1
Chapter 5
Accounting for
merchandising operations
2
Learning objectives
1. Differentiate between a service business and a
merchandising business
2. Identify the differences between the perpetual and
the periodic inventory system
3. Record purchase transactions under the
perpetual inventory system
4. Record sales transactions under the perpetual
inventory system
3
Learning objectives
5. Prepare adjusting and closing entries under the
perpetual inventory system
6. Describe and prepare the multiple-step and
single-step income statements
4
Learning objective 1
Differentiate between a service
business and a merchandising
business
5
Merchandising operations
▪ Merchandiser - a business that derives their
earnings from buying and then selling products to
customers
– Service business derives earnings from providing
services to customers
▪ Merchandise inventory - the goods purchased by
a merchandiser for resale to customers
– Also known as merchandise or inventory
6
Merchandising operations
Two types of merchandising businesses:
1. Wholesalers - businesses that purchase
products and sell them to other wholesalers or
retailers
2. Retailers - businesses that purchase their
products from manufacturers or wholesalers and
sell them to the end customer
7
Merchandising and service businesses
▪ The main differences between a merchandising
business and a service business can be seen by
comparing the income statements of the two
Merchandiser's
Income Statement
For the month ended May 31, 2011
Service Business
Income Statement
For the month ended May 31, 2011
$
$
Sales
1,000
Revenues
1,000
Cost of Goods Sold
(400)
Expenses
(500)
Gross Profit
Expenses
Net income/(Net loss)
600
Net income/(Net loss)
500
(100)
500
8
Merchandising and service businesses
▪ The merchandiser uses a Sales or Sales
Revenues account to record sales of merchandise
– Service business uses a Revenues account to record
earnings from providing services to customers
▪ Two new line items unique to merchandisers
1. Cost of goods sold
2. Gross profit
9
Accounts unique to merchandisers
Cost of goods sold
▪ The cost of the inventory sold by the business
during the accounting period
– Also known as cost of sales or cost of merchandise sold
Gross profit
▪ Net sales revenues minus the cost of goods sold
▪ Represents the amount of earnings the business
has made from selling its goods
– Also known as gross margin
10
Accounts unique to merchandisers
▪ Merchandisers also report the value of merchandise
inventory purchased for resale in the Merchandise
Inventory account
– Also known as just Inventory
▪ Reported as a current asset in the balance sheet
11
Operating cycle
▪ The duration of time between when the business
acquires materials or services, uses them in their
operations, and finally receives cash from selling
their goods or services
▪ Length of time varies
between business types
– E.g. Fruit seller may be a
few weeks
– E.g. Car seller may be
months
12
Cost flow of inventory
▪ Operating cycle of a merchandiser can be
translated into the cost flow of inventory over an
accounting period
– Net purchases: purchases
less any purchases that
are returned
13
Learning objective 2
Identify the differences between the
perpetual and the
periodic inventory system
14
Perpetual and periodic inventory systems
▪ Perpetual inventory system continuously keeps
track of the value of inventory available for sale and
cost of goods sold as each transaction occurs
▪ Periodic inventory system updates the value of
inventory available for sale and the cost of goods
sold only at the end of the accounting period
15
Perpetual and periodic inventory systems
▪ Inventory transactions are demonstrated using the
perpetual inventory system
▪ Periodic inventory system is illustrated in the
appendix
16
Learning objective 3
Record purchase transactions under
the perpetual inventory system
17
Invoice
▪ A bill created by the seller and sent to the buyer that
contains the details of the sale
▪ It is a source document used by the seller to record
the sale and by the buyer to record the purchase
18
Invoice
▪ Seller
▪ Invoice date
▪ Invoice number
▪ Buyer
▪ Purchase order
number
▪ Credit terms
▪ Shipping terms
▪ Merchandise
details
▪ Invoice total
19
Purchase of merchandise for cash
Example:
▪ Purchased 10 snowboards for $300 each
(10 x $300 = $3,000) and paid for them in cash
Purchase of merchandise for cash:
Aug.
4 Merchandise Inventory
Cash
(Purchased merchandise for cash.)
