CHAPTER 5
Merchandising Operations
Chapter Overview
Chapter 5 first compares a service business with a merchandising business and then discusses the
purchase and sale of merchandise inventory. The chapter then explains how to complete the accounting
cycle for a merchandising company. Following an illustration of the operating cycle, both the periodic
and perpetual inventory systems are defined; however, only the perpetual inventory system is
emphasized. Students learn to make journal entries based on the purchase invoice. Purchase discounts,
purchase returns and allowances, and transportation costs are discussed. The terms FOB destination and
FOB shipping point are explained. The chapter then illustrates the journal entries for cash and credit sales,
cost of goods sold, sales discounts, and sales returns and allowances. Gross profit is explained. A midchapter summary problem asks students to prepare journal entries, post transactions to Inventory and Cost
of Goods Sold, and decide whether borrowing funds to take advantage of a discount is wise.
The second part of the chapter begins with a discussion of the adjusting and closing process in a
merchandising business. Students add an inventory adjustment to the adjusting entries previously
learned. Closing entries for a merchandiser are journalized and posted. Preparation of the financial
statements is discussed, emphasizing the classifications on the income statement. The multi-step and
single-step income statement formats are compared. The gross profit percentage and the inventory
turnover and ways to use these ratios in decision making complete the chapter. Decision guidelines help
students answer some key questions about a merchandiser’s financial statements. A summary problem
reviews closing entries, financial statements, and inventory turnover. An appendix to the chapter covers
the use of a work sheet for a merchandiser and the accounting for merchandise in a periodic inventory
system. The work sheet for a merchandising business is illustrated and the similarities and differences
between this work sheet and a service business’s work sheet are highlighted. The computation of cost of
goods sold in a periodic inventory system is discussed and illustrated.
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Chapter 5: Teaching Outline
1) Define inventory.
2) Compare a service business with a merchandising business.
a) Exhibit 5-1 Financial Statements of a Service Company and a Merchandiser
3) Describe the operating cycle of a merchandising business.
a) Exhibit 5-2 Operating Cycle of a Merchandiser
4) Distinguish between the perpetual and periodic inventory systems.
5) Account for the purchase of inventory using a perpetual system.
a) Exhibit 5-3 Purchase Invoice
b) Purchase Discounts
c) Purchase Returns and Allowances
i) Exhibit 5-4 Purchase Allowance
d) Transportation Costs
i) FOB shipping point
ii) FOB destination point
iii) Exhibit 5-5 FOB Terms Determine Who Pays the Freight
iv) Freight in
v) Freight out
6) Account for the sale of inventory using a perpetual system.
a) Define Accounting Vocabulary
b) Cash Sale
c) Exhibit 5-6 Sales Invoice
d) Sales on Account
e) Sales Returns and Allowances
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f) Sales Discounts
g) Gross Profit or Gross Margin
7) Discuss the physical inventory count at the end of the accounting period.
a) Adjusting entry for inventory shrinkage
8) Describe the closing process for a merchandising business.
a) Exhibit 5-7 Closing Entries for a Merchandiser—Amounts Assumed
9) Explain and prepare the financial statements for a merchandising business.
a) Income Statement
i) Sales
ii) Cost of goods sold
iii) Gross profit
iv) Operating expenses
Selling expenses
General expenses
v) Operating income or income from operations
vi) Other revenue and expense
vii) Net income
b) Statement of Retained Earnings
c) Balance Sheet
i) Discuss inventory
d) Exhibit 5-8 Financial Statements—Amounts Assumed
10) Discuss the formats for the income statement.
a) Multi-Step Income Statement
b) Single-Step Income Statement
i) Exhibit 5-9 Single-Step Income Statement
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11) Discuss the importance of financial analysis in evaluating operations.
a) Gross Profit Percentage
b) Inventory Turnover
12) Discuss the work sheet for a merchandising business.
a) Exhibit 5A-1 Accounting Work Sheet for a Merchandising Business
13) Describe the accounting for merchandise in a periodic inventory system.
a) Recording the Purchase of Inventory
i) Exhibit 5B-1 Purchase Invoice
b) Recording Purchases and Purchase Discounts
c) Recording Purchase Returns and Allowances
d) Recording Transportation Costs
e) Recording the Sale of Inventory
f) Cost of Goods Sold
i) Exhibit 5B-2 Measuring Cost of Goods Sold in a Periodic Inventory System
g) Exhibit 5B-3 Partial Income Statement Periodic Inventory System
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Chapter 5: Summary Handout for Students
1. Merchandising consists of buying and selling products rather than services.
o
Inventory is the merchandise that a company holds for sale for its customers.
