5
MERCHANDISING OPERATIONS
AND THE MULTIPLE-STEP
INCOME STATEMENT
5-1
Financial Accounting, Sixth Edition
Study Objectives
5-2
1.
Identify the differences between a service company and a
merchandising company.
2.
Explain the recording of purchases under a perpetual inventory
system.
3.
Explain the recording of sales revenues under a perpetual
inventory system.
4.
Distinguish between a single-step and a multiple-step income
statement.
5.
Determine cost of goods sold under a periodic system.
6.
Explain the factors affecting profitability.
Merchandising Operations
Merchandising Companies
Buy and Sell Goods
Wholesaler
Retailer
Consumer
The primary source of revenues is referred to as
sales revenue or sales.
5-3
SO 1 Identify the differences between service and merchandising companies.
Merchandising Operations
Income Measurement
Sales
Revenue
Less
Cost of
Goods Sold
Not used in a
Service business.
Equals
Cost of goods sold is the total
cost of merchandise sold during
the period.
5-4
Gross
Profit
Illustration 5-1
Income measurement process
for a merchandising company
Less
Operating
Expenses
Equals
Net
Income
(Loss)
SO 1 Identify the differences between service and merchandising companies.
Merchandising Operations
Illustration 5-2
Operating
Cycles
The operating cycle
of a merchandising
company ordinarily
is longer than that of
a service
company.
5-5
SO 1 Identify the differences between service and merchandising companies.
Merchandising Operations
Flow of Costs
Illustration 5-3
Companies use either a perpetual inventory system or a periodic inventory
system to account for inventory.
5-6
SO 1 Identify the differences between service and merchandising companies.
Merchandising Operations
Flow of Costs
Perpetual System
5-7

Maintain detailed records of the cost of each
inventory purchase and sale.

Records continuously show inventory that should be
on hand.

Company determines cost of goods sold each time a
sale occurs.
SO 1 Identify the differences between service and merchandising companies.
Merchandising Operations
Flow of Costs
Periodic System

Do not keep detailed records of the goods on hand.

Cost of goods sold determined by count at the end of
the accounting period.

Calculation of Cost of Goods Sold:
Beginning inventory
Add: Purchases, net
Goods available for sale
Less: Ending inventory
Cost of goods sold
5-8
$ 100,000
800,000
900,000
125,000
$ 775,000
SO 1
Merchandising Operations
Flow of Costs
Additional Consideration
Perpetual System:
►
Traditionally used for merchandise with high unit
values.
►
Provides better control over inventories.
►
Requires additional clerical work and additional cost to
maintain inventory records.

5-9
Easier now with bar codes and inexpensive
software.
SO 1 Identify the differences between service and merchandising companies.
Recording Purchases of Merchandise

Made either cash or credit (on account).

Normally recorded when
Illustration 5-5
goods are received.

Purchase invoice should
support each credit
purchase.
5-10
SO 2 Explain the recording of purchases under a perpetual inventory system.
Recording Purchases of Merchandise
Illustration 5-5
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.
May 4
Inventory
Accounts payable
5-11
3,800
3,800
SO 2 Explain the recording of purchases under a perpetual inventory system.
Recording Purchases of Merchandise
Freight Costs – Terms of Sale
Illustration 5-6
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.
5-12
Freight costs incurred by the seller are an operating expense.
Recording Purchases of Merchandise
Illustration: Assume upon delivery of the goods on May 6, Sauk
Stereo pays Haul-It Freight Company $150 for freight charges, the
entry on Sauk Stereo’s books is:
May 6
Inventory
150
Cash
150
Assume the freight terms on the invoice in Illustration 5-5 had
required PW Audio Supply to pay the freight charges, the entry by
PW Audio Supply would have been:
May 4
Freight-out
Cash
5-13
150
150
SO 2 Explain the recording of purchases under a perpetual inventory system.
Recording Purchases of Merchandise
Purchase Returns and Allowances
Purchaser may be dissatisfied because goods are
damaged or defective, of inferior quality, or do not meet
specifications.
5-14
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 an allowance
(deduction) from the
purchase price.
SO 2 Explain the recording of purchases under a perpetual inventory system.
Recording Purchases of Merchandise
Illustration: Assume that on May 8 Sauk Stereo returned to
PW Audio Supply goods costing $300.
May 8
Accounts payable
Inventory
5-15
300
300
SO 2 Explain the recording of purchases under a perpetual inventory system.
Recording Purchases of Merchandise
Purchase Discounts
Credit terms may permit buyer to claim a cash
discount for prompt payment.
Advantages:

Purchaser saves money.

Seller shortens the operating cycle.
Example: Credit terms may read 2/10, n/30. 2% cash discount
offered if payment is made within 10 days of invoice date;
otherwise full (net) amount is due within 30 days.
5-16
SO 2 Explain the recording of purchases under a perpetual inventory system.
Recording Purchases of Merchandise
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 to record its May 14 payment.
May 14
Accounts payable
Inventory
Cash
3,500
70
3,430
(Discount = $3,500 x 2% = $70)
5-17
SO 2 Explain the recording of purchases under a perpetual inventory system.
Recording Purchases of Merchandise
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:
June 3
Accounts payable
Cash
5-18
3,500
3,500
SO 2 Explain the recording of purchases under a perpetual inventory system.
Recording Purchases of Merchandise
Purchase Discounts
Should discounts be taken when offered?
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%
(365/20 = 18.25 twenty-day periods x 2% = 36.5%)
5-19
SO 2 Explain the recording of purchases under a perpetual inventory system.
Recording Purchases of Merchandise
Summary of Purchasing Transactions
Inventory
Debit
4th - Purchase
6th – Freight-in
$3,500
150
Balance
$3,280
5-20
Credit
$300
70
8th - Return
14th - Discount
SO 2 Explain the recording of purchases under a perpetual inventory system.
Recording Sales of Merchandise

Made using cash or credit (on account).

