Merchandising Operations
and the Accounting Cycle
Chapter 5
Income Statements
Service Co.
Income Statement
Year ended June 30, 20xx
Service revenue
$xxx
Expenses:
Salary expense
x
Depreciation expense
x
Income tax expense
x
Net income
$ xx
Merchandising Co.
Income Statement
Year ended June 30, 20xx
Sales revenue
$xxx
Cost of goods sold
x
Gross profit
xx
Operating expenses:
Salary expense
x
Depreciation expense
x
Net income
$ xx
Objective 1
Account for the purchase
of inventory.
Purchase of Inventory
Merchant
prepares
purchase
order
Compares
Suppliers
send
merchandise
and a bill
Purchase of Inventory Example
 On May 1, the Sporting Store acquired on
account $2,000 of various items for resale.
 The supplier sent the merchandise along
with a bill stating the quantity, price, and
terms of sale.
 What is the journal entry?
Purchase of Inventory Example
May 1
Inventory
$2,000
Accounts Payable
$2,000
Purchased inventory on account
Inventory
Accounts Payable
2,000
2,000
Recording Purchase Returns
and Allowances Example
 Assume that on May 4 a $100 item was
returned prior to payment of the invoice.
 What is the journal entry?
May 4
Accounts Payable
100
Inventory
100
Merchandise was returned
Recording Purchase Returns
and Allowances Example
 Assume that one of the items of merchandise
is slightly damaged, and the store was given
a $10 allowance.
 What is the journal entry?
May 4
Accounts Payable
10
Inventory
10
Received a purchase allowance
Recording Purchase Returns
and Allowances Example
Inventory
2,000 100
10
Bal. 1,890
Accounts Payable
100 2,000
10
Bal. 1,890
Purchase Discounts
 Credit terms are stated in expressions such as:
 2/10, N/30, meaning that a discount of 2% is
allowed if the invoice is paid within 10 days;
otherwise the full (net) amount is due within
30 days.
Purchase Discounts Example
 Assume the Sporting Store purchased
merchandise for $1,000 with terms of
2/10, N/30.
 The store paid within the discount period.
 The 2% discount ($20) is deducted from the
amount due ($1,000) and $980 is remitted.
Purchase Discounts Example
 What is the journal entry?
Accounts Payable 1,000
Cash
980
Inventory
20
To record payment of invoice within the
discount period
Recording Transportation Costs
 Transportation costs are the cost of moving
inventory from seller to buyer.
 FOB stands for Free on Board and governs
the passing of title of the goods.
 Selling/buying agreements usually specify
FOB terms.
Recording Transportation Costs
FOB Shipping Point
FOB Destination
Freight Charges Example
 Assume that on May 9 the Sporting Store
paid $60 for freight.
 What is the journal entry?
May 9
Inventory
60
Cash
Paid a freight bill
60
Objective 2
Account for the sale of inventory
Sale of inventory
 The amount a business earns from selling
merchandise is called sales revenue
 Inventory that has been sold to customers is
called cost of goods sold
Sporting Store Example
 Assume that on May 11 the store sold
merchandise costing $1,800 for $2,600
in cash.
 What are the journal entries?
Sporting Store Example
May 11
Cash
2,600
Sales Revenue
2,600
To record sale of merchandise
May 11
Cost of Goods Sold 1,800
Inventory
1,800
To record the cost of merchandise sold
Sporting Store Example
 On May 15, the store sold to Maria Gym
$5,000 worth of merchandise with a cost
of $3,000.
 Terms are 2/10, N/30.
Maria Gym
Total
Invoice
Terms 2/10, N/30
$5,000
Sales Discounts and Sales
Returns and Allowances Example
 On May 17, Maria Gym returned $1,500
worth of goods that cost $900.
 In addition, a credit of $100 was allowed
for merchandise that was damaged.
 What are the journal entries?
Sales Discounts and Sales
Returns and Allowances Example
May 17
Sales Returns and Allowance 1,500
Accounts Receivable
1,500
Received returned merchandise
May 17
Inventory
Cost of Goods Sold
Returned goods to inventory
900
900
Sales Discounts and Sales
Returns and Allowances Example
May 17
Sales Returns and Allowance
100
Accounts Receivable
100
Credit granted for damaged goods
 There is no entry required for inventory
since the goods were not returned.
Sales Discounts and Sales
Returns and Allowances Example
 On May 20, the store received a check from
Maria Gym for the balance due.
