Lesson 6
Accounting for Merchandising
Activities
Task Team of
FUNDAMENTAL ACCOUNTING
School of Business, Sun Yat-sen University
Outline
•
•
•
•
•
•
•
Merchandising activities
Operating cycle of merchandising companies
Merchandising cost accounts
Inventory systems
Merchandise purchases
Sales transactions
Adjusting and closing entries
2
Introduction
• Scandals in stock market occur now and then.
Among them, financial frauds or income
manipulation are common. Income manipulation
typically starts from making up sales revenues as
well as purchases, for example, GuangXia
(Yinchuan).
• In this lesson you are required to think about,
• Why these income statement numbers are so important?
• How they are recorded in accounting system?
3
Merchandising Activities
Merchandising Companies
Manufacturer
Wholesaler
Retailer
4
Customer
Reporting Financial Performance
• Service organizations sell time to earn revenue.
– Examples: accounting firms, law firms, and plumbing
services
Revenues
－
Expenses
5
＝
Net
income
Reporting Financial Performance
• Merchandising companies sell merchandise to earn revenue.
– Examples: sporting goods, clothing, and auto parts stores
Net
Sales
－
Cost of
Goods Sold
＝
Gross
Profit
6
－
Expenses
＝
Net
Income
Operating Cycle of Merchandise Companies
• Begins with the purchase of merchandise and ends with the
collection of cash from the sale of merchandise.
Credit Sale
Cash Sale
Cash
collection
Purchases
Purchases
Cash
sales
Merchandise
inventory
Account
receivable
Merchandise
inventory
Credit sales
7
Merchandising Cost Accounts
Beginning inventory
Year 1
+
Net cost of
purchases
Merchandise
=available
for sale
Ending Inventory
Year 1
+
Cost of Goods
Sold
Becomes beginning
inventory of Year 2
8
Income
Statement
Balance
Sheet
Inventory Systems
Perpetual Method
Gives a continual record of the amount of inventory on hand.
When an item is sold it is recorded in the Cost of Goods Sold
account.
Periodic Method
Requires updating the inventory account only at the end of
the period. Acquisition of merchandise inventory is recorded
in a temporary Purchases account.
9
Inventory Systems
• Perpetual provides a continuous record of:
– The amount of inventory on hand.
– Cost of goods sold to date.
• Periodic requires a physical count of goods to
determine:
– The amount of inventory on hand.
– Cost of goods sold.
10
Comparison of Perpetual and Periodic Systems
Source of Information
Equation
Periodic System
Perpetual System
Beginning Inventory
Carried over from
prior period
Carried over from
prior period
Add: Purchases
Accumulated in the
Purchases account
Accumulated in the
inventory account
Equals:
Cost of Goods Available for Sale
Less: Ending Inventory Measured at end of
period by physical
inventory count
Perpetual record
updated at every sale
Cost of Good Sold
Measured at every
sale based on
perpetual record
Computed as a
residual amount at
end of period
11
Comparison of Periodic and Perpetual Systems
Transaction
Periodic
Merchandise purchased Purchases
XX
from supplier on account
Accounts Payable
Perpetual
XX
Inventory
XX
Accounts Payable
XX
Merchandise returned to Accounts Payable
XX
supplier
Purchases returns & allow. XX
Accounts Payable
Inventory
Merchandise sold to
customer on account
Accounts Receivable
XX
Sales
XX
Cost of Goods Sold
XX
Inventory
XX
Accounts Receivable
Sales
XX
XX
12
XX
XX
Comparison of Periodic and Perpetual Systems
Transaction
Periodic
Perpetual
Merchandise retuned
by customer
Sales Returns & Allow. XX
Accounts Receivable XX
Sales Returns & Allow. XX
Accounts Receivable XX
Inventory
XX
Cost of Goods Sold
XX
At the end of
accounting period
Cost of Goods Sold
XX
No entry
Inventory (beginning) XX
Purchases
XX
Inventory (ending)
XX
Cost of goods Sold
XX
13
Merchandise Purchases
•
•
The operating cycle of merchandise companies
involves the purchase and subsequent sale of
merchandise inventory.
Purchase of inventory can either on account or by
cash.
Oct. 1
Inventory
5,000
Accounts Payable /cash
Purchased inventory.
