6-1
Chapter
6
Merchandising
Activities
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
Operating Cycle of a Merchandising
Company
6-2
Cash
Accounts
Receivable
McGraw-Hill/Irwin
Inventory
2. Sale of merchandise
on account
© The McGraw-Hill Companies, Inc., 2008
6-3
Comparing Merchandising Activities with
Manufacturing Activities
Purchase
inventory in
ready-to-sell
condition.
Merchandising
Company
McGraw-Hill/Irwin
Manufacture
inventory and
have a longer and
more complex
operating cycle.
Manufacturing
Company
© The McGraw-Hill Companies, Inc., 2008
Income Statement of a
Merchandising Company
Computer City
Condensed Income Statement
For the Year Ended December 31, 2007
$ 900,000
Revenue from sales
540,000
Less: Cost of goods sold
$ 360,000
Gross profit
270,000
Less: Expenses
$ 90,000
Net income
6-4
Cost of
goods sold
represents
the expense
of goods
that are
sold to
customers.
Gross profit is a useful means of measuring
the profitability of sales transactions.
© The McGraw-Hill Companies, Inc., 2008
McGraw-Hill/Irwin
6-5
Two Approaches Used in Accounting for
Merchandise Inventories
Perpetual
Inventory
System
McGraw-Hill/Irwin
Periodic
Inventory
System
© The McGraw-Hill Companies, Inc., 2008
6-6
Perpetual vs. Periodic Inventory
Systems
09/05, Worley Co. purchased 100 laser lights for resale for $30 per unit from
Electronic City on account.
09/10, Worley Co. sold 10 laser lights for $50/unit on account to ABC Radios.
09/15, Worley Co. paid Electronic City $3,000 for the September 5 purchase.
09/22, Worley Co. received $500 from ABC Radios as payment in full for their
purchase on September 10.
GENERAL JOURNAL
In the perpetual system
Date
Account Titles and Explanation
Sept. 5 Inventory
Accounts Payable (Electronic City)
Sept. 10 Accounts Receivable (ABC Radios)
Sales
10 Cost of Goods Sold
Inventory
Sept. 15 Accounts Payable (Electronic City)
Cash
Sept. 22 Cash
Accounts Receivable (ABC Radios)
McGraw-Hill/Irwin
In the periodic system
Debit Credit
3,000
3,000
500
500
300
300
3,000
3,000
500
500
Account Titles and Explanation
Purchases
Accounts Payable (Electronic City)
Accounts Receivable (ABC Radios)
Sales
Debit Credit
3,000
3,000
500
500
Accounts Payable (Electronic City)
Cash
Cash
Accounts Receivable (ABC Radios)
3,000
3,000
500
500
© The McGraw-Hill Companies, Inc., 2008
6-7
Perpetual Inventory Systems
Taking a Physical Inventory
In order to ensure
the accuracy of
their perpetual
records, most
businesses take a
complete physical
count of the
merchandise on
hand at least once
a year.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
6-8
Taking a Physical Inventory
Reasonable amounts of inventory shrinkage are viewed as
a normal cost of doing business. Examples include
breakage, spoilage and theft.
On December 31, Worley Co. counts its inventory.
An inventory shortage of $2,000 is discovered.
GENERAL JOURNAL
Date
Account Titles and Explanation
Dec. 31 Cost of Goods Sold
Inventory
McGraw-Hill/Irwin
Debit
Credit
2,000
2,000
© The McGraw-Hill Companies, Inc., 2008
6-9
Periodic Inventory system
Computing Cost of Goods Sold
The accounting records of Party Supply show the following:
Inventory, Jan. 1, $ 14,000; Purchases (during year) 130,000; At
December 31, Party Supply counted the merchandise on hand at
$12,000.
Inventory (beginning of the year)
Add: Purchases
Cost of goods available for sale
Less: Inventory (end of year)
Cost of goods sold
McGraw-Hill/Irwin
$ 14,000
130,000
144,000
12,000
$ 132,000
© The McGraw-Hill Companies, Inc., 2008
Creating a Cost of Goods Sold
Account
6-10
Now, Party Supply must
create the Cost of Goods
Sold account.
GENERAL JOURNAL
Date
Account Titles and Explanation
Dec. 31 Cost of Goods Sold
Inventory (beginning of year)
Purchases
McGraw-Hill/Irwin
Debit
Credit
144,000
14,000
130,000
© The McGraw-Hill Companies, Inc., 2008
Creating a Cost of Goods Sold
Account
6-11
Now, Party Supply must
record the ending inventory
amount.
GENERAL JOURNAL
Date
Account Titles and Explanation
Dec. 31 Inventory (end of year)
Cost of Goods Sold
McGraw-Hill/Irwin
Debit
Credit
12,000
12,000
© The McGraw-Hill Companies, Inc., 2008
6-12
Selecting an Inventory System
Factors Suggesting a
Perpetual Inventory System
Large company with
professional management.
