Financial Accounting
with IFRS 5th Edition
Wiley Custom Edition
Chapter 5
Accounting for Merchandise Operations
Weygandt ● Kimmel
Ch 5 Accounting for Merchandise Operations
Copyright © John Wiley & Sons, Inc.
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Chapter Outline
Ch 5 Accounting for Merchandise Operations
Copyright © John Wiley & Sons, Inc.
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Learning Objective 1
Describe Merchandising
Operations and Inventory
Systems
3
Merchandising Operations and Inventory Systems
Merchandising Companies buy and sell goods.
Examples:
• Tesco
• Carrefour
Ch 5 Accounting for Merchandise Operations
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Merchandising Operations and Inventory Systems
• The primary source of revenue is the sale of merchandise, simply as
sales revenue or sales.
• Two categories of expenses:
◆
cost of goods sold: the total cost of merchandise sold during the period
◆
operating expenses
Ch 5 Accounting for Merchandise Operations
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Merchandising Company
Income Measurement
ILLUSTRATION 5.1
Income measurement process for a merchandising company
Ch 5 Accounting for Merchandise Operations
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Operating Cycles
• The operating cycle of a merchandising company ordinarily is longer
than that of a service company.
• The purchase of merchandise inventory and its eventual sale lengthen
the cycle.
Ch 5 Accounting for Merchandise Operations
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Operating Cycles
ILLUSTRATION 5.2
Operating cycle for a service
company
ILLUSTRATION 5.3
Operating cycle for a
merchandising company
Ch 5 Accounting for Merchandise Operations
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Flow of Costs Overview
• Beginning inventory plus the cost of goods purchased is the cost of
goods available for sale.
• As goods are sold, they are assigned to cost of goods sold.
• Those goods that are not sold by the end of the accounting period
represent ending inventory
Ch 5 Accounting for Merchandise Operations
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Flow of Costs Overview
• Companies use either a perpetual inventory system or a periodic
inventory system to account for inventory.
ILLUSTRATION 5.4
Flow of costs
Ch 5 Accounting for Merchandise Operations
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Flow of Costs – Perpetual System
• Maintain detailed records of the cost of each inventory purchase
and sale
• Records continuously show inventory that should be on hand for
every item
• Company determines cost of goods sold each time a sale occurs
Ch 5 Accounting for Merchandise Operations
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Flow of Costs – Periodic System
• Do not keep detailed inventory records of the goods on hand
throughout the period
• Determine the cost of goods sold only at the end of the
accounting period—that is, periodically.
• Takes a physical inventory count to determine the cost of goods
on hand.
Ch 5 Accounting for Merchandise Operations
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Flow of Costs – Periodic System
1. Determine the cost of goods on hand at the beginning of the
accounting period.
2. Add to it the cost of goods purchased.
3. Subtract the cost of goods on hand as determined by the physical
inventory count at then end of the accounting period.
Ch 5 Accounting for Merchandise Operations
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Comparison of Perpetual and Periodic
ILLUSTRATION 5.5 Comparing perpetual and periodic inventory systems
Ch 5 Accounting for Merchandise Operations
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Advantages of the Perpetual System
• Traditionally used for merchandise with high unit values
• Shows quantity and cost of inventory that should be on hand at any
time
• Provides better control over inventories than a periodic system
• Shows quantity and cost of inventory that should be on hand at any time.
• Allows for companies to check that counts agree with records at any
time.
• If shortages are discovered, investigation can occur immediately.
Ch 5 Accounting for Merchandise Operations
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DO IT! 1 Merchandising Operations and Inventory
Systems
Indicate whether the following statements are true or false. If
false, indicate how to correct the statement.
1. The primary source of revenue for a merchandising
company results from performing services for customers.
2. The operating cycle of a service company is usually shorter
than that of a merchandising company.
3. Sales revenue less cost of goods sold equals gross profit.
4. Ending inventory plus the cost of goods purchased equals
cost of goods available for sale.
