CHAPTER
5
ACCOUNTING FOR
MERCHANDISING
OPERATIONS
A merchandising company is an
enterprise that buys and sells goods
(called inventory) to earn a profit.
Inventory includes all goods that the
company owns and expects to sell in
the normal course of operations.
Sales Revenue (Sales) is the selling price
of merchandise sold.
Net Sales equals sales revenue minus and
sales returns and sales discounts.
Cost of Goods Sold (a.ka. Cost of sales)
represents the cost of the goods
(inventory) the business sold to its
customers.


Note: When inventory is held by the
business, it is a current asset on the
Balance Sheet.
When inventory is sold, the inventory’s
cost becomes an expense to the
business and is shown on the Income
Statement.
Sales - Cost of Goods Sold = Gross Profit
Revenue
(COGS)
(Gross Margin)
Gross Profit is an important measure of
business success for a merchandiser
because all other expenses of the business
are deducted from this gross profit to get
Net Income.
OPERATING CYCLES FOR A
SERVICE COMPANY AND A
MERCHANDISING COMPANY
Service Company
Receive
Cash
Cash
Perform
Services
Accounts
Receivable
Merchandising Company
Receive
Cash
Cash
Buy
Inventory
Sell Inventory
Accounts
Receivable
Merchandise
Inventory

Is the average time it takes to go from
cash to cash in producing revenues. The
operating cycle of a merchandising
company is longer than that of a service
company. The purchase of merchandise
and its eventual sale lengthens the
cycle.
There are 2 main types of inventory
accounting systems:
1. Perpetual – where detailed records of
each inventory purchase and sale are
maintained. Cost of goods sold is
calculated at the time of each sale. Used
for all types of goods.
2. Periodic – detailed records are not
maintained. Cost of goods sold is
calculated only at the end of the
accounting period. Used for inexpensive
goods.
PURCHASES OF
MERCHANDISE
General Journal
Date Account Title and Explanation Ref
May 4 Merchandise Inventory
Accounts Payable
To record goods purchased on
account, terms n/30.
Debit
3,800
For purchases on account, Merchandise
Inventory is debited and Accounts Payable is
credited. For cash purchases, Merchandise
Inventory is debited and Cash is credited.
J1
Credit
3,800
QUANTITY DISCOUNTS
• The larger the quantity purchased, the
lower the price per item.
• The merchandise inventory is simply
recorded at the discounted cost.


Purchase discounts are offered to customers
for early payment of the balance due.
For example
◦ 2/10, n/30
 deduct 2% from the invoice total if the bill is fully
paid within 10 days, or pay the full amount within
30 days.
◦ n/30 or net 30
 No discount offered, payment is due 30 days after
invoice date
Ex. 1 – discount
June 13
Accounts Payable 1,000
Merchandise Inventory
20
Cash
980
To record payment on account
within discount period. Discount is $20
($1000 x 0.02)
Ex. 2 – no discount
Accounts Payable 1,000
Cash
Paid on account
1,000
When merchandise is sold and a perpetual inventory
system is in use, two journal entries are required.
Ex. Sold $1500 of merchandise on account. The cost
of the merchandise was $1000.
#1 – Record the sale at its selling price
Accounts Receivable
1500
Sales
1500
#2 – Transfer the cost of the same from Inventory (an
asset) to Cost of Goods Sold (an expense)
Cost of Goods Sold
1000
Inventory
1000
Sellers may offer discounts to
encourage prompt payment.
Example: Terms are 3/15 n/30; client
pays within discount period.
Cash
1455
Sales Discounts
45
Accounts Receivable
1500
If merchandise is sold and then returned by the
customer, we must complete two journal
entries.
#1 – Record the return at its selling price
Sales, returns and allowances
Accounts receivable
3000
3000
#2 – Record the reinstatement of the cost of the
merchandise to inventory.
Inventory
Cost of Goods Sold
2000
2000
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The sales agreement should indicate whether the
seller or the buyer is to pay the cost of transporting
the goods to the buyer’s place of business.
FOB Shipping Point
1. Goods delivered to shipping point by seller
2. Buyer pays freight costs from shipping
point to destination
FOB Destination
1. Goods delivered to destination
by seller
2. Seller pays freight costs
FOB – Free on board

Merchandise Inventory is debited by the
buyer, if the buyer pays the freight bill (FOB
shipping point).
◦ Any freight paid by the purchaser is part of the cost of
the merchandise purchased.
◦ The Merchandise Inventory account is increased for
freight costs paid by the buyer to transport goods to
the buyer’s place of business.

Freight Out (or Delivery Expense) is debited
by the seller, if the seller pays the freight bill
(FOB destination).
ACCOUNTING FOR
FREIGHT COSTS
General Journal
Date Account Title and Explanation
May 4 Merchandise Inventory
Cash
To record payment of freight.
Ref
Debit
150
J1
Credit
When the purchaser directly incurs the freight
costs, the account Merchandise Inventory is
debited and Cash is credited.
150