 What is the balance due?
Accounts Receivable May 15 = $5,000
Less May 17 returns and allowances $1,600
Equals May 20 balance due of $3,400
Sales Discounts and Sales
Returns and Allowances Example
 Maria took advantage of the sales terms –
2/10, N/30.
May 20
Cash
3,332
Sales Discounts
68
Accounts Receivable
3,400
Cash collected within the discount period
Objective 3
Use sales and gross profit
to evaluate a company.
Sales Revenue
Net sales
=
Sales Revenue less Sales Returns and Sales Discounts
Gross Profit or Gross Margin
Target Corporation
Income Statement (Adapted)
Year Ended December 31, 2000
Net sales revenue (same as Net sales)
Cost of goods sold (same as Cost of sales)
Gross profit (same as Gross margin)
Expenses:
Selling, general, administrative
7,490
Depreciation expense
854
Interest expense
393
Other expenses, net
302
Total operating expenses
Net earnings (same as Net income)
Millions
$33,212
23,029
10,183
9,039
$ 1,144
Operating Cycle of a Merchandising Business
Purchase and Cash Sale
Purchase and Sale on Account
Cash
Cash
Accounts
Receivable
Inventory
Inventory
Inventory Systems
Perpetual
Periodic
Objective 4
Adjust and close the accounts
of a merchandising business.
Adjustments to Inventory
Example
Book Inventory
Balance
$255,000
Physical
Count
$252,500
$2,500 difference
Adjustments to Inventory
Example
 What is the journal entry?
December 31
Cost of Goods Sold
2,500
Inventory
2,500
To adjust inventory to physical count
Closing Entries for a
Merchandising Business
Revenues
Income
Summary
2,760,000
7,348
C.G.S.
1,490,400
1,884,348 2,767,348
883,000
Sales Discount
22,824
Returns and A.
Capital
Account
32,605
Other Exp.
338,519
883,000
Objective 5
Prepare a merchandiser’s
financial statements.
Income Statement Formats
 There are two basic formats for the income
statement:
1 Multi-step
2 Single-step
Multi-Step Format
Sporting Store
Income Statement
Year Ended December 31, 2002
Sales revenue
$2,760,000
Sales discounts
– 22,824
Returns and allowances
– 32,605
Net sales revenue
$2,704,571
Cost of goods sold
–1,490,400
Gross margin
$1,214,171
Multi-Step Format
Gross margin
Operating expenses:
Wage expense
Rent expense
Insurance expense
Depreciation expense
Supplies expense
$1,214,171
Operating income
$ 876,652
– 166,285
– 137,000
– 16,302
–
9,781
–
8,151
Multi-Step Format
Operating income
Other revenue and expenses:
Interest revenue
Interest expense
$876,652
Net income
$883,000
7,348
– 1,000
Single-Step Format
Sporting Store
Income Statement
Year Ended December 31, 2005
Revenues:
Net sales (net of sales discounts)
$2,704,571
Interest revenue
7,348
Total revenues
$2,711,919
Single-Step Format
Expenses:
Cost of goods sold
Wage expense
Rent expense
Interest expense
Insurance expense
Depreciation expense
Supplies expense
Total expenses
Net income
$1,490,400
166,285
137,000
1,000
16,302
9,781
8,151
$1,828,919
$ 883,000
Objective 6
Use the gross margin percentage
and the inventory turnover
ratio to evaluate a business.
Using the Financial Statements
for Decision Making
Gross profit percentage = Gross profit
÷ Net sales revenue
Inventory turnover = Cost of goods sold
÷ Average inventory
Gross Profit on $1 for Three
Merchandisers
$1.00 —
$0.75 —
$0.50 —
$0.25 —
Gross
margin
$0.45
Cost of
goods sold
$0.55
Gross
margin
$0.42
Gross
margin
$0.21
Cost of
goods sold
$0.58
Cost of
goods sold
$0.79
$0.00
Austin
Sound
Target
Wal-Mart
Corporation Stores, Inc.
Rate of Inventory Turnover for
Three Merchandisers
7.0 times
per year
Wal-Mart Stores, Inc.
1
2
3
4
5
6
7
Target Corporation
1
2
3
5.4 times
per year
4
5
Austin Sound
2.3 times
per year
1
Jan
Mar
2
Jun
Sep
Dec
End of Chapter 5