Ch 5 Accounting for Merchandise Operations
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Learning Objective 2
Record Purchases Under
a Perpetual System
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Recording Purchases Under a Perpetual System
• Made using cash or credit (on account)
• Normally record when goods are received from the seller
• Each cash purchase should be supported by a canceled check or a cash
register receipt indicating the items purchased and amounts paid.
• Purchase invoice should support each credit purchase
• Purchaser uses as a purchase invoice a copy of the sales invoice sent
by the seller.
Ch 5 Accounting for Merchandise Operations
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Recording
Purchases Under a
Perpetual System
ILLUSTRATION 5.6
Sales invoice used as purchase
invoice by Sauk Stereo
Ch 5 Accounting for Merchandise Operations
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Recording Purchases Under a Perpetual System
• The contents of this invoice, identify these items:
1.
2.
3.
4.
5.
6.
7.
8.
Seller
Invoice date
Purchaser
Salesperson
Credit terms
Freight terms
Goods sold: catalog number, description, quantity, price per unit
Total invoice amount
Ch 5 Accounting for Merchandise Operations
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Recording Purchases Under a Perpetual System
Illustration: Sauk Stereo (the buyer) uses as a purchase invoice the sales
invoice prepared by PW Audio Supply, Inc. (the seller). Prepare the journal
entry for Sauk Stereo for the invoice from PW Audio Supply.
Ch 5 Accounting for Merchandise Operations
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Freight Costs
• The sales agreement should indicate who—the seller or the buyer—is
to pay for transporting the goods to the buyer’s place of business.
• FOB mean free on board
• FOB shipping point: the seller places the goods free on board the
carrier, and the buyer pays the freight costs.
• FOB destination: seller places the goods free on board to the buyer’s
place of business, and the seller pays the freight.
Ch 5 Accounting for Merchandise Operations
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Freight Costs
ILLUSTRATION 5.7 Shipping terms
Ownership of the goods
passes to the buyer when the
public carrier accepts the
goods from the seller.
Ownership of the goods
remains with the seller until
the goods reach the buyer.
Freight costs incurred by the seller are an operating expense.
Ch 5 Accounting for Merchandise Operations
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Freight Costs Incurred by the Buyer
Illustration: Assume upon delivery of the goods on May 6, Sauk
Stereo pays Public Freight Company €150 for freight charges, the
entry on Sauk Stereo’s books is:
Ch 5 Accounting for Merchandise Operations
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Freight Costs Incurred by the Seller
Illustration: Assume the freight terms on the invoice on slide
number 13 had required PW Audio Supply to pay the freight
charges, the entry by PW Audio Supply would be:
Ch 5 Accounting for Merchandise Operations
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Purchase Returns and Allowances
Purchaser may be dissatisfied because goods are damaged or defective,
of inferior quality, or do not meet specifications.
Purchase Return
• Return goods for credit if the sale was made on credit, or for a cash
refund if the purchase was for cash.
Purchase Allowance
• May choose to keep the merchandise if the seller will grant a
reduction of the purchase price.
Ch 5 Accounting for Merchandise Operations
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Purchase Returns and Allowances
Purchaser may be dissatisfied because goods are damaged or
defective, of inferior quality, or do not meet specifications.
Purchase Return
Purchase Allowance
Return goods for credit
if the sale was made on
credit, or for a cash
refund if the purchase
was for cash.
May choose to keep the
merchandise if the seller
will grant a reduction
from the purchase price.
Ch 5 Accounting for Merchandise Operations
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Purchase Returns and Allowances
Illustration: Assume Sauk Stereo returned goods costing €300 to
PW Audio Supply on May 8.
Ch 5 Accounting for Merchandise Operations
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Purchase Returns and Allowances
Review Question
In a perpetual inventory system, a return of defective merchandise by a purchaser is
recorded by crediting:
a.
Purchases
b.
Purchase Returns
c.
Purchase Allowance
d.
Inventory
Ch 5 Accounting for Merchandise Operations
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Purchase Returns and Allowances
Review Question
In a perpetual inventory system, a return of defective merchandise by a purchaser is
recorded by crediting:
a.
Purchases
b.
Purchase Returns
c.
Purchase Allowance
d.