Management and employees
wanting information about
items in inventory and the
quantities of specific
products that are selling.
Factors Suggesting a
Periodic Inventory System
Small company, run by
owner.
Accounting records of
inventories and specific
product sales not needed in
daily operations; such
information developed
primarily for use in annual
income tax returns.
Items in inventory with a high Inventory with many different
per-unit cost.
kinds of low-cost items.
Low volume of sales
transactions or a
computerized accounting
system.
Merchandise stored at
multiple locations or in
warehouses separate from
McGraw-Hill/Irwin
sales sites.
High volume of sales
transactions and a manual
accounting system.
All merchandise stored at the
sales site (for example, in the
store).
© The McGraw-Hill Companies, Inc., 2008
6-13
Credit Terms and Cash Discounts
2/10, n/30
Percentage
of Discount
McGraw-Hill/Irwin
# of Days
Discount Is
Available
Otherwise,
the Full
Amount Is
Due
# of Days
when Full
Amount Is
Due
© The McGraw-Hill Companies, Inc., 2008
6-14
Recording Purchases at Net Cost
Purchases are
recorded at their
net amounts.
Net
Method
McGraw-Hill/Irwin
Purchase
Discounts Lost
are recorded
when payment
is made outside
the discount
period.
© The McGraw-Hill Companies, Inc., 2008
6-15
Recording Purchases at Net Cost
On July 6, Play Clothes purchased $4,000 of
merchandise on credit with terms of
2/10, n/30 from Kid’s Clothes.
Prepare the journal entry for Play Clothes.
GENERAL JOURNAL
Date
Account Titles and Explanation
July 6 Inventory
Accounts Payable (Kid's Clothes)
McGraw-Hill/Irwin
$4,000  98% = $3,920
Debit
Credit
3,920
3,920
© The McGraw-Hill Companies, Inc., 2008
6-16
Recording Purchases at Net Cost
On July 15, Play Clothes pays the full amount
due to Kid’s Clothes.
Prepare the journal entry for Play Clothes.
GENERAL JOURNAL
Date
Account Titles and Explanation
July 15 Accounts Payable (Kid's Clothes)
Cash
McGraw-Hill/Irwin
Debit
Credit
3,920
3,920
© The McGraw-Hill Companies, Inc., 2008
6-17
Recording Purchases at Net Cost
Now, assume that Play Clothes waited until
July 20 to pay the amount due in full to Kid’s
Clothes.
Prepare the journal entry for Play Clothes.
GENERAL JOURNAL Nonoperating Expense
Date
Account Titles and Explanation
July 20 Accounts Payable (Kid's Clothes)
Purchase Discounts Lost
Cash
McGraw-Hill/Irwin
Debit
Credit
3,920
80
4,000
© The McGraw-Hill Companies, Inc., 2008
Recording Purchases at Gross
Invoice Price
6-18
Purchases are
recorded at their
gross amounts.
Gross
Method
McGraw-Hill/Irwin
Purchase
discounts taken
are recorded
when payment
is made inside
the discount
period.
© The McGraw-Hill Companies, Inc., 2008
6-19
Recording Purchases at Gross
Invoice Price
On July 6, Play Clothes purchased $4,000 of
merchandise on credit with terms of
2/10, n/30 from Kid’s Clothes.
Prepare the journal entry for Play Clothes.
GENERAL JOURNAL
Date
Account Titles and Explanation
July 6 Inventory
Accounts Payable (Kid's Clothes)
McGraw-Hill/Irwin
Debit
Credit
4,000
4,000
© The McGraw-Hill Companies, Inc., 2008
6-20
Recording Purchases at Gross
Invoice Price
On July 15, Play Clothes pays the full amount
due to Kid’s Clothes.
Prepare the journal entry for Play Clothes.
Reduces Cost of
$4,000  98% = $3,920
GENERAL
JOURNAL
Goods Sold
Date
Account Titles and Explanation
July 15 Accounts Payable (Kid's Clothes)
Cash
Purchase Discounts Taken
McGraw-Hill/Irwin
Debit
Credit
4,000
3,920
80
© The McGraw-Hill Companies, Inc., 2008
6-21
Recording Purchases at Gross
Invoice Price
Now, assume that Play Clothes waited until
July 20 to pay the full amount due to Kid’s
Clothes.
Prepare the journal entry for Play Clothes.
GENERAL JOURNAL
Date
Account Titles and Explanation
July 20 Accounts Payable (Kid's Clothes)
Cash
McGraw-Hill/Irwin
Debit
Credit
4,000
4,000
© The McGraw-Hill Companies, Inc., 2008
6-22
Returns of Unsatisfactory
Merchandise
On August 5, Play Clothes returned $500 of
unsatisfactory merchandise purchased from Kid’s
Clothes on credit terms of 2/10, n/30. The purchase
was originally recorded at net cost.
Prepare the journal entry for Play Clothes.