2. Operating cycle of a merchandising business:
o
Purchase of inventory from a vendor
o
Sale of inventory to a customer
o
Collection of the cash from customers
3. Inventory accounting systems:
o
Perpetual system
o
Periodic system
4. Accounting for inventory in the perpetual system:
o
Purchase of inventory
Purchase discounts
Purchase returns and allowances
Transportation costs
FOB shipping point
FOB destination point
Freight in
Freight out
o
Sale of inventory
Sales revenue
Cash sales
Sales on account
Cost of goods sold
Sales returns and allowances
Sales discount
Gross profit
5. Adjusting entry to adjust the Inventory account based on the physical count.
6. Closing the accounts of a merchandiser.
7. Preparing a merchandiser’s financial statements:
o
Income Statement
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Sales – Cost of goods sold = Gross profit
Gross profit – Operating expenses = Operating income (or Income from operations)
Operating income +/- Other revenue and expense = Net income (loss)
o
Statement of retained earnings
o
Balance sheet
8. Multi-step versus Single-step Income Statement.
9. Ratios for decision making:
o
Gross profit percentage = Gross profit/Net sales revenue
o
Inventory turnover = Cost of goods sold/ Average inventory
10. Accounting for inventory in a periodic inventory system.
o
Use of Purchases, Purchase discounts, Purchase returns and allowances
o
Net purchases = Purchases – Purchase discounts – Purchase returns and allowances
Calculate Cost of goods sold for the Income Statement:
Beginning inventory + Net purchases + Freight in = Cost of goods available for sale –
Ending inventory = Cost of goods sold
11. Work sheets to print for in-class practice (bookmatch), as specified by your instructor.
12. Myaccountinglab.com homework algorithmic assignments:
o
E5-13; E5-14; E5-15; E5-18; E5-19; E5-24; P5-28A; P5-30A; P5-31A. For Appendices: P5A2A; S5B-1; E5B-2; E5B-3; P5B-5A
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Lecture Outline Tips: Key Topics
As mentioned in the previous lecture outlines, the first stumbling block for students in accounting can be
debits and credits, the second stumbling block can be adjusting entries, and the third stumbling block can
be accounting for inventory. Just when students have the hang of it, new accounts (primarily inventory
and cost of goods sold) and transactions are thrown at them!
A perpetual inventory system is theoretically always up-to-date. If you need to know the balance of
inventory, you simply look in the inventory ledger account. A periodic system is updated periodically,
hence the name. If you need to know the balance of inventory, you must perform a calculation.
The purchase of inventory, the sale of inventory, and the payment for inventory are three separate events.
A company may purchase and sell inventory before it pays for it, which is great cash flow management!
In this case, revenue and cost of goods sold would be reported on the income statement and an
outstanding payable would still be on the balance sheet for the inventory that was sold.
The seller ALWAYS has two entries—record the sales price and record the cost of goods sold. Likewise,
if a customer returns inventory, the seller still has two entries—record the return and the resulting
increase in inventory. However, the purchaser has one entry—record the inventory and cash payment or
payable. It may be helpful to provide seller and purchaser journal entries side by side for a series of
transactions. Students can see how the transactions affect both companies and identify related accounts
for both companies. For example, a receivable for one is a payable for the other; a sales return for one is
a purchase return for the other.
When computing cash discounts, do not forget to record any returns before calculating the required
payment. A discount cannot be taken on inventory already returned!
The only way to ensure a correct inventory balance is to take a physical count. Every company should
take a physical count at least once a year, even those using the perpetual inventory method. Transactions
can take place that are not recorded, such as theft, damage, and errors.
Students may be surprised to see the dollar amount differences between gross profit and net income. Just
because a company has gross profit does not mean it will have net income. It must price its products to
have enough revenue to cover the cost of the product and any other expenses incurred. Also, operating
income is a better indicator of day-to-day operations than net income. Net income and cash flow are
different concepts when using the accrual method. Just because a company has net income does not mean
it has positive cash flow.
