Chapter Five
Accounting for
Merchandising
Businesses
McGraw-Hill/Irwin
©The McGraw-Hill Companies, Inc. 2006
Merchandising Businesses
Merchandising
businesses generate
revenue by selling
goods. The goods
purchased for resale
are called
merchandise
inventory.
Sale
Product Costs Versus Selling
and Administrative Costs
Product
Costs
Selling &
Admin.
Costs
Costs that are
included in
inventory.
Costs that are not
included in
inventory. They
are sometimes
called period
costs.
Allocation of Inventory Cost Between
Asset and Expense Accounts
Beginning
Inventory
Balance
Cost of Goods
Available for Sale
Inventory
Cost of
Purchased
Goods
+
=
During the
Available
Period
for Sale
Merchandise Inventory
(Balance Sheet)
Cost of Goods Sold
(Income Statement)
Gross Margin (or Gross Profit)
Sales Revenue
- Cost of Goods Sold
Gross Margin
Perpetual Inventory System
Perpetual
Inventory
System
Inventory account
is adjusted
perpetually
(continually)
throughout the
accounting period.
Perpetual Inventory System
Let’s see how a
perpetual
inventory system
works by looking
at transactions for
June’s Plant Shop
(JPS).
Event 1: JPS acquired $15,000 by issuing
common stock.
1. Increase assets
(cash).
Asset Source
Transaction
2. Increase equity
(common stock).
Cash
15,000
+ Inventory
+
n/a
=
=
Common
Retained
Stock
+ Earnings
15,000 +
n/a
Revenue
n/a
-
Expenses
n/a
=
=
Net
Income
n/a
Cash Flow
15,000 FA
Event 2: JPS purchased merchandise inventory
for $14,000 cash.
Asset
Exchange
Transaction
1. Decrease assets (cash).
2. Increase assets
(merchandise
inventory).
Cash
+ Inventory
14,000
(14,000) +
=
=
Common
Retained
Stock
+ Earnings
+
n/a
n/a
Revenue
n/a
-
Expenses
n/a
=
=
Net
Income
n/a
Cash Flow
(14,000) OA
Event 3a: JPS recognized sales revenue from
selling inventory for $12,000.
1. Increase assets (cash).
Asset Source
Transaction
2. Increase equity (sales
revenue).
Cash
12,000
+ Inventory
+
n/a
=
=
Common
Retained
Stock
+ Earnings
+
n/a
12,000
Revenue
12,000
-
Expenses
n/a
=
=
Net
Income
12,000
Cash Flow
12,000 OA
Event 3b: JPS recognized $8,000 of cost of goods
sold.
1. Decrease assets
(merchandise
inventory).
Asset Use
Transaction
2. Decrease equity (cost of
goods sold).
Cash
n/a
+ Inventory =
+
(8,000) =
Common
Retained
Stock
+ Earnings
+
n/a
(8,000)
Revenue
n/a
-
Expenses
8,000
=
=
Net
Income
(8,000)
Cash Flow
n/a
Event 4: JPS paid $1,000 cash for selling
expenses.
1. Decrease assets (cash).
Asset Use
Transaction
2. Decrease equity (selling
expenses).
Cash
+ Inventory
n/a
(1,000) +
=
=
Common
Retained
Stock
+ Earnings
+
n/a
(1,000)
Revenue
n/a
-
Expenses
1,000
=
=
Net
Income
(1,000)
Cash Flow
(1,000) OA
Other Topics
Purchasing inventory often involves:
•Transportation costs
•Inventory returns
•Purchase allowances
•Cash discounts
Let’s look at these
transactions for JPS.
Event 1: JPS purchased merchandise inventory
on account with a list price of $8,000. The
payment terms are 2/10 n/30.
Before
analyzing this
transaction,
let’s learn a
little about cash
discounts.
Cash 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
Cash Discounts
2/10, n/30
Percentage
of Discount
# of Days
Discount Is
Available
Otherwise,
the Full
Amount Is
Due
# of Days
when Full
Amount Is
Due
Event 1: JPS purchased merchandise inventory
on account with a list price of $8,000. The
payment terms are 2/10 n/30.
1. Increase assets
(merchandise
inventory).
Asset Source
Transaction
2. Increase liabilities
(accounts payable).
Net Method
$ 8,000  98% = $ 7,840
Cash
n/a
+
+
Accts.
Rec.
n/a
+ Inventory
+
7,840
=
=
Accts.