3,000
3,000
Purchase of merchandise on credit
▪ A credit sale credits the Accounts Payable account
instead of the Cash account
Purchase of merchandise for cash:
Aug.
4 Merchandise Inventory
Accounts Payable
(Purchased merchandise on credit.)
3,000
3,000
Purchase returns and allowances
▪ Sometimes when an order of merchandise is
received by the buyer it may need to be returned to
the supplier
▪ A purchase return or allowance is an adjustment
of the purchase price of merchandise recorded in
the accounts of the buyer
▪ The difference between a purchase return and a
purchase allowance is that the merchandise is not
returned to the seller in a purchase allowance
22
Purchase returns and allowances
Example:
▪ Returned 3 snowboards for a full refund of
(3 x $300 = $900)
Purchase return:
Aug.
6 Accounts Payable
Merchandise Inventory
(Returned merchandise purchased on credit.)
900
900
Trade discounts on purchases
▪ Sellers may grant customers a reduction to the price
of the goods if a minimum quantity is purchased
▪ A trade discount is a reduction of the list price of
merchandise that is granted to the buyer
▪ The list price is the full price of an item listed in the
catalog of the seller before deducting any trade
discounts
▪ The value of the trade discount is not separately
recorded in the accounts
24
Trade discounts on purchases
Example:
▪ Supplier offers 10% trade discount on
snowboarding pants if total purchase is greater than
$3,000
▪ Purchased 30 pairs at a list price of $120
(30 x $120 = $3,600)
▪ Eligible for 10% discount (10% x $3,600 = $360)
▪ Amount recorded in Merchandise Inventory account
($3,600 - $360 = $3240)
25
Trade discounts on purchases
Remember:
▪ Amount of trade discount is not recorded in the
accounts!
Trade discount on purchase:
Aug.
7 Merchandise Inventory
Cash
(Cash purchase of inventory with trade discount.)
3,240
3,240
Purchase discounts
Purchase discounts:
▪ Discounts received for payment of an account within
the discount period
▪ Recorded in the accounts of the buyer
27
Credit terms
Credit terms:
▪ Specify when the full amount of an invoice is due to
be paid, including:
– Percentage discount
– Discount period
– Credit period of an invoice
28
Credit terms
▪ Credit terms may be stated as:
2/14, n/30
▪ 2 = percentage discount
▪ 14 = discount period, the time that a customer has
to take advantage of the purchase discount
▪ n/30 = net 30 = credit period, the time that a
customer has to pay an invoice by the due date
▪ Where no discount is given terms are stated as n/30
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Credit terms
Example:
2/14, n/30
▪ The customer gets a 2% discount on the purchase
price if the invoice is paid in full within 14 days of
the invoice, otherwise they are liable to pay the full
balance within 30 days of the invoice
30
Credit period
31
Credit terms
▪ Alternatively credit terms could be stated n/EOM
(net end of month)
▪ n/15 EOM means that the invoice is to be paid in full
15 days after the end of the month in which the
invoice was issued
32
Example – calculating purchase discounts
Steps to calculate purchase discounts:
1. Calculate the outstanding amount of the invoice to
be paid
2. Calculate the amount of the discount
3. Calculate the amount of cash to be paid
4. Record the journal entry
33
Example – calculating purchase discounts
Example:
▪ Purchases = $3,000
▪ Purchase returns = $900
▪ Credit terms = 2/10 n/30
▪ Paid invoice within discount period
34
Example – calculating purchase discounts
Step 1: Calculate the outstanding amount of the
invoice to be paid
Accounts Payable = Invoice total - purchase returns & allowances
= $3,000 - $900
= $2,100
35
Example – calculating purchase discounts
Step 2: Calculate the amount of the discount
Discount = Accounts payable x discount (%)
= $2,100 x 2%
= $2,100 x 0.02
= $42
36
Example – calculating purchase discounts
Step 3: Calculate the amount of cash to be paid
Cash payment = Accounts payable - discount ($)
= $2,100 - $42
= $2,058
37
Example – calculating purchase discounts
Step 4: Record the journal entry
Purchase discount:
Aug.