Inventory (Correct)
Ch 5 Accounting for Merchandise Operations
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Purchase Discounts
•
Credit terms may permit buyer to claim a cash discount for prompt
payment.
•
Advantages:
◆
◆
Purchaser saves money
Seller shortens the operating cycle by converting the accounts receivable
into cash earlier
Example: Credit terms may read 2/10, n/30.
Ch 5 Accounting for Merchandise Operations
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Examples of Credit Terms
2/10, n/30
• 2% discount if paid within 10 days, otherwise net amount due within 30
days.
1/10 EOM
• 1% discount if paid within first 10 days of next month.
n/10 EOM
• Net amount due within the first 10 days of the next month.
Ch 5 Accounting for Merchandise Operations
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Purchase Discounts Example
Illustration: Assume Sauk Stereo pays the balance due of €3,500
(gross invoice price of €3,800 less purchase returns and allowances
of €300) on May 14, the last day of the discount period. Prepare
the journal entry Sauk Stereo makes on May 14 to record the
payment.
Ch 5 Accounting for Merchandise Operations
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Purchase Discount Example – No Discount
Illustration: If Sauk Stereo failed to take the discount, and instead
made full payment of €3,500 on June 3, the journal entry would be:
Ch 5 Accounting for Merchandise Operations
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Taking Purchase Discounts
Should discounts be taken when offered?
• Passing up the discount may be viewed as paying interest for use of
the money.
Discount of 2% on €3,500
€3,500 invested at 10% for 20 days
Savings by taking the discount
€70.00*
19.18
€50.82
Example: 2% for 20 days = Annual rate of 36.5% (2% × 365/20)
*(€3,500 × 36.5% × 20) ÷ 365 = €70
Ch 5 Accounting for Merchandise Operations
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Summary of Purchasing Transactions
• The following T-account provides a summary of the previous
transactions on Inventory.
Ch 5 Accounting for Merchandise Operations
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Do It! 2 Purchase Transactions
On September 5, Zhū Company buys merchandise on account from Gāo Company.
The purchase price of the goods paid by Zhū is ¥15,000, and the cost to Gāo
Company was ¥8,000. On September 8, Zhū returns defective goods with a selling
price of ¥2,000. Record the transactions on the books of Zhū Company.
Ch 5 Accounting for Merchandise Operations
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Learning Objective 3
Record Sales Under a
Perpetual System
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Recording Sales - Perpetual System
• Sales may be made on credit or for cash
• Sales revenue, like service revenue, is recorded when the
performance obligation is satisfied
• Performance obligation is satisfied when goods are transferred from
seller to buyer (In accordance with the revenue recognition principle)
• Sales invoice should support each credit sale
Ch 5 Accounting for Merchandise Operations
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Recording Sales - Perpetual System
• The seller makes two entries for each sale.
• The first entry records the sale: The seller increases (debits) Cash (or
Accounts Receivable, if a credit sale), and also increases (credits) Sales
Revenue.
• The second entry records the cost of the merchandise sold: The seller
increases (debits) Cost of Goods Sold, and also decreases (credits)
Inventory for the cost of those goods.
Ch 5 Accounting for Merchandise Operations
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Sales invoice should support each credit sale
Sales invoice
should support
each credit sale.
ILLUSTRATION 5.6
Sales invoice used as purchase
invoice by Sauk Stereo
Ch 5 Accounting for Merchandise Operations
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Entries to Record Sales
Journal Entries to Record a Sale
#1
#2
Accounts Receivable
Sales Revenue
XXX
Cost of Goods Sold
Inventory
XXX
Ch 5 Accounting for Merchandise Operations
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XXX
XXX
Selling
Price
Cost
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Recording Sales Example
Illustration: PW Audio Supply records the sale of €3,800 on May 4 to Sauk
Stereo on account as follows (assume the merchandise cost PW Audio Supply
€2,400).
Ch 5 Accounting for Merchandise Operations
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Sales Returns and Allowances
• “Flip side” of purchase returns and allowances
• Contra revenue account (debit) to Sales Revenue
• Sales not reduced (debited) because:
• Would otherwise obscure importance of sales returns and allowances as
a percentage of sales.