Pay.
7,840
+
+
Common
Retained
Stock
+ Earnings
+
n/a
n/a
Revenue
n/a
-
Expenses
n/a
=
=
Net
Income
n/a
Cash Flow
n/a
Event 2: JPS returned some of the inventory
purchased in Event 1. The list price of the
returned merchandise was $1,000.
1. Decrease assets
(merchandise inventory).
Asset Use
Transaction
2. Decrease liabilities
(accounts payable).
Net Method
$ 1,000  98% = $
Cash
n/a
+
+
Accts.
Rec.
n/a
+ Inventory =
+
(980) =
Accts.
Pay.
(980)
+
+
Common
Retained
Stock
+ Earnings
+
n/a
n/a
Revenue
n/a
980
-
Expenses
n/a
=
=
Net
Income
n/a
Cash Flow
n/a
Event 3: JPS paid cash to settle the account
payable due on the inventory purchased in Event
1. The payment was made after the end of the
discount period.
1. Decrease assets (cash).
2. Decrease liabilities
(accounts payable).
Asset Use
Transaction
3. Decrease equity
(interest expense).
Cash Payment
$ 8,000  $ 1,000 = $ 7,000
Accts.
Cash
+ Rec.
(7,000) + n/a
+ Inventory
+
n/a
=
=
Accts.
Common
Retained
Pay.
+
Stock
+ Earnings
(6,860) +
+
n/a
(140)
Accounts Payable
$ 7,840  $ 980 = $ 6,860
Revenue
n/a
- Expenses =
140 =
Net
Income
(140)
Cash Flow
(7,000) OA
Event 4: The shipping terms for the inventory
purchased in Event 1 were FOB shipping point.
JPS paid the freight company $300 cash for
delivering the merchandise.
Before
analyzing this
transaction,
let’s learn a
little about
transportation
costs.
Transportation Costs
Buyer
Seller
FOB shipping point
(buyer pays)
Freight Terms
Cost Title
Merchandise
FOB destination
(seller pays)
Responsible Party
Buyer
Seller
FOB Shipping Point
FOB Destination
Transportation-in
Transportation-out
FOB = Free on Board
Event 4: The shipping terms for the inventory
purchased in Event 1 were FOB shipping point.
JPS paid the freight company $300 cash for
delivering the merchandise.
Asset
Exchange
Transaction
1. Decrease assets (cash).
2. Increase assets
(merchandise inventory).
Cash
+
(300) +
Accts.
Rec.
n/a
+ Inventory
+
300
=
=
Accts.
Pay.
n/a
+
+
Common
Retained
Stock
+ Earnings
+
n/a
n/a
Revenue
n/a
- Expenses
n/a
=
=
Net
Income
n/a
Cash Flow
(300) OA
Event 5a: JPS recognized $24,750 of revenue on
the cash sale of merchandise that cost $11,500.
1. Increase assets (cash).
2. Increase equity (sales
revenue).
Cash
+
24,750 +
Accts.
Rec.
n/a
+ Inventory
+
n/a
=
=
Accts.
Pay.
n/a
+
+
Common
Retained
Stock
+ Earnings
+
n/a
24,750
Asset Source
Transaction
Revenue - Expenses
24,750 n/a
=
=
Net
Income
24,750
Cash Flow
24,750 OA
Event 5b: JPS recognized $11,500 of cost of
goods sold.
1. Decrease assets
(merchandise
inventory).
Asset Use
Transaction
2. Decrease equity (cost of
goods sold).
Cash
n/a
+
+
Accts.
Rec. + Inventory =
+
(11,500) =
n/a
Accts.
Pay.
n/a
+
+
Common
Stock
+
+
n/a
Retained
Earnings
(11,500)
Revenue
n/a
- Expenses =
11,500 =
Net
Income
(11,500)
Cash Flow
n/a
Event 6: JPS incurred $450 of freight costs on
inventory delivered to customers.
1. Decrease assets (cash).
Asset Use
Transaction
2. Decrease equity
(transportation-out).
Responsible Party
Buyer
Seller
FOB Shipping Point
FOB Destination
Transportation-in
Transportation-out
Freight Terms
Cost Title
Accts.
Cash
+ Rec. + Inventory
+
n/a
(450) + n/a
=
=
Accts.
