Accounting 20
Module 3
Lesson 10
Accounting 20
1
Lesson 10
Accounting 20
2
Lesson 10
Lesson 10 - Merchandising Businesses
Read pages 475 to 501 in the text.
Topics:
•
•
•
•
•
•
•
•
•
Introduction
Examining Changes to the Financial Statements for Merchandising Businesses
Analyzing Merchandising Transactions
Remember These Important Points
Do You Understand?
Conclusion
Self Test
Answers for Self Test
Assignment 10
After studying lesson 10, the student should be able to
•
prepare a Cost of Goods Sold section of an income statement.
•
prepare a formal income statement and related classified balance sheet for a
merchandising business using the periodic inventory system.
•
prepare the General Journal entries for a merchandising business from transaction
information.
•
post the General Journal entries to either a T-account or a three-column ledger.
•
prepare a formal income statement and related classified balance sheet from the
ledger.
•
indicate the correct use of the Purchases account and how the asset account
Inventory fits into the Cost of Goods sold calculation.
Accounting 20
3
Lesson 10
Accounting 20
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Lesson 10
Introduction
To this point, we have dealt exclusively with service businesses--hairdressing salons, auto
body repair shops, golf courses, plumbers, and so on. We will now concentrate on
merchandise businesses who sell goods, not services,--jewellery, clothes, groceries, baked
goods, furniture, and so on. These businesses are called merchandise businesses because
they buy goods at one price and resell these goods to customers at another price.
The price of the goods sold to customers is usually higher than the purchase price, thus
providing the business with an income. This income must cover three things:
•
the cost of the merchandise sold
•
the payment of expenses
•
sufficient profit
A number of new accounts will be introduced for the remainder of this course to
accommodate the special needs of a merchandising operation.
For the moment you need to be familiar with only two merchandising accounts, Purchases
and Sales.
Accounting 20
5
Lesson 10
Examining Changes to the Financial Statements for
Merchandising Businesses
Since a merchandising business sells products, it has an additional asset called
merchandise inventory.
Merchandise inventory is a current asset because it is something of value owned by the
business. Merchandise inventory is classified as a current asset because the inventory
was purchased for the purpose of being sold to consumers within a short period of time.
Merchandising businesses do not like to hold on to inventory for a long period of time.
Storing inventory costs money, and the longer it is stored, the costlier it becomes. In fact,
one of the measures of the profitability of a merchandising business is the length of time
the inventory remains in the stockroom. The longer the time, the poorer the business'
operations.
Read carefully and study textbook pages 478 and 479. Note the phrase "at cost" after
Inventory. Remember that the asset is always valued at cost--the original price of the
asset; it is never listed at the selling price.
Cost of Goods Sold
Read carefully pages 480 and 481.
In order to be able to calculate a net income figure, it is necessary to know the cost of the
merchandise sold.
A merchandising business earns most of its revenue by selling merchandise from its stock
of inventory. When goods are sold, the cost of those goods is then an expense which is
matched against revenue--for the same accounting period--to determine a profit (net
income) or a net loss. This expense is called cost of goods sold because it represents the
cost of buying the goods that are sold.
Pay particular attention to the second "Condensed Income Statement" on page 480 of the
textbook.
Accounting 20
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Lesson 10
Calculating the Cost of Goods Sold
Read carefully pages 481 to 483.
Two methods of calculating the cost of goods sold are perpetual inventory and periodic
inventory.
Perpetual Inventory means the control is kept for each item of merchandise inventory. A
stock card is created for each item, and as stock comes and goes, the individual stock cards
are updated to show current counts of stock. At any time, the amount of stock available of
any one item can be read from the stock card for that item. Once a year, all the items in
inventory are physically counted during the taking of the annual inventory to verify the
inventory records. The perpetual method is usually used in merchandising businesses
that sell expensive items that require control--for example, department stores, furniture
stores, jewellery stores, car dealerships, and so on.