1 Accounts Payable
Merchandise Inventory
Cash
2,100
42
2,058
(Payment of accounts payable within discount period.)
▪ If the invoice was paid after the discount period then
the journal entry for the repayment debits Accounts
Payable and credits Cash for the full amount of the
invoice less the purchase return
Transportation costs
▪ There are usually additional costs associated with
transporting purchased goods
▪ Buyer and seller must agree who pays for these
costs
▪ The party that owns the title of the goods is
responsible for paying the costs incurred to
transport the goods
▪ Shipping terms determine when the title passes
from the seller to the buyer
39
Shipping terms
▪ The FOB point (free on board) determines when the
ownership passes from the seller to the buyer
▪ There are two FOB points:
1. FOB shipping point
2. FOB destination
40
FOB shipping point
FOB shipping point:
▪ Title of the goods passes to the buyer when the
merchandise leaves the shipping point
▪ The buyer is responsible for paying transport costs
and bears the risk of damage to the goods while
they are in transit
41
FOB destination
FOB destination:
▪ Title of the goods passes to the buyer when the
merchandise arrives at the buyers
▪ The seller is responsible for paying transport costs
and bears the risk of damage to the goods while
they are in transit
42
Shipping Terms
43
Example – transportation costs
▪ $90 charge to transport snowboards from the seller
to the buyer
▪ Different journal entries depending on whether it is
the seller or the buyer that pays for these costs
44
Example – transportation costs
FOB shipping point:
▪ Buyer records the payment as part of inventory
because it is a cost incurred to transport the
inventory and prepare it so it is ready to be sold
FOB shipping point transportation charges (in the books of the buyer):
Aug.
4 Merchandise Inventory
Cash
(Paid transportation charges with cash.)
90
90
Example – transportation costs
FOB destination:
▪ Seller records the payment in the Delivery Expense
account
▪ This is because transport charges are considered
costs incurred in order to sell the merchandise, not
a cost of the merchandise itself
FOB destination transportation charges (in the books of the seller):
Aug.
4 Delivery Expense
Cash
(Paid transportation charges with cash.)
90
90
Learning objective 4
Record sales transactions under the
perpetual inventory system
47
Sale of merchandise on credit
▪ Perpetual inventory system requires two journal
entries
▪ One records the revenue earned
▪ The other transfers the cost of the merchandise sold
to an expense account and records the reduction of
the value of the inventory held
Sale of merchandise on credit
Example:
▪ Sold 5 Slopestyle jackets on credit for $450 each
(5 x $450 = $2,250)
▪ Cost $200 each (5 x $200 = $1,000)
Sale of merchandise on credit
Sale of merchandise on credit (record revenue earned):
Aug.
17 Accounts Receivable
2,250
Sales Revenues
2,250
(Sold merchandise on credit.)
Sale of merchandise on credit (transfer asset to expense account):
Aug.
17 Cost of Goods Sold
Merchandise Inventory
(Cost of merchandise sold.)
1,000
1,000
Sales returns and allowances
▪ A sales return or allowance is an adjustment to
the selling price of merchandise recorded in the
accounts of the seller
▪ The difference between a sales return and a sales
allowance is that the merchandise is not returned to
the seller in a sales allowance
▪ Different journal entries for the sales return and the
sales allowance
51
Sales returns and allowances
A sales return must record two journal entries:
1. The reduction in the revenue earned and
associated asset, either Cash or Accounts
Receivable
2. The increase in the merchandise inventory held
by the business and the reduction in the expense
of the cost of merchandise sold
A sales allowance only records the first entry
because the merchandise is not returned
52
Sales returns and allowances
▪ Reduction in revenue is recorded in an account
called Sales Returns and Allowances
▪ Sales Returns and Allowances is a contra revenue
account that has a normal debit balance
▪ It is reported as a reduction in sales revenue in the
income statement
53
Example – sales return
Example:
▪ Customer returned 2 Slopestyle jackets
▪ Originally sold for $450 each (2 x $450 = $900)
▪ Cost $200 each (2 x $200 = $400)
▪ Jackets were in good condition so can be returned
to inventory at full cost
Example – sales return
Sales return (reduction in revenue and asset):
Aug.