Pay.
n/a
Common
+
Stock
+
+
+
n/a
Retained
Earnings
(450)
Revenue
n/a
- Expenses =
450 =
Net
Income
(450)
Cash Flow
(450) OA
Event 7: JPS purchased $14,000 of merchandise
inventory on account with credit terms of 1/10
n/30. The inventory was delivered FOB
destination. The freight costs were $400.
1. Increase assets
(merchandise inventory).
Asset Source
Transaction
2. Increase liabilities
(accounts payable).
Net Method
$ 14,000  99% = $ 13,860
Freight Terms
Cost Title
Cash
n/a
+
+
Accts.
Rec. + Inventory =
+
13,860 =
n/a
Responsible Party
Buyer
Seller
FOB Shipping Point
FOB Destination
Transportation-in
Transportation-out
Accts.
Common
Pay.
+
Stock
+
13,860 +
+
n/a
Retained
Earnings
n/a
Revenue
n/a
- Expenses
n/a
=
=
Net
Income
n/a
Cash Flow
n/a
Event 8a: JPS recognized $16,800 of revenue from the
sale on account of merchandise that cost $8,660. The
freight terms were FOB shipping point. The party
responsible paid freight costs of $275 in cash. JPS does
not offer a cash discount to purchasers.
1. Increase assets
(accounts receivable).
Asset Source
Transaction
2. Increase equity (sales
revenue).
Responsible Party
Buyer
Seller
FOB Shipping Point
FOB Destination
Transportation-in
Transportation-out
Freight Terms
Cost Title
Cash
n/a
+
+
Accts.
Rec.
+ Inventory
n/a
16,800 +
=
=
Accts.
Pay.
n/a
+
+
Common
Stock
+
+
n/a
Retained
Earnings
16,800
Revenue
- Expenses
16,800 n/a
=
=
Net
Income
16,800
Cash Flow
n/a
Event 8b: JPS recognized $8,660 of cost of goods
sold.
1. Decrease assets
(merchandise
inventory).
Asset Use
Transaction
2. Decrease equity (cost of
goods sold).
Cash
n/a
+
+
Accts.
Rec. + Inventory =
+
(8,660) =
n/a
Accts.
Pay.
n/a
+
+
Common
Stock
+
+
n/a
Retained
Earnings
(8,660)
Revenue
n/a
- Expenses =
8,660 =
Net
Income
(8,660)
Cash Flow
n/a
Event 9: JPS paid $9,900 cash in partial settlement of the
account payable that arose from purchasing inventory on
account in Event 7. The partial payment was made within
the discount period for merchandise with a list price of
$10,000.
1. Decrease assets (cash).
Asset Use
Transaction
2. Decrease liabilities
(accounts payable).
Net Method
$ 10,000  99% = $ 9,900
Cash
+
(9,900) +
Accts.
Rec.
n/a
+ Inventory
+
n/a
=
=
Accts.
Common
Pay.
+ Stock
+
(9,900) +
+
n/a
Retained
Earnings
n/a
Revenue
n/a
- Expenses
n/a
=
=
Net
Income
n/a
Cash Flow
(9,900) OA
Event 10: JPS paid $8,000 cash for selling and
administrative expenses.
1. Decrease assets (cash).
Asset Use
Transaction
2. Decrease equity (selling
and admin. expense).
Cash
+
(8,000) +
Accts.
Rec.
n/a
+ Inventory
+
n/a
=
=
Accts.
Pay.
n/a
Common
+ Stock
+
+
+
n/a
Retained
Earnings
(8,000)
Revenue
n/a
- Expenses =
8,000 =
Net
Income
(8,000)
Cash Flow
(9,900) OA
Events Affecting Sales
Sales of inventory often involves:
•Inventory returns
•Purchase allowances
•Cash discounts
Let’s look at these
transactions for JPS.
Event 1a: JPS sold on account merchandise with
a list price of $8,500. Payment terms were 1/20
n/30. The merchandise had cost JPS $5,100.
1. Increase assets
(accounts receivable).
Asset Source
Transaction
2. Increase equity (sales
revenue).
Net Method
$ 8,500  99% = $ 8,415
Cash
n/a
+
+
Accts.
Rec.
+ Inventory
n/a
8,415 +
=
=
Accts.
Pay.
n/a
+
+
Common
Stock
+
+
n/a
Retained
Earnings
8,415
Revenue
- Expenses
8,415 n/a
=
=
Net
Income
8,415
Cash Flow
n/a
Event 1b: JPS recognized $5,100 of cost of goods
sold.
1. Decrease assets
(merchandise
inventory).