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ASSIGNMENT GRID
Assignment Topic(s)
E5-14
E5-15
E5-16
E5-17
E5-18
E5-19
E5-20
E5-21
E5-22
E5-23
1
10
Easy
2
5–10
Easy
2
10
Easy
2
5–10
Easy
3
10
Easy
3
10
Easy
2
4
5
5
Easy
Easy
4
5
5
5–10
5–10
10
Easy
Easy
Easy
6
10
Easy
10–15
Easy
10–15
Easy
10–15
Easy
15–20
Easy
15–20
Easy
10–15
Medium
10–15
15–20
10–15
Medium
Medium
Medium
10–15
10–15
Medium
Medium
Describing periodic and perpetual inventory
systems
1
Journalizing purchase transactions from an
invoice—perpetual inventory
2
Journalizing purchase transactions—perpetual
inventory
2
Computing inventory and cost of goods sold
amounts
2, 3
Journalizing purchase and sales transactions—
perpetual system
2, 3
Journalizing sales transactions—perpetual
system
3
Journalizing adjusting and closing entries, and
computing gross profit
4
Making closing entries
4
Journalizing closing entries
4
Preparing a merchandiser’s multi-step income
statement to evaluate the business
4, 5
Preparing a multi-step income statement
5
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Level
of
Difficulty
Learning
Objective(s)
Short Exercises
S5-1
Comparing periodic and perpetual inventory
systems
S5-2
Analyzing purchase transactions—perpetual
inventory
S5-3
Journalizing purchase transactions—perpetual
inventory
S5-4
Journalizing purchase transactions—perpetual
inventory
S5-5
Journalizing sales transactions—perpetual
inventory
S5-6
Journalizing sales transactions—perpetual
inventory
S5-7
Computing net sales and gross profit—
perpetual inventory
S5-8
Adjusting inventory for shrinkage
S5-9
Journalizing closing entries—perpetual
inventory
S5-10
Preparing a merchandiser’s income statement
S5-11
Preparing a merchandiser’s balance sheet
S5-12
Computing the gross profit percentage and
the rate of inventory turnover
Exercises
E5-13
Estimated
Time in
Minutes
E5-24
E5-25
Preparing a single-step income statement.
Calculate gross profit percentage to evaluate
the business
5, 6
Calculating gross profit percentage and inventory
to evaluate the business
6
Problems (Group A)
P5-26A
Journalizing purchase and sale transaction—
perpetual inventory
1, 2, 3
P5-27A
Journalizing purchase and sale transactions—
perpetual inventory
2, 3
P5-28A
Journalizing purchase and sale transactions—
perpetual system
2, 3
P5-29A
Journalizing purchase and sale transactions—
perpetual inventory
2, 3
P5-30A
Preparing financial statements and preparing
closing entries
4, 5
P5-31A
Making closing entries, preparing financial
statements, and computing gross profit
percentage and inventory turnover
4, 5, 6
P5-32A
Preparing a multi-step income statement and a
classified balance sheet
5
P5-33A
Preparing a multi-step income statement and
calculating gross profit percentage
5, 6
Problems (Group B)
P5-34B
Journalizing purchase and sale transactions—
perpetual inventory
1, 2, 3
P5-35B
Journalizing purchase and sale transactions—
perpetual inventory
2, 2
P5-36B
Journalizing purchase and sales transactions—
perpetual inventory
2, 3
P5-37B
Journalizing purchase and sales transactions—
perpetual inventory
2, 3
P5-38B
Preparing financial statements and preparing
closing entries
4, 5
P5-39B
Making closing entries, preparing financial
statements, and computing gross profit
percentage and inventory turnover
4, 5 6
P5-40B
Preparing a multi-step income statement and a
classified balance sheet
5
P5-41B
Preparing a multi-step income statement and
calculating gross profit percentage
5, 6
Continuing Exercise
P5-42
Accounting for both merchandising and
service operations
1, 2, 3, 4, 5
10–15
Easy
10
Easy
10–15
Easy
20–25
Medium
15–20
Medium
20–25
Medium
35–45
Medium
20–30
Medium
30–40
Medium
15–25
Medium
10–15
Easy
20–25
Easy
15–20
Medium
20–25
Medium
35–45
Medium
20–30
Medium
30–40
Medium
15–25
Medium
20–30
Medium
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Continuing Problem
P5-43
Accounting for both merchandising and
service operations
Practice Set
P5-44
Accounting for both merchandising and
service operations
1, 2, 3, 4, 5
20–30
Medium
1, 2, 3, 4, 5
20–30
Medium
5
5
20–30
50–60
Difficult
Difficult
4
30–40
Medium
5
Easy
10–15
Medium
20–25
Medium
20–25
10–15
Medium
Medium
35–40
Medium
35–40
10–15
10–15
Medium
Medium
Medium
180
Difficult
Decision Cases
Case 1
Using the financial statements to decide on
a business expansion
Case 2
Expanding a business
Ethical Issue
Financial Statement Case
Case 1
Closing entries for a well-known company
Team Project
Appendix Short Exercises
S5B-1
Computing cost of goods sold in a periodic
inventory system
Appendix Exercises