21 Sales Returns and Allowances
900
Accounts Receivable
900
(Customer returned merchandise purchased on credit.)
Sales return (merchandise returned to inventory):
Aug.
21 Merchandise Inventory
Cost of Goods Sold
(Cost of merchandise returned to inventory.)
400
400
Sales returns – damaged goods
▪ If the goods are returned damaged then an estimate
is made as to how much they can be sold for
▪ If they are estimated to be sold for lower than their
original cost, then they must be recorded in
inventory at this lower value
▪ The difference in the new selling price and the cost
of the merchandise is recorded as a debit to an
expense account called Loss from Defective
Merchandise
Sales returns – damaged goods
Example:
▪ Customer returned 2 Slopestyle jackets
▪ Cost $200 each (2 x $200 = $400)
▪ Estimated can only be sold for $150 each
(2 x $150 = $300)
▪ Difference is loss from defective merchandise
($400 - $300 = $100)
Sales returns – damaged goods
▪ First journal entry to record the reduction in revenue
and asset is the same
▪ Second journal entry to record the merchandise
returned to inventory recognizes the loss from the
damaged goods
Sales return (damaged merchandise returned to inventory):
Aug.
21 Merchandise Inventory
Loss from Defective Merchandise
Cost of Goods Sold
(Cost of damaged merchandise returned to inventory.)
300
100
400
Sales allowance
▪ A sales allowance may refund part or all of the
purchase price
▪ The buyer keeps the merchandise, so the seller
only needs to record the first journal entry
Example - sales allowance
Example:
▪ The goods arrived damaged at the buyers
▪ Seller agreed to a $340 reduction in the price of the
goods
Sales allowance (only records the reduction in revenue and asset):
Aug.
21 Sales Returns and Allowances
Accounts Receivable
340
340
(Sales allowance for damaged merchandise.)
▪ The buyer kept the goods so the seller does not
record the return of the merchandise to inventory
Trade discounts on sales
▪ Sellers may grant customers a reduction to the price
of the goods if a minimum quantity is purchased
▪ The value of the trade discount is not separately
recorded in the accounts
61
Example - trade discounts on sales
Example:
▪ The list price of snow mittens is $100
▪ A 20% trade discount is given for purchases of 10
or more, so discount price is $80 each
▪ A customer purchases 10 for $80 each
▪ Seller records revenue of $800 based on the
discounted price (not the list price)
62
Sales discounts
Sales discounts:
▪ Discounts offered to customers to encourage
payment of their account within the discount period
▪ Recorded in the accounts of the seller
▪ Sales returns and allowances and any transport
costs on the invoice do not receive the discount
63
Example – calculating sales discounts
Steps to calculate sales discounts:
1. Calculate the outstanding amount of the invoice to
be received from customer
2. Calculate the amount of the discount
3. Calculate the amount of cash to be received
4. Record the journal entry
64
Example – calculating sales discounts
Example:
▪ Invoice total = $ 4,500
▪ Sales returns = $850
▪ Transport costs = $250 (included in invoice total)
▪ Credit terms = 3/14 n/60
▪ Customer paid invoice within discount period
65
Example – calculating sales discounts
Step 1: Calculate the outstanding amount of the
invoice to be received from customer
Accounts
Invoice
=
Receivable
total
Sales returns
Transport
& allowances
costs
= $4,500 - $850 - $250
= $3,400
66
Example – calculating sales discounts
Step 2: Calculate the amount of the discount
Discount = Accounts receivable x discount (%)
= $3,400 x 3%
= $3,400 x 0.03
= $102
67
Example – calculating sales discounts
Step 3: Calculate the amount of cash to be received
Cash receipt = Accounts receivable - discount ($)
= $3,400 - $102
= $3,298
68
Example – calculating sales discounts
Step 4: Record the journal entry
Sales discount:
Aug.
27 Cash
Sales Discounts
Accounts Receivable
3,298
102
3,400
(Receipt of accounts receivable within discount period.)