In this course, we will concentrate on the periodic inventory method. In this system,
control of merchandise inventory is not kept for each individual item, but, rather, for the
entire value of the merchandise in stock. Merchandise inventory is physically counted on
a periodic basis. This is called taking a physical inventory. For example, once a year, a
total value for all merchandise inventory items is arrived at and recorded as the beginning
inventory for the fiscal period. During the year, incoming purchases of merchandise
inventory are added to stock and the additions are recorded in the accounting books. At
the end of the year, the entire inventory is counted once again and recorded as the ending
inventory of the fiscal period. Businesses that use this method carry a lot of stock of small
inexpensive items. Examples are grocery stores, hardware stores, and so on.
Study carefully and learn the formula to calculate cost of goods sold on pages 482 and 483
as well as the summary given.
Explaining the Factors that Affect Sales Revenue
Read pages 483 to 484 carefully.
Most merchandising companies allow customers to obtain a refund for returning
merchandise found to be unsatisfactory.
The customer may agree to keep the merchandise if a partial refund or allowance is
offered and the merchandise has only minor defects. This is known as a sales allowance.
Accounting 20
7
Lesson 10
The merchandise may have major defects in which case a complete return of merchandise
and a total refund is appropriate. This is known as a sales return.
The two are sufficiently similar and can be combined in the same account--Sales Returns
and Allowances. This amount is considered a contra sales account--a reduction in sales
revenue--which is debited.
When a customer returns a sale, the business has two alternate courses of action:
•
give the customer a cash refund.
•
credit the customer's account--reduce their outstanding balance.
Sales Discounts are a cash incentive to encourage customers to pay their accounts before
the due date. This account is a contra revenue account and is therefore debited. Study
and learn the examples on page 484 in the textbook.
Note that Net Sales is calculated by subtracting Sales Returns and Allowances and Sales
Discounts from Gross Sales.
Explaining the Factors that Affect Cost of Goods Sold
Read pages 484 to 486 in the textbook.
Transportation-In is an account used for the cost of shipping goods from the manufacturer
to the place of business; it is part of the cost of goods section.
Purchases Returns and Allowances are goods which are unsatisfactory when they are
received by a business. These goods may be returned to the wholesaler or a lower price
may be negotiated. This account decreases the cost of goods delivered; it is considered a
contra purchases account and is therefore credited.
Purchases Discount is a discount (incentive) for a business to pay a bill before the due
date. This account is also considered a contra purchases account and is therefore credited.
Net Purchases is calculated by subtracting Purchases Returns and Allowances and
Purchases Discounts from the Cost of Delivered Goods.
Accounting 20
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Lesson 10
Analyzing Merchandising Transactions
Study pages 491 to 500. Pay particular attention to the examples provided for you.
Comparing Cash Sales to Credit Sales
•
When selling goods for cash,
Debit: Cash
Credit: Sales
•
When selling goods on credit,
Debit: Accounts Receivable/
Credit: Sales
Recording Sales Returns and Allowances
Debit: Sales Returns and Allowances
Credit: Accounts Receivable/
Recording Sales Discounts Transactions
Example:
on a credit sale of $1 000, a discount of 3% is given. The customer paid in
time to take advantage of the discount.
Debit: Cash
Sales Discounts
Credit:
Accounts Receivable
970
30
1 000
The Sales Discount is for 3% and is debited, therefore, for $30. Sales discount reduces the
amount of cash received to $970.
The entire amount of the invoice of $1 000 must be credited to Accounts Receivable to
reduce the outstanding balance to zero.
Accounting 20
9
Lesson 10
Recording the Cost of Goods Sold Transactions
Read pages 495 to 497 carefully on perpetual inventory.
Analyzing Inventory Changes
In the periodic method, the Inventory account changes only at the end of the period, when
a physical count is made.
Note that the beginning inventory is the same as the ending inventory from the last
accounting period.