14
5,000
Trade Discounts
Trade discounts are used by manufacturers and
wholesalers to change selling prices without republishing
their catalogs.
Example
MarCo, Inc. offers a 20% trade
discount on orders of 100
units or more of their popular
product Racer. Each Racer
has a list price of $5.00.
Quantity sold
100
Price per unit
$ 5.00
Total
500
Less 20% discount
(100)
Invoice price
$ 400
15
Purchase Discounts
• Purchase discount is a deduction from the invoice price
granted to induce early payment of the amount due. Example
– 2/10, n30
Credit Period = 30 days
Terms
Discount Period =
10 days
Time
Oct.11
Oct.1
Due
Oct.31
(Full amount minus 2%
discount) due between Oct.1
and Oct.11
Full amount due
anytime between
Oct.12 and Oct.31
Purchase
16
Purchase Discounts
2/10,n/30
Discount
Percent
Number of
Days Discount
Is Available
Otherwise,
Net (or All) Is
Due
17
Credit
Period
Purchase Discounts
• Assume the purchase of $4,000 inventory on October
1 was on the terms 2/10,n30.
Case 1-Discount taken
Oct.11 Accounts Payable
4,000
Inventory
80
Cash
3,920
2% x (5,000 - 1,000) = 80
Case 2-Discount not taken
Oct.31 Accounts Payable
Cash
18
4,000
4,000
Managing Discounts
Failing to take a 2/10, n/30 discount is really expensive!
365 days ÷ 20 days × 2% = 36.5% annual rate
Days
in a
year
Number
of additional
days before
payment
Percent
paid to
keep
money
19
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.
Purchase Returns and Allowances
Accounts Payable
Inventory
XXX
XXX
Defective merchandise returned to supplier.
20
Purchase Returns and Allowances
On Nov. 1, Helo Inc. purchased $10,000 of
Merchandise Inventory on account, credit terms
are 2/10, n/30.
GENERAL JOURNAL
Date
Description
Nov 1 Merchandise Inventory
Accounts Payable
21
Page 29
PR
Debit
Credit
10,000
10,000
Purchase Returns and Allowances
On Nov 5, Helo Inc. returned $250 of defective
merchandise to the supplier.
GENERAL JOURNAL
Date
Description
Nov 5 Accounts payable
Merchandise Inventory
22
Page 31
PR Debit Credit
250
250
Purchase Returns and Allowances
On Nov 9, Helo Inc. paid the amount owed for the
purchase of Nov 1.
GENERAL JOURNAL
Date
Description
Page 54
PR
Nov 9 Accounts payable
Debit
Credit
9,750
Merchandise inventory
Cash
195
9,555
Purchase
Return
Amount Due
Discount
Cash Paid
23
$ 10,000
(250)
9,750
(195)
$ 9,555
Transportation Costs
Terms
Ownership transfers
to buyer when goods
are passed to
Transportation
costs paid by
Carrier
Buyer
Buyer
Seller
FOB shipping point
FOB destination
Transportation Charges
Inventory
XXX
Accounts Payable
XXX
Transportation charges on goods purchased FOB
shipping point.
24
Recording Purchases Information
Matrix, Inc.
Total Cost of Merchandise Purchases
2011
For Year Ended May 31, 2002
Invoice cost of merchandise purchases
$ 692,500
Less:
Purchase discounts received
(10,388)
Purchase returns and allowances
(4,275)
Add:
Cost of transportation-in
4,895
Total cost of merchandise purchases
$ 682,732
25
Sales Transactions


For a business engaged in a merchandising activity, revenue takes the form
of sales.
The entry to record the sale of merchandise on credit under a perpetual
inventory system requires two entries
• On March 10,
TomCom sold
$20,000 of
merchandise on
account. The
merchandise was
carried in inventory
at a cost of $16,000.
GENERAL JOURNAL
Date
Description
Mar. 10 Accounts Receivable
Page 3
PR Debit Credit
20,000
Sales
Cost of Goods Sold
Merchandise Inventory
26
20,000
16,000
16,000
Sales Discounts
•
A sales discount is a cash discount taken by
customers against an amount owed to the seller.
• On May 8, Joye Co. sold merchandise costing $3,000 for
$5,000 on account. Credit terms were 2/10, n/30.