▪ If the invoice was paid after the discount period then
the journal entry for the cash receipt debits Cash
and credits Accounts Receivable for the full amount
of the invoice less the sales return
Sales Taxes
▪ Most states and many other taxation authorities
impose a tax on the sale of merchandise to the final
consumer
▪ Seller collects tax at time of sale, incurring a liability
to forward the tax to the taxation authority
▪ Recorded in the Sales Tax Payable account
▪ Sales taxes usually stated as a % of the sales price
70
Example – sales taxes
Example:
▪ Sales price = $100
▪ Sales tax = 5% = $5
▪ Price charged to customer = $105
Credit sale with sales tax:
Aug.
30 Cash
Revenues
Sales Tax Payable
(Credit sale with sales tax.)
105
100
5
Example – sales taxes
▪ Periodically, the seller remits the tax collected over
a period to the taxation authority in one lump sum
Payment of sales tax to taxation authority:
Jan.
15 Sales Tax Payable
Cash
(Paid sales tax collected to taxation authority.)
7,000
7,000
Sales taxes
▪ Taxation authorities normally exempt businesses
from paying sales taxes on merchandise purchased
if that merchandise is to be resold to customers and
they hold a resellers certificate
▪ Generally only the final consumer that pays the
sales taxes on their purchases
73
Learning objective 5
Prepare adjusting and
closing entries under the
perpetual inventory system
74
Adjusting entries for a merchandiser
▪ At the end of the accounting period a physical
inventory count is taken
▪ This is used to calculate the dollar value of the
inventory on hand
▪ The value of inventory on hand is compared to the
balance of the Merchandise Inventory account
▪ These values are rarely equal due to inventory
shrinkage
75
Inventory shrinkage
▪ Inventory shrinkage (or shortage) is the reduction
in the value of inventory due to:
– Theft
– Deterioration
– Breakage
– Errors in the Merchandise Inventory account
▪ Calculated as the difference between the value of
Inventory reported in the Merchandise Inventory
account and the value of inventory revealed through
the inventory count
76
Inventory shrinkage
▪ An adjusting entry is recorded to make the balance
of the Merchandise Inventory account equal to the
value of inventory physically on hand
▪ Inventory shrinkage is recorded in the Cost of
Goods Sold account when not material
77
Example - inventory shrinkage
Example:
▪ Balance of Merchandise Inventory account before
adjustment = $70,000
▪ Inventory count = $68,000 worth of inventory on
hand
▪ Shrinkage = $70,000 - $68,000 = $2,000
Example - inventory shrinkage
Journal entry:
Inventory shrinkage:
Aug.
31 Cost of Goods Sold
Merchandise Inventory
(Adjusting entry for inventory shrinkage.)
2,000
2,000
Inventory shrinkage
▪ If the shrinkage is material, then may need to be
disclosed as a separate line item on the income
statement
▪ Debit Loss on Inventory Shrinkage rather than
Cost of Goods Sold
80
Closing entries of a merchandiser
▪ At the end of the accounting period closing entries
are recorded
▪ Same steps for both service businesses and
merchandisers:
– Step 1: Close all temporary accounts with a credit balance
to the Income Summary account
– Step 2: Close all temporary accounts with a debit balance
to the Income Summary account.
– Step 3: Close the Income Summary account to equity
– Step 4: Close the Withdrawals account to equity
81
Closing entries of a merchandiser
▪ First two steps include closing the additional
temporary accounts unique to merchandising
operations
▪ Last two steps are the same as for service
businesses so will not be shown
▪ Accounts unique to merchandisers are highlighted
82
Step 1: Close accounts with credit balance
▪ Merchandiser uses the Sales Revenues account
rather than the Revenues account used by the
service entity
Journal entry to close all temporary accounts with a credit balance:
Dec.
31 Sales Revenues
Income Summary
(To close temporary accounts with a credit balance.)
200,000
200,000
Step 2: Close accounts with debit balance
▪ Merchandiser has additional expense accounts that
need to be closed at the end of the accounting
period
Journal entry to close all temporary accounts with a debit balance:
Dec.