E5A-1
Preparing the work sheet and journalizing
closing entries
E5B-2
Preparing the merchandiser’s work sheet, financial
statements and closing entries
E5B-3
Preparing the merchandiser’s work sheet, financial
statements and closing entries
E5B-4
Cost of goods sold in a periodic system
Appendix Problems
P5A-2A
Preparing a merchandiser’s work sheet,
preparing financial statements, and preparing
closing entries
P5A-3B
Preparing a merchandiser’s work sheet,
preparing financial statements, and preparing
closing entries
P5B-5A
Journalizing periodic transactions
P5B-6B
Journalizing periodic transactions
Comprehensive Problem
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End of Chapter Exercises and Problems Available in Alternate Accounting Software
Programs:
Excel Templates: P5-27A; P5-29A; P5-37B
QuickBooks: P5-27A; P5-29A; P5-37B
Peachtree: P5-27A; P5-30A; P5-37B
General Ledger: P5-27A; P5-30A; P5-37B
Pre-Test Questions on MyAccountingLab: S5-1 (1), S5-4 (2), S5-5 (3); S5-9 (4); S5-10 (5); S512 (6) For Appendices: E5A-1; E5B-4
Post-Test Questions on MyAccountingLab: P5-36B (2, 3), P5-39B (4, 5, 6). For Appendices:
P5A-3B; P5B-6B
Answer Key to Chapter 5 Quiz
1.
2.
3.
4.
5.
C
A
C
A
D
6. B
7. B
8. D
9. A
10. B
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Name
Date
Section
CHAPTER 5
TEN-MINUTE QUIZ
Circle the letter of the best response.
1.
Which of the following statements is true?
A.
Gross profit – Cost of goods sold = Net sales
B.
Net sales + Gross profit = Cost of goods sold
C.
Gross profit = Net sales – Cost of goods sold
D.
Net sales + Cost of goods sold = Gross profit
2.
J.P.’s Convenience Store purchased merchandise for $800, terms 2/10 n/30. J.P.’s later returned
$100 of the merchandise. The supplier paid the $20 freight and sent an invoice for the
merchandise retained plus the freight. The entry to record the payment of the invoice within the
discount period would include all of the following except
A.
credit to Inventory, $14.40.
B.
debit to Accounts payable, $720.
C.
credit to Cash, $706.
D.
All of the above would be included.
3.
The entry to record the sale of $100 of merchandise with terms of 2/10 n/30 will include a
A.
debit to Sales for $98.
B.
debit to Cash $100.
C.
debit to Accounts receivable of $100.
D.
debit to Sales discounts for $2.
4.
Lawson Co. had a $72,000 beginning inventory and a $78,000 ending inventory. Sales were
$480,000, purchases of merchandise were $258,000, merchandise returned was $15,000,
discounts taken were $12,000, and transportation costs were $18,000. Cost of goods sold for the
period was
A.
$243,000.
B.
$207,000.
C.
$147,000.
D.
$255,000.
5.
Which of the following statements about a work sheet is false?
A.
The inventory amount that appears in the balance sheet debit column is the adjusted
balance for Inventory.
B.
Sales discounts appears in the debit column of the income statement.
C.
If the debit column of the income statement is greater than the credit column, the
company has incurred a net loss for the period.
D.
The total of the balance sheet debit column on the work sheet is also the amount of total
assets.
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6.
The Inventory account has a debit balance of $30,000 on December 31. A physical count reveals
that the merchandise on hand is $29,000. The entry to adjust the inventory on December 31
would include a
A.
credit to Cost of goods sold, $1,000.
B.
credit to Inventory, $1,000.
C.
credit to Accounts payable, $1,000.
D.
credit to Retained earnings, $1,000.
Table 5-1
Selling expenses .......................................................................... $ 20,000
Cost of goods sold ......................................................................... 160,000
Sales .............................................................................................. 245,000
General expenses............................................................................. 40,000
Interest expense ................................................................................. 2,000
Sales returns and allowances ............................................................. 5,000
7.
Refer to Table 5-1. On a multi-step income statement, operating income is
A.
$25,000.
B.
$20,000.
C.
$18,000.
D.
$85,000.
8.
Refer to Table 5-1. The gross profit percentage is (rounded)
A.
35%.
B.
65%.
C.
67%.
D.
33%.
9.
Would Gross profit, Operating income, and Net income appear on a single-step income
statement?
Gross Profit
Operating Income Net Income
A.
No
No
Yes
B.
Yes
Yes
Yes
C.
No
Yes
Yes
D.
