
12,900
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2005
Step 3: Close Income Summary to Owner’s Capital
Dec. 31 Income Summary
K. Mart, Capital
12,900
12,900
To close Income Summary account
Income Summary
308,100
321,000
12900
Bal.
-
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2005
Step 4: Close Withdrawals Account to Owner’s Capital.
Dec. 31 K Mart, Capital
K Mart, Withdrawals
4,000
4,000
To close the withdrawals account
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2005
5. Financial statement format
 Define and prepare multiple-step and singlestep income statements.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2005
Income Statement Formats
Multiple-Step
Single-Step
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2005
Z-Mart Company
Income Statement
For Year Ended December 31, 2005
Sales
Less: Sales discounts
Sales returns
Net sales
Cost of Goods Sold
Gross profit from sales
Operating expenses:
Selling expenses:
Depreciation expense-Store
Salaries expense
Rent expense-Selling
Store supplies expense
Advertising expense
General and adm inistrative expenses:
Depreciation expense-Office
Office salaries expense
Insurance expense
Rent expense
Supplies expense
Total operating expenses
Incom e form operation
Other revenue and gains
Interest revenue
Gain on sale of building
Other expenses and losses
Interest expense
Total other revenue and gains
Net Incom e
McGraw-Hill/Irwin
$ 321,000
$
$
$
$
$
$
3,000
18,500
8,100
1,200
11,300
700
25,300
600
900
1,800
1,000
2,500
$
4,300
2,000
6,300
$ 314,700
230,400
$
84,300
MultipleStep
Income
Statement
42,100
29,300
$
71,400
12,900
$
14,900
3,500
1,500
2,000
© The McGraw-Hill Companies, Inc., 2005
Operating expenses
 Selling expenses include the expenses of
promoting sales by displaying and advertising
merchandise, making sales, and delivering
goods to customers.
 General and administrative expenses support
a company’s overall operations and include
expenses related to accounting, HR
management, and financial management.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2005
Single-Step Income Statement
For Year Ended Decem ber 31, 2005
Revenue
Net sales
$ 314,700
Interest revenue
1,000
Gain on sale of building
2,500
Total Revenue
318,200
Expenses
Cost of goods sold
$ 230,400
Selling expenses
42,100
G&A expenses
29,300
Interest expense
1,500
Total expense
303,300
Net incom e
$ 14,900
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2005
Multiple-Step vs. Single-Step Income
statement

A multiple-step income statement format
shows detailed computations of net sales and
other costs and expenses, and report subtotals
for various classes of items.




Gross profit
Income from operations
Net income
A single-step income statement lists revenues
and expenses with very few categories.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2005
Classified Balance Sheet
Merchandising Company
Balance Sheet
December 31, 2005
Assets
Cash
Merchandise Inventory
Equipment
$
10,200
1,200
16,000
Total assets
$
27,400
McGraw-Hill/Irwin
Liabilities
Accounts payable
$
Notes payable
Total liabilities
$
Equity
Total liabilities and equity $
1,200
4,000
5,200
22,200
27,400
© The McGraw-Hill Companies, Inc., 2005
6. Decision Analysis
- Current Ratio & Acid-Test Ratio
Helps assess the company’s ability to
pay its debts in the near future
Liquidity measure
Current Assets
Current Ratio =
Current Liabilities
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2005
6. Decision Analysis
- Acid-Test Ratio
Acid-Test
=
Ratio
Quick Assets
Current Liabilities
Acid-Test
Cash + S-T Investments + Receivables
=
Current Liabilities
Ratio
A common rule of thumb is the acid-test ratio should have a
value of at least 1.0 to conclude a company is unlikely to
face liquidity problems in the near future.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2005
6. Decision Analysis
- Gross Margin Ratio
Gross
Margin =
Ratio
Net Sales - Cost of Goods Sold
Net Sales
Percentage of dollar sales available to cover expenses
and provide a profit.
Indicate the company’s pricing capability of its products
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2005
6. Decision Analysis
- Supermarket
1. Industry Characteristics


High volume, Low profit margin
Chain of stores
2. Key success factors


Inventory control
Store location decision
3. Companies for analysis


McGraw-Hill/Irwin
Walmart
Target
© The McGraw-Hill Companies, Inc., 2005
6. Walmat & Target
- Current Ratio
CR
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
WMT
0.90
0.90
0.90
0.90
1.00
0.90
0.90
1.20
1.30
1.70
1.50
Target
1.50
1.69
1.55
1.59
1.37
1.16
Current Ratio
1.80
1.70
1.60
Current Ratio
1.50
1.40
1.30
1.20
1.10
1.00
0.90
0.80
1994
1996
1998
2000
2002
2004
2006
Year
WMT
McGraw-Hill/Irwin
Target
© The McGraw-Hill Companies, Inc., 2005
6. Walmat & Target
- Acid-test Ratio
ATR
2005
2004
2003
2002
2001
2000
WMT
0.19
0.17
0.17
0.13
0.15
0.13
Target
0.76
0.89
0.78
0.84
0.61
0.36
1999
1998
1997
1996
1995
Acid-test Ratio
1.00
0.90
Acid-test Ratio
0.80
0.70
0.60
0.50
0.40
0.30
0.20
0.10
1994
1996
1998
2000
2002
2004
2006
Year
WMT
McGraw-Hill/Irwin
Target
© The McGraw-Hill Companies, Inc., 2005
6. Walmat & Target
- Gross Profit Margin
GPM
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
WMT
23.06%
22.94%
22.46%
22.35%
22.02%
22.16%
22.03%
21.48%
21.29%
20.81%
20.85%
Target
33.62%
32.87%
32.45%
21.79%
17.80%
15.22%
31.67%
31.23%
31.08%
Gross Profit Margin
40.00%
Gross Profit Margin
35.00%
30.00%
25.00%
20.00%
15.00%
10.00%
1994
1996
1998
2000
2002
2004
2006
Year
WMT
McGraw-Hill/Irwin
Target
© The McGraw-Hill Companies, Inc., 2005
6. Walmat & Target
- Profit Margin
PM
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
WMT
3.59%
3.60%
3.53%
3.46%
3.23%
3.45%
3.41%
3.37%
3.13%
3.05%
3.07%
Target
4.58%
4.02%
3.85%
3.68%
3.33%
3.23%
3.39%
3.05%
2.73%
3.50%
3.37%
3.71%
Industry
Profit Margin
5.00%
4.50%
Profit Margin
4.00%
3.50%
3.00%
2.50%
2.00%
1.50%
1.00%
1994
1996
1998
2000
2002
2004
2006
Year
WMT
McGraw-Hill/Irwin
Target
© The McGraw-Hill Companies, Inc., 2005