31 Income Summary
110,000
Sales Returns and Allowances
2,000
Sales Discounts
4,000
Cost of Goods Sold
Delivery Expense
Other Expenses
(To close temporary accounts with a debit balance
70,000
6,000
28,000
Learning objective 6
Describe and prepare the
multiple-step and
single-step income statements
85
Multiple step income statement
▪ Multiple-step income statement is an income
statement format that presents revenues and
expenses of the business under several categories
▪ Highlights the relation between categories through
the use of subtotals
86
Multiple step income statement
There are three main sections of the multiple-step
income statement:
1. Calculation of gross profit
2. Income from operations
3. Nonoperating items
Together these sections result in the net income or
net loss for the period
87
Calculation of gross profit
▪ Gross profit shows the amount of gross profit
earned through the principle revenue generating
activities of the business
Extremely Board
Income Statement (extract)
For the month ended December 31, 2011
$
Sales Revenues
$
200,000
Sales returns and allowances
(2,000)
Sales discounts
(4,000)
(6,000)
Net sales
194,000
Cost of goods sold
(70,000)
Gross profit
124,000
88
Income from operations
▪ Income from operations represents the income
earned from the central operations of the business
▪ For a merchandiser or manufacturer it is calculated
as gross profit less the operating expenses of the
business
▪ For a service business it is calculated as operating
revenues less operating expenses
89
Income from operations
▪ Operating expenses of the business are further
subdivided into two expense categories
▪ Selling expenses are the expenses incurred in
selling the merchandise of the business
▪ Include:
– Advertising costs
– Display costs
– Storage costs
– Selling and delivery costs
90
Income from operations
▪ General and administrative expenses are the
expenses incurred to support the running of the
business
▪ Include expenses incurred for business support
services such as human resource management and
the accounting and finance departments
91
Income from operations
$
$
Gross profit
$
124,000
Operating expenses:
Selling expenses:
Wages expense - sales staff
(11,000)
Delivery expense
(6,000)
Advertising expense
(5,000)
Total selling expenses
(22,000)
General and administrative expenses:
Salaries expense - office staff
Depreciation expense - office equipment
Total general and administrative expenses
Total operating expenses
Income from operations
(10,000)
(2,000)
(12,000)
(34,000)
90,000
92
Nonoperating items and net income
▪ Nonoperating items are items that are not involved
in the central operations of the business
▪ Generally either:
– Small in value so as not to be considered part of the main
operations of the business
– Items that do not recur each period
▪ Nonoperating items may be divided into two
classifications
93
Nonoperating items and net income
1. Other revenues and gains may include:
▪ Interest revenue
▪ Dividend revenue
▪ Rent revenue
▪ Gains made by selling an item of property, plant or
equipment
94
Nonoperating items and net income
2. Other expenses and losses may include:
▪ Interest expense
▪ Losses from the sale of property, plant and
equipment
▪ You will learn about some of these items later
95
Nonoperating items and net income
▪ Finally, the net income earned or the net loss
incurred during the period is calculated as the final
bottom line of the income statement
96
Income from operations
$
$
$
Income from operations
90,000
Other revenues and gains:
Dividend revenues
2,000
Gain on sale of equipment
5,000
Total other revenues and gains
7,000
Other expenses and losses:
Interest expense
Total other expenses and losses
Net income / (Net loss)
(1,000)
(1,000)
96,000
97
Single-step income statement
▪ Single-step income statement is an income
statement format that presents all of the revenues of
the business together and then subtracts all of the
expenses in one step to arrive at the net income or
loss of the business
▪ More difficult for users to compare and analyze the
gross profit or income from operations of the
business
▪ No breakdown of expense categories
▪ But is simpler to prepare
98
Single-step income statement
$
$
Revenues
Net sales
194,000
Dividend revenues
2,000
Gain on sale of equipment
5,000
Total revenues
201,000
Expenses
Cost of goods sold
(70,000)
Selling expenses
(22,000)
General and administrative expenses
(12,000)
Interest expense
Total Expenses
Net income / (Net loss)
(1,000)
(105,000)
96,000
99