Asset Use
Transaction
2. Decrease equity (cost of
goods sold).
Cash
n/a
+
+
Accts.
Rec. +
+
n/a
Inventory =
(5,100) =
Accts.
Pay.
n/a
+
+
Common
Stock
+
+
n/a
Retained
Earnings
(5,100)
Revenue
n/a
- Expenses =
5,100 =
Net Income
(5,100)
Cash Flow
n/a
Event 2a: The customer in Event 1a returned
inventory with a $1,000 list price that JPS had
sold with 1/10 n/30 payment terms. The
merchandise had originally cost JPS $600.
1. Decrease assets
(accounts receivable).
Asset Use
Transaction
2. Decrease equity
(retained earnings).
Net Method
$ 1,000  99% = $
Cash
n/a
+
+
Accts.
Rec.
+ Inventory
n/a
(990) +
=
=
Accts.
Pay.
n/a
+
+
Common
Stock
+
+
n/a
Retained
Earnings
(990)
990
Revenue
- Expenses
(990) n/a
=
=
Net
Income
(990)
Cash Flow
n/a
Event 2b: The cost of the goods ($600) is
returned to the inventory account.
1. Increase assets
(merchandise
inventory).
Asset Source
Transaction
2. Increase equity (cost of
goods sold).
Cash
n/a
+
+
Accts.
Rec. + Inventory
+
600
n/a
=
=
Accts.
Pay.
n/a
+
+
Common
Stock
+
+
n/a
Retained
Earnings
600
Revenue
n/a
- Expenses =
(600) =
Net
Income
600
Cash Flow
n/a
Event 3: JPS collected the balance of the account
receivable from the customer that purchased the
goods in Event 1a.
Asset
Exchange
Transaction
1. Increase assets (cash).
2. Decrease assets (accounts
receivable).
Let’s assume the customer paid
within the discount period.
Accounts Receivable
$ 8,415  $ 990 = $ 7,425
Cash
+
7,425 +
Accts.
Rec.
+ Inventory
n/a
(7,425) +
=
=
Accts.
Pay.
n/a
+
+
Common
Stock
+
+
n/a
Retained
Earnings
n/a
Revenue
n/a
- Expenses
n/a
=
=
Net
Income
n/a
Cash Flow
7,425 OA
Event 3: JPS collected the balance of the account
receivable from the customer that purchased the
goods in Event 1a.
1. Increase assets (cash).
Asset
Exchange &
Source
2. Decrease assets (accounts
receivable).
3. Increase equity (interest
revenue).
Now, let’s assume the customer did
not pay within the discount period.
Cash Payment
$ 7,425  $
75 = $ 7,500
Cash
+
7,500 +
Accts.
Rec.
+ Inventory
n/a
(7,425) +
=
=
Accts.
Pay.
n/a
Common
+
Stock
+
+
+
n/a
Accounts Receivable
$ 8,415  $ 990 = $ 7,425
Retained
Earnings
75
Revenue
- Expenses
75 n/a
=
=
Net
Income
75
Cash Flow
7,500 OA
Lost, Damaged, or Stolen
Inventory
Most merchandise
companies
experience some
level of inventory
shrinkage, a term
that reflects
decreases in
inventory for reasons
other than sales to
customers.
Lost, Damaged, or Stolen
Inventory
Assume a company determined that $500 of
inventory was lost through shrinkage. Here is
how it would effect the statements:
Assets =
(500) =
Liab.
n/a
+
+
Equity
(500)
Revenue n/a
-
Expenses
500
=
=
Net
Income
(500)
Cash Flow
n/a
In general journal form, the entry is as follows:
Account Title
Inventory Loss (or Cost of Goods Sold)
Inventory
Debit
500
Credit
500
Gross Margin Percentage
This measure indicates how much
of each sales dollar is left after deducting the
cost of goods sold to cover expenses and
provide a profit.
Gross Margin
Net Sales
Other things being equal, the
company with the higher gross
margin percentage is pricing its
products higher.
Return on Sales
Net income expressed as a percentage of
sales provides insight as to how much of
each sales dollar is left as net income
after all expenses are paid.
Net Income
Net Sales
Other things being equal, the company
with the higher return on sales
percentage is doing a better job of
controlling costs.
Financing Merchandise
Inventory
Borrow
Money from
Bank
Interest
Expense
Use Cash
Opportunity
Cost
Purchase on
Account
Higher Prices
and/or
Interest
End of Chapter Five