Yes
No
No
10.
Which of the following is false?
A.
Net sales = Sales revenue – Sales returns and allowances – Sales discounts
B.
Inventory turnover = Cost of goods sold ÷ Ending inventory
C.
Gross profit percentage = Gross profit ÷ Net sales
D.
Sales – Cost of goods sold = Gross profit
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Reference Document 5-1
MERCHANDISE TRANSACTIONS
Students often have difficulty with merchandise transactions. They sometimes confuse the accounts that a seller
uses vs. those a purchaser uses. It is helpful to see how the two parties record the same transaction, each from their
specific viewpoint.
Purchase and Sales transaction:
5/1/10
5/1/10
ABC Co. purchased 1,000 Widgets of inventory for $3 each on account, terms 2/10, net 30. The
seller’s inventory cost is $1 each.
ABC Co. (Purchaser)
XYZ Co. (Seller)
Inventory
3,000
Accounts payable 3,000
Account receivable
Sales
To record purchase of inventory on
Account (1000 x $3).
To record sale on account
(100 units x $3).
Cost of goods sold
Inventory
3,000
3,000
1,000
1,000
To remove the cost of inventory and
record the cost of the goods sold
(100 x $ 1).
5/3/10
ABC Co. returned 100 items to XYZ Co. for credit.
Accounts payable 300
Inventory
Inventory
300
To record return of 100 units (10x$1).
Decrease Inventory and Accounts
payable.
100
Accounts receivable 100
To record the return of the 100
units into inventory and reducing
Accounts receivable.
Sales returns & allowances 300
Accounts receivable
300
To record the sales return (at selling price) and
reduction in accounts receivable.
5/7/10
ABC Co. paid the amount due to XYZ Co.
Accounts payable 2700
Inventory
Cash
Cash
54
2,646
2,646
Sales discount
54
Accounts receivable
2,700
The amount in the “account” is the net amount, $3,000 less $300.
The discount is the account due, $2,700 x 2%=$54.
The cash is the difference between the amount on account and the discount amount.
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Reference Document 5-2
PERIODIC INVENTORY SYSTEM
The perpetual inventory system records inventory purchases, purchase returns and allowances, freight-in,
and the removal of inventory upon sale directly in the inventory account. The periodic system records
inventory purchases, purchase returns and allowances, and freight-in in individual expense and contra
expense accounts. No entry is made to remove the inventory from the purchases account upon sale.
Therefore, it is necessary that the ending inventory be counted and costed to adjust the Inventory account
to the correct balance and compute and record the cost of goods sold.
Following are the accounts affected by the transactions in Exhibits 5B-3 and 5B-4 for the perpetual and
periodic inventory systems.
PERPETUAL SYSTEM:
Inventory
Beg Bal
38,600 3000 (B)
(A) 91,400 1,200 (C)
(D) 5,200 90,800(E)
End Bal
40,200
Cost of Goods Sold
(E) 90,800
90,800
PERIODIC SYSTEM:
Purchases
Freight-in
(A)91,400
(D)5,200
91,400
5,200
Purchase Discounts
3,000 (B)
3,000
(B) Beg Bal
Inventory
38,600
38,600
Purchase Returns & Allowances
1,200 (C)
1,200
Transactions recorded under both the perpetual and periodic inventory systems are as follows:
(A)
(B)
(C)
(D)
Purchase of $91,400 of inventory
Purchase discounts taken, $3,000
Purchase Returns and Allowances, $1,200
Freight-in incurred on inventory purchases, $5,200
Transactions recorded under the perpetual inventory system only are as follows:
(E) Cost of inventory sold, $90,800
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Periodic Inventory System Adjustment:
(F) The ending inventory count shows that $40,200 is on hand. The objective of the entry is to
(F1) remove the beginning inventory balance of $38,600.
(F2) remove the balance of the Purchases and Freight-in expense accounts.
(F3) remove the balance of the Purchase discounts and Purchase returns and allowances accounts.
(F4) record ending inventory of $40,200.
(F5) record Cost of goods sold expense of $90,800.
Purchases
(A) 91,400
0
Freight-in
91,400 (F2)
Purchase Discounts
(F3)3,000 3,000
0
Purchase Returns & Allowances
(F3) 1,200
1,200 (C)
0
(D) 5,200
0
5,200 (F2)
Inventory
(B) Beg Bal
38,600
(F4) 40,200
40,200
38,600(F1)
Cost of Goods Sold
(F5) 90,800
90,800
NOTE: The Inventory account and Cost of goods sold balances are the same under the perpetual and
periodic inventory systems.
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