• Could distort comparisons.
Ch 5 Accounting for Merchandise Operations
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Sales Returns and Allowances - Example
Illustration: Prepare the entry PW Audio Supply would make to record the
credit for returned goods that had a €300 selling price (assume a €140 cost).
Assume the goods were not defective.
Ch 5 Accounting for Merchandise Operations
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Sales Returns and Allowances
• Sales Returns and Allowances is a contra revenue account to Sales
Revenue.
• The normal balance of Sales Returns and Allowances is a debit.
• Disclosure of this information is important to management
• Excessive returns and allowances may suggest problems—inferior
merchandise, inefficiencies in filling orders, errors in billing customers,
or delivery or shipment mistakes.
Ch 5 Accounting for Merchandise Operations
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Sales Returns and Allowances - Example
Illustration: Assume the returned goods were defective and had a net
realizable value of €50, PW Audio would make the following entries:
Ch 5 Accounting for Merchandise Operations
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Sales Returns and Allowances
What happens if the goods are not returned but the seller grants
the buyer an allowance by reducing the purchase price?
• In this case, the seller debits Sales Returns and Allowances and
credits Accounts Receivable for the amount of the allowance.
• An allowance has no impact on Inventory or Cost of Goods Sold.
Ch 5 Accounting for Merchandise Operations
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Sales Returns and Allowances
Review Question
The cost of goods sold is determined and recorded each time a sale occurs in:
a.
periodic inventory system only.
b.
a perpetual inventory system only.
c.
both a periodic and perpetual inventory system.
d.
neither a periodic nor perpetual inventory system.
Ch 5 Accounting for Merchandise Operations
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Sales Returns and Allowances
Review Question
The cost of goods sold is determined and recorded each time a sale occurs in:
a.
periodic inventory system only.
b.
a perpetual inventory system only. (Correct)
c.
both a periodic and perpetual inventory system.
d.
neither a periodic nor perpetual inventory system.
Ch 5 Accounting for Merchandise Operations
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Sales Discounts
• Offered to customers to promote prompt payment of balance due
• Contra-revenue account (debit) to Sales Revenue
Ch 5 Accounting for Merchandise Operations
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Sales Discounts
Illustration: Assume Sauk Stereo pays the balance due of €3,500 (gross invoice
price of €3,800 less purchase returns and allowances of €300) on May 14, the last
day of the discount period. Prepare the journal entry PW Audio Supply makes to
record the receipt on May 14.
Ch 5 Accounting for Merchandise Operations
Copyright © John Wiley & Sons, Inc.
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Data Analytics and Credit Sales
Credit sales, sales returns and allowances, and sales discounts all
provide rich opportunities for the use of data analytics.
• Effectively analyzing data can help a company expand its sales
base while minimizing the risk of unpaid receivables.
• To achieve the optimal cost-benefit balance on sales discounts,
companies statistically analyze past discount practices.
Ch 5 Accounting for Merchandise Operations
Copyright © John Wiley & Sons, Inc.
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DO IT! 3 Sales Transactions
On September 5, Zhū Company buys merchandise on account from Gāo
Company. The selling price of the goods is ¥15,000, and the cost to Gāo
Company was ¥8,000. On September 8, Zhū returns defective goods with a
selling price of ¥2,000 and a net realizable value of ¥300. Record the
transactions on the books of Gāo Company.
Ch 5 Accounting for Merchandise Operations
Copyright © John Wiley & Sons, Inc.
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Learning Objective 4
Apply the Steps in the
Accounting Cycle to a
Merchandising Company
55
Adjusting Entries
• Generally same as a service company
• Using a perpetual system will require additional adjustment to make
records agree with actual inventory on hand
• Involves adjusting Inventory and Cost of Goods Sold
Ch 5 Accounting for Merchandise Operations
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Adjusting Entries Example
Illustration: Suppose that PW Audio Supply has an unadjusted balance of
€40,500 in Inventory. Through a physical count, PW Audio Supply determines
that its actual merchandise inventory at December 31 is €40,000. The
company would make an adjusting entry as follows.