GENERAL JOURNAL
Date
Account Titles and Explanation
Aug. 5 Accounts Payable (Kid's Clothes)
Inventory
McGraw-Hill/Irwin
$500  98% = $490
Debit
Credit
490
490
© The McGraw-Hill Companies, Inc., 2008
6-23
Transportation Costs on Purchases
Transportation costs (freight-in) related to the
acquisition of assets are part of the cost of the asset
being acquired.
On July 6, Play Clothes paid $150 for the
shipping of merchandise from Kid’s Clothes.
Jul 6 Merchandise Inventory
Cash
150
150
To record payment of freight terms FOB
shipping point
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
6-24
Transactions Relating to Sales
Computer City
Partial Income Statement
For the Year Ended December 31, 2007
Revenue
Sales
Less: Sales returns and allowances $
Sales discounts
Net sales
$ 912,000
8,000
4,000
12,000
$ 900,000
Credit terms and merchandise returns
affect the amount of revenue earned by
the seller.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
6-25
Sales
On August 2, Kid’s Clothes sold $2,000 of
merchandise to Play Clothes on credit terms 2/10,
n/30. Kid’s Clothes originally paid $1,000 for the
merchandise.
Because Kid’s Clothes uses a perpetual inventory
system, they must make two entries.
Date
Account Titles and Explanation
Aug. 2 Accounts Receivable (Play Clothes)
Sales
2 Cost of Goods Sold
Inventory
McGraw-Hill/Irwin
Debit Credit
2,000
2,000
1,000
1,000
© The McGraw-Hill Companies, Inc., 2008
6-26
Sales Returns and Allowances
On August 5, Play Clothes returned $500 of unsatisfactory
merchandise to Kid’s Clothes from the August 2 sale. Kid’s
Clothes cost for this merchandise was $250.
Because Kid’s Clothes uses a perpetual inventory system, they
must make two entries.
Contra-revenue
Date
Account Titles and Explanation
Debit Credit
Aug. 5 Sales Returns and Allowances
500
Accounts Receivable (Play Clothes)
500
Inventory
250
Cost of Goods Sold
250
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
6-27
Sales
On July 6, Kid’s Clothes sold $4,000 of merchandise to
Play Clothes on credit with terms of 2/10, n/30. The
merchandise originally cost Kid’s Clothes $2,000.
Because Kid’s Clothes uses a perpetual inventory
system, they must make two entries.
Date
Account Titles and Explanation
July 6 Accounts Receivable (Play Clothes)
Debit
4,000
Sales
Cost of Goods Sold
Inventory
McGraw-Hill/Irwin
Credit
4,000
2,000
2,000
© The McGraw-Hill Companies, Inc., 2008
6-28
Sales Discounts
On July 15, Kid’s Clothes receives the full
amount due from Play Clothes from the
July 6 sale.
Prepare the journal entry for Kid’s Clothes.
Contra-revenue
$4,000  98% = $3,920
GENERAL JOURNAL
Date
Account Titles and Explanation
July 15 Cash
Sales Discounts
Accounts Receivable (Play Clothes)
McGraw-Hill/Irwin
Debit
Credit
3,920
80
4,000
© The McGraw-Hill Companies, Inc., 2008
6-29
Sales Discounts
Now, assume that it wasn’t until July 20 that
Kid’s Clothes received the full amount due
from Play Clothes from the July 6 sale.
Prepare the journal entry for Kid’s Clothes.
GENERAL JOURNAL
Date
Account Titles and Explanation
July 20 Cash
Accounts Receivable (Play Clothes)
McGraw-Hill/Irwin
Debit
Credit
4,000
4,000
© The McGraw-Hill Companies, Inc., 2008
6-30
Delivery Expenses
Delivery costs incurred by sellers are
debited to Delivery Expense, an
operating expense.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
6-31
Accounting for Sales Taxes
Businesses collect sales tax at the point of sale.
Then, they remit the tax to the appropriate
governmental agency at times specified by law.
$1,000 sale  7% tax = $70 sales tax
GENERAL JOURNAL
Date
Account Titles and Explanation
Cash
Sales Tax Payable
Sales
McGraw-Hill/Irwin
Debit
Credit
1,070
70
1,000
© The McGraw-Hill Companies, Inc., 2008
6-32
Financial Analysis
Net Sales
Gross
Profit
Margins
• Trends over time
• Gross profit  Net sales
• Comparable store sales
•Overall gross profit
margin
• Sales per square foot of
selling space
McGraw-Hill/Irwin
•Gross profit margins by
department and
products
© The McGraw-Hill Companies, Inc., 2008
Ethics, Fraud, and
Corporate Governance
6-33
Sales discounts and allowances are contra-revenue
accounts. Sales discounts and allowances reduce
gross sales. As such, net income will be incorrect if
discounts and allowances are not properly recorded.
The pressure brought to bear on subordinates to
implement fraudulent schemes developed by top
management can often be intense. Top
management can threaten employees with
termination if they fail to participate in the fraud.
Unfortunately, employees who acquiesce to such
pressure face tremendous legal risks.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008