GENERAL JOURNAL
Date
Description
May 8 Accounts Receivable
Page 5
PR
Debit
Credit
5,000
Sales
5,000
Cost of Goods Sold
3,000
Merchandise Inventory
27
3,000
Sales Discounts
• On May 17, Joye Co. received a
check for $4,900 in full
payment of the May 8 sale.
GENERAL JOURNAL
Date
Description
May 17 Cash
Page 7
PR
Debit
Credit
4,900
Sales Discounts
100
Accounts Receivable
28
5,000
Sales Returns and Allowances
• On May 12, Joye Co. sold merchandise costing
$4,000 for $6,000 on account The credit terms
were 2/10, n/30.
GENERAL JOURNAL
Date
Description
May 12 Accounts Receivable
Page 6
PR
Debit
Credit
6,000
Sales
6,000
Cost of Goods Sold
4,000
Merchandise Inventory
29
4,000
Sales Returns and Allowances
• On May 14, merchandise with a sales price of $600 and a
cost of $400 was returned to Joye Co. The return is
related to the May 12 sale.
GENERAL JOURNAL
Date
Description
May 14 Sales Returns and Allowance
Page 7
PR
Debit
600
Accounts Receivable
Merchandise Inventory
Cost of Goods Sold
30
Credit
600
400
400
Sales Returns and Allowances
• On May 20, Joye received the amount owed to it from
the sale of May 12.
GENERAL JOURNAL
Date
Description
Page 7
PR Debit Credit
May 20 Cash
5,292
Sales Discounts
108
Account Receivable
Sale
Return
Amount Due
Discount
Cash Received
31
5,400
$ 6,000
(600)
$ 5,400
(108)
$ 5,292
Recording Sales Information
Unix Inc.
Computation of Gross Profit
For Year Ended December 31, 2011
Sales
Less:
Sales discounts
Sales returns and allowances
Net sales
Cost of goods sold
Gross profit
$
$ 29,412
18,500
2,451,000
47,912
$ 2,403,088
(1,928,600)
$
474,488
Sales discounts and returns and allowances
are Contra Revenue accounts.
32
Adjustments-Perpetual Inventory
• Perpetual inventory systems keep a running total of
inventory levels by recording sales and purchase
transactions.
• Periodic adjustments must be made to account for
shrinkage (loss due to theft or deterioration of
inventory).
33
Adjustments-Perpetual Inventory
Inventory per accounting records: $198,000
Inventory per physical count:
$194,200
Difference (shrinkage)
$3,800
Adjustment required:
Oct.31
Cost of Goods Sold
Inventory
3,800
3,800
To record inventory shrinkage revealed by physical
count.
34
Closing Entries – Perpetual System
• The closing process is similar for merchandising and
service companies.
Merchandising companies have additional temporary
accounts that must be closed.
These include:
– Sales
– Sales Returns & Allowances
– Sales Discounts
– Cost of Goods Sold
35
Discussion Case
CIMC
CIMC is the number one stock in China, mainly due to its “excellent”
operating performance. However, in early 2005, the operating
performance of CIMC was challenged. Analysts argued that, the
surprisingly high operating performance is questionable. Specifically,
abnormal growth was found in the following items,
1. Sales revenue
2. Gross profits
3. Accounts receivable
4. Inventory
However, no growth was found in cash collected from customers.
36
Discussion Case
•
Required:
• How to calculate the growth
rates in sales, gross profits,
inventory, accounts
receivables, and cash?
• Are there are relationships
between the above items?
• How to verify the growth in
above items?
37
Summary
• The operating cycle of merchandise companies begins with the
purchase of merchandise and end with the collection of cash from the
sale of merchandise.
• Perpetual method and period method are two inventory systems.
Today perpetual method is more and more adopted.
• Accounting for merchandise purchases records purchases, trade
discount, cash discounts, purchase returns and allowance,
transportation costs.
• Accounting for sales transactions records sales, sales discount, sales
returns and allowance, etc.
• Under perpetual inventory system, adjustments must be made for
shrinkage at the end of period.
• Closing entries transfers balances in sales, sales returns and allowance,
sales discounts and cost of goods sold into income summary account.
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The End of Lesson 6