Ch 5 Accounting for Merchandise Operations
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Closing Entries
• Like a service company, closes to Income Summary all accounts that
affect net income
• Credits all temporary accounts with debit balances
• Debits all temporary accounts with credit balances
Ch 5 Accounting for Merchandise Operations
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Closing Entries
Ch 5 Accounting for Merchandise Operations
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Closing Entries
Ch 5 Accounting for Merchandise Operations
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Summary of Merchandising Entries
ILLUSTRATION 5.8 Daily recurring and adjusting and closing entries
Ch 5 Accounting for Merchandise Operations
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Summary of Merchandising Entries
ILLUSTRATION 5.8 Daily recurring and adjusting and closing entries
Ch 5 Accounting for Merchandise Operations
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Summary of Merchandising Entries - Events
ILLUSTRATION 5.8 Daily recurring and adjusting and closing entries
Ch 5 Accounting for Merchandise Operations
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DO IT! 4 Closing Entries
The trial balance of Celine’s Sports Wear Shop at December 31 shows
Inventory €25,000, Sales Revenue €162,400, Sales Returns and
Allowances €4,800, Sales Discounts €3,600, Cost of Goods Sold
€110,000, Rent Revenue €6,000, Freight-Out €1,800, Rent Expense
€8,800, and Salaries and Wages Expense €22,000. Prepare the closing
entries for the above accounts.
Ch 5 Accounting for Merchandise Operations
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Learning Objective 5
Prepare Financial
Statements for a
Merchandising Company
65
Income Statement
• Primary source of information for evaluating a company’s
performance
• Format is designed to differentiate between various sources of
income and expense
Ch 5 Accounting for Merchandise Operations
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Income Statement Presentation of Sales
ILLUSTRATION 5.9 Computation of net sales
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Income Statement Example
Gross Profit
On the basis of the sales data for PW Audio Supply (net sales of €460,000)
and cost of goods sold under the perpetual inventory system (assume
€316,000), PW Audio Supply’s gross profit is €144,000, computed as shown.
ILLUSTRATION 5.10 Computation of gross profit
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Gross Profit Rate
We also can express a company’s gross profit as a percentage, called the
gross profit rate.
• Analysts generally consider the gross profit rate to be more useful
than the gross profit amount.
• The rate expresses a more meaningful (qualitative) relationship
between net sales and gross profit.
Gross Profit
÷
Net Sales
=
Gross Profit Rate
€144,000
÷
€460,000
=
31.3%
ILLUSTRATION 5.11 Gross profit rate formula and computation
Ch 5 Accounting for Merchandise Operations
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Operating Expenses
• Incurred in the process of earning sales revenue. Operating expense
for PW Audio Supply include the following.
ILLUSTRATION 5.12 Operating expenses
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Other Income and Expense
Various revenues and gains and expenses and losses that are unrelated to the company’s
main line of operations.
ILLUSTRATION 5.13 Examples of other income and expense
Interest expense, if material, must be disclosed on the face of the income statement.
Ch 5 Accounting for Merchandise Operations
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Income Statement
Key Items:
• Sales
• Gross Profit
• Operating Expenses
• Other Income and Expense
• Net Income
ILLUSTRATION 5.14 Income statement
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Comprehensive Income Statement
• Presents items not included in the determination of net income.
• Items included in comprehensive income are either reported in a
combined statement of net income and comprehensive income, or in a
separate comprehensive income statement.