Normally recorded when
Illustration 5-5
earned, usually when
goods transfer from seller
to buyer.

Sales invoice should
support each credit sale.
5-21
SO 3 Explain the recording of sales revenues
under a perpetual inventory system.
Recording Sales of Merchandise
Journal Entries to Record a Sale
#1
Cash or Accounts receivable
XXX
Sales revenue
#2
Cost of goods sold
Inventory
5-22
XXX
YYY
Selling
Price
Cost
YYY
SO 3 Explain the recording of sales revenues
under a perpetual inventory system.
Recording Sales of Merchandise
Illustration: Assume PW Audio Supply records its May 4
sale of $3,800 to Sauk Stereo on account (Illustration 5-5)
as follows. Assume the merchandise cost PW Audio Supply
$2,400.
May 4
Accounts receivable
3,800
Sales revenue
4
Cost of goods sold
Inventory
5-23
3,800
2,400
2,400
SO 3 Explain the recording of sales revenues
under a perpetual inventory system.
Recording Sales of Merchandise
Sales Returns and Allowances

“Flipside” of purchase returns and allowances.

Contra-revenue account (debit).

Sales not reduced (debited) because:
►
Would obscure importance of sales returns and
allowances as a percentage of sales.
►
5-24
Could distort comparisons.
SO 3 Explain the recording of sales revenues
under a perpetual inventory system.
Recording Sales of Merchandise
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.
May 8
Sales returns and allowances
300
Accounts receivable
8
Inventory
140
Cost of goods sold
5-25
300
140
SO 3 Explain the recording of sales revenues
under a perpetual inventory system.
Recording Sales of Merchandise
Illustration: Assume the returned goods were defective and
had a scrap value of $50, PW Audio would make the following
entries:
May 8
Sales returns and allowances
300
Accounts receivable
8
Inventory
50
Cost of goods sold
5-26
300
50
SO 3 Explain the recording of sales revenues
under a perpetual inventory system.
Recording Sales of Merchandise
Sales Discount
5-27

Offered to customers to promote prompt payment.

“Flipside” of purchase discount.

Contra-revenue account (debit).
SO 3 Explain the recording of sales revenues
under a perpetual inventory system.
Recording Sales of Merchandise
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.
May 14
3,430 *
Cash
Sales discounts
70
Accounts receivable
3,500
* [($3,800 – $300) X 98%]
5-28
SO 3 Explain the recording of sales revenues
under a perpetual inventory system.
Income Statement Presentation
Single-Step Income Statement

Subtract total expenses from total revenues

Two reasons for using the single-step format:
1) Conceptually the company does not realize any
type of profit until total revenues exceed total
expenses.
2) Format is simpler and easier to read.
5-29
SO 4 Distinguish between a single-step and a multiple-step income statement.
Income Statement Presentation
SingleStep
Illustration 5-7
5-30
SO 4
Income Statement Presentation
Multiple-Step Income Statement

Highlights the components of net income.

Three important line items:
1) gross profit,
2) income from operations, and
3) net income.
5-31
SO 4 Distinguish between a single-step and a multiple-step income statement.
Income Statement Presentation
MultipleStep
Illustration 5-8
Key
Line
Items
5-32
SO 4
Income Statement Presentation
Sales Revenues
Illustration 5-9
5-33
SO 4 Distinguish between a single-step and a multiple-step income statement.
Income Statement Presentation
Gross Profit
Illustration 5-11
Comparisons with past amounts and rates and with those in the industry
indicate the effectiveness of a company’s purchasing and pricing policies.
5-34
SO 4 Distinguish between a single-step and a multiple-step income statement.
Income Statement Presentation
Operating Expenses
5-35
Illustration 5-11
Income Statement Presentation
Nonoperating Activities
Various revenues and expenses and gains and losses that are
unrelated to the company’s main line of operations.
Illustration 5-10
5-36
SO 4 Distinguish between a single-step and a multiple-step income statement.
Income
Statement
Presentation
Illustration 5-11
5-37
Income Statement Presentation
Determining Cost of Goods Sold Under a
Periodic System
5-38

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.
SO 5 Determine cost of goods sold under a periodic system.
Income Statement Presentation
Determining Cost of Goods Sold Under a
Periodic System
Illustration 5-13
Cost of goods sold for a
merchandiser using a
periodic inventory system
5-39
SO 5
Evaluating Profitability
Gross Profit Rate
May be expressed as a percentage by dividing the amount
of gross profit by net sales.
A decline in the gross profit rate might have several causes.
5-40
►
Selling products with a lower “markup.”
►
Increased competition may result in a lower selling price.
►
Company forced to pay higher prices to its suppliers without
being able to pass these costs on to its customers.
SO 6 Explain the factors affecting profitability.
Evaluating Profitability
Gross Profit Rate
Illustration 5-15
Why does Wal-Mart have a lower gross profit rate than Target
and the industry average?
5-41
SO 6 Explain the factors affecting profitability.
Evaluating Profitability
Profit Margin Ratio
Measures the percentage of each dollar of sales that results
in net income.
How do the gross profit rate and profit margin ratio differ?
5-42
►
Gross profit rate - measures the margin by which selling
price exceeds cost of goods sold.
►
Profit margin ratio - measures the extent by which selling
price covers all expenses (including cost of goods sold).
SO 6 Explain the factors affecting profitability.
Evaluating Profitability
Profit Margin Ratio
Illustration 5-17
How does Wal-Mart compare to its competitors?
Keep in mind that an increasing percentage of Wal-Mart’s sales is from
low-margin groceries.
5-43
SO 6 Explain the factors affecting profitability.