ILLUSTRATION 5.15 Separate statement of net income and comprehensive income
Ch 5 Accounting for Merchandise Operations
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Classified Statement of Financial Position
ILLUSTRATION 5.16 Assets section of a classified statement of financial position
Ch 5 Accounting for Merchandise Operations
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DO IT! 5 Financial Statement Classifications
Indicate in which financial statement and under what classification each of the following
would be reported (Income statement – IS; statement of financial position – SFP; retained
earnings statement – RES)
Financial
Statement
Account
Classification
Accounts payable
Accounts receivable
Accumulated Depreciation-Buildings
Accumulated Depreciation-Equipment
Advertising Expense
Buildings
Cash
Depreciation Expense
Dividends
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DO IT! 5 Financial Statement Classifications
Indicate in which financial statement and under what classification each of the following
would be reported (Income statement – IS; statement of financial position – SFP; retained
earnings statement – RES)
Financial
Statement
Account
Classification
Equipment
Freight-Out
Gain on Disposal of Plant Assets
Insurance Expense
Interest Expense
Interest Payable
Inventory
Land
Notes Payable (due in 3 years)
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DO IT! 5 Financial Statement Classifications
Indicate in which financial statement and under what classification each of the following
would be reported (Income statement – IS; statement of financial position – SFP; retained
earnings statement – RES)
Financial
Statement
Account
Classification
Property Taxes Payable
Salaries and Wages Expense
Salaries and Wages Payable
Sales Returns and Allowances
Sales Revenue
Share Capital—Ordinary
Utilities Expense
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Learning Objective *6
Prepare a Worksheet for
a Merchandising
Company
78
Using a Worksheet
• As indicated in Chapter 4, a worksheet enables companies to
prepare financial statements before they journalize and post
adjusting entries.
• The steps in preparing a worksheet for a merchandising company
are the same as for a service company.
• The following Illustration shows the worksheet for PW Audio
Supply (excluding non-operating items). The unique accounts for
a merchandiser using a perpetual inventory system are in red.
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ILLUSTRATION 5A.1 Worksheet for merchandising company
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Learning Objective *7
Record Purchases and
Sales of Inventory Under
a Periodic Inventory
System
81
Determining Cost of Goods Sold Under a Periodic
System
Two basic systems of accounting for inventories:
• the perpetual inventory system
• the periodic inventory system
One key difference between the two systems is the point at which the
company computes cost of goods sold.
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Determining Cost of Goods Sold Under a Periodic
Inventory System
• No running account of changes in inventory.
• Ending inventory determined by physical count.
• Cost of goods sold not determined until the end of the period.
• Cost of goods sold by subtracting ending inventory from the cost
of goods available for sale.
ILLUSTRATION 5B.1 Basic formula
for cost of goods sold using the
periodic system
Ch 5 Accounting for Merchandise Operations
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Cost of Goods Sold Example
ILLUSTRATION 5B.2 Cost of goods sold for a merchandiser using a periodic inventory system
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Recording Merchandise Transactions
• Record revenues when sales are made.
• Do not record cost of merchandise sold on date of sale.
• Physical inventory count determines:
1. Cost of merchandise on hand and
2. Cost of merchandise sold during the period
• Record purchases in Purchases account (rather than the inventory
account).
• Purchase returns and allowances, purchase discounts, and freight
costs are recorded in separate accounts.
Ch 5 Accounting for Merchandise Operations
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Recording Purchase of Merchandise
Illustration: On the basis of the sales invoice (Illustration 5.6) and receipt of
the merchandise ordered from PW Audio Supply, Sauk Stereo records the
€3,800 purchase as follows.
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Freight Costs Example (Periodic)
Illustration: If Sauk pays Public Freight Company €150 for freight charges on
its purchase from PW Audio Supply on May 6, the entry on Sauk’s books is:
Ch 5 Accounting for Merchandise Operations
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Purchase Return Example (Periodic)
Illustration: Sauk Stereo returns €300 of goods to PW Audio Supply and
prepares the following entry to recognize the return.
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Purchase Discount Example (Periodic)
Illustration: On May 14 Sauk Stereo pays the balance due on account to PW
Audio Supply, taking the 2% cash discount allowed by PW Audio for payment
within 10 days. Sauk Stereo records the payment and discount as follows.
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Recording Sales of Merchandise (Periodic)
Illustration: PW Audio Supply, records the sale of €3,800 of merchandise to
Sauk Stereo on May 4 (sales invoice No. 731, slide 31) as follows.
No entry is recorded for cost of goods sold at the time of the sale under a
periodic system.
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Sales Returns and Allowances (Periodic)
Illustration: To record the returned goods received from Sauk Stereo on May
8, PW Audio Supply records the €300 sales return as follows.
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Sales Discounts (Periodic)
Illustration: On May 14, PW Audio Supply receives payment of €3,430 on
account from Sauk Stereo. PW Audio honors the 2% cash discount and
records the payment of Sauk’s account receivable in full as follows.
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Comparison of Entries—Perpetual vs. Periodic
ILLUSTRATION 5B.3 Comparison of entries for perpetual and periodic inventory systems
Ch 5 Accounting for Merchandise Operations
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Comparison of Entries—Perpetual vs. Periodic
ILLUSTRATION 5B.3 Comparison of entries for perpetual and periodic inventory systems
Ch 5 Accounting for Merchandise Operations
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Journalizing and Posting Closing Entries
• All accounts that affect the determination of net income are closed to
Income Summary
• In journalizing, all debit column amounts are credited, and all credit
columns amounts are debited
1. Beginning inventory balance is debited to Income Summary and
credited to Inventory
2. Ending inventory balance is debited to Inventory and credited to
Income Summary
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Journalizing and Posting Closing Entries
• The two entries for PW Audio Supply are as follows.
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Journalizing and Posting Closing Entries
• The Inventory and Income Summary accounts after posting.
ILLUSTRATION 5B.4 Posting closing entries for merchandise inventory
Ch 5 Accounting for Merchandise Operations
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Journalizing and Posting Closing Entries
Often, the closing of Inventory is included with other closing entries, as
shown for PW Audio Supply
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Journalizing and Posting Closing Entries
Ch 5 Accounting for Merchandise Operations
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Journalizing and Posting Closing Entries
Ch 5 Accounting for Merchandise Operations
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ILLUSTRATION 5B.5 Worksheet
for merchandising company—
periodic inventory system
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Income Statement Columns
ILLUSTRATION 5B.6 Worksheet procedures for inventories
ILLUSTRATION 5B.7 Computation of cost of goods sold from worksheet columns
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Learning Objective *8
Prepare adjusting entries
for credit sales with
returns and allowances.
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3
Adjusting Entries for Credit Sales with Returns and
Allowances
• At the end of the accounting period a company must estimate
the amount of goods sold during the period that will be returned
in subsequent periods and accrue for this amount.
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Adjusting Entries for Credit Sales with Returns and
Allowances
• Assume that Rainbow Company began operations on January 1, 2025. On
January 12, 2025, Rainbow sells 100 pairs of shoes for $100 each on
account to Tanner Inc. Rainbow allows Tanner to return any unused shoes
within 45 days of purchase. The cost of each product is $60. Rainbow
records the sale as follows.
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Adjusting Entries for Credit Sales with Returns and
Allowances
• On January 24, Tanner returns two pairs of shoes because they were
the wrong color. Rainbow records the return as follows.
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Adjusting Entries for Credit Sales with Returns and
Allowances
• On January 31, Rainbow prepares monthly financial statements and
estimates that it is likely that only one more pair of shoes will be
returned. Rainbow records two adjusting entries to account for this
estimate.
• The first entry requires a debit to Sales Returns and Allowances and a
credit to Refund Liability for the selling price of the estimated returns.
• The second entry requires a debit to Estimated Inventory Returns and a
credit to Cost of Goods Sold for the cost of the estimated returns.
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Adjusting Entries for Credit Sales with Returns and
Allowances
• Rainbow makes the following adjusting entries to account for
expected return at January 31, 2025.
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Adjusting Entries for Credit Sales with Returns and
Allowances
• On February 18, Tanner returns another pair of shoes to Rainbow.
Assuming that Tanner has not already paid Rainbow for the shoes,
Rainbow records the entry as follows.
Ch 5 Accounting for Merchandise Operations
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Adjusting Entries for Credit Sales with Returns and
Allowances
• If Tanner had initially paid for the shoes in cash or paid its balance due
on a credit purchase prior to returning the shoes on February 18,
Rainbow would credit Accounts Payable rather than Accounts
Receivable as shown in the following entry.
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