Learn this formula:
Beginning Inventory
Add: Net Purchases
= Goods Available for Sale
Less: Ending Inventory
= Cost of Goods Sold
Analysis:
If you know the value of goods on hand at the start of a period and add this figure to the
value of all merchandise purchased during the period, you will know the total value of
goods available for customers to buy. If you then subtract the goods still on hand at the
end of the period, the resultant figure will show the amount of goods that have left the
business and have presumably been bought by customers. In a completed income
statement, this figure would then be subtracted from sales to show a gross profit figure.
This calculation of the cost of goods sold is the major difference between an income
statement for a service type business and an income statement for a merchandising
operation. Note that the difference between the beginning and ending inventories is built
into the cost of goods calculation.
Accounting 20
10
Lesson 10
Purchasing Merchandise
The Purchases account is debited whenever the business buys merchandise from its
suppliers with the intention of selling the merchandise to its customers.
Purchases does not include machinery, supplies, furniture, or any other asset bought by
the company in order to carry on its everyday business.
For example, when a furniture store buys furniture from a manufacturer to be put on
display for customers to buy, then the account is Purchases.
If the same company buys furniture for the office to be used by the company in its
operation, this furniture is not Purchases because it is not for resale to customers.
Purchases refers only to merchandise bought for resale to customers; purchases has a
debit balance.
Transactions:
•
When merchandise is purchased for cash
Debit: Purchases
Credit: Cash
•
When merchandise is purchased on account
Debit: Purchases
Credit: Accounts Payable/
Transportation-In
Freight charges must be added to the cost of purchases to determine the cost of delivered
goods. This is called Transportation-In and it is an expense account so it must be debited.
•
If cash is received,
Debit: Transportation-in
Credit: Cash
Accounting 20
11
Lesson 10
•
When credit terms are given,
Debit: Transportation-in
Credit: Accounts Payable/
Purchases Returns and Allowances
When merchandise received from suppliers is unsatisfactory, it may be returned or an
allowance may be granted on the purchase price. In either case the cost of purchases must
decrease.
Debit: Accounts Payable/
Credit: Purchases Returns and Allowances
Purchases Discount
Page 500 shows you how a transaction is calculated and it gives the required journal
entry. Be responsible for pages 500 and 501 in the textbook.
Remember These Important Points
•
Any merchandise inventory on hand, that is, not sold, at the end of an accounting
period (one month, three months, one year, and so on) is an asset of the business.
•
Since the merchandise inventory is expected to be sold within a short time--within
one year of the balance sheet date, if not sooner--it must be reported as a current
asset.
•
Current assets are listed in this order: Cash, Marketable Securities, Accounts
Receivable, and Inventory. Marketable Securities are Canadian stocks, bonds, or
treasury bills which are used to generate revenue.
•
Inventory is listed "at cost". This means the asset is valued at the original price of
the asset--rather than at the selling price or replacement cost.
Accounting 20
12
Lesson 10
•
The main source of revenue for any merchandising business is the sale of
merchandise, reported under Revenue as Sales of Goods.
•
On the basis of the matching principle, revenue is matched for the same accounting
period against the expense of buying goods (cost of goods sold) to calculate the gross
profit from sales.
•
The cost of unsold goods, the inventory, is an unexpired cost. Therefore, Inventory
is reported as a current asset on the balance sheet.
•
To calculate the Cost of Goods Sold;
Beginning Inventory
Add: Net Purchases
= Goods Available for Sale
Less: Ending Inventory
= Cost of Goods Sold
•
To calculate Gross Profit from Sales
Sales Revenue
Minus: Cost of Goods Sold
= Gross Profit from Sales
•
Sales Returns and Allowances and Sales Discounts are contra sales accounts.
Because they are a reduction of sales revenue, they are debited.
•
Net Sales is calculated by subtracting Sales Returns & Allowances and Sales
Discounts from Gross Sales.
•
Purchases Returns and Allowances and Purchases Discounts are contra purchases
accounts. Because they are a reduction of purchases, they are credited.
•
Net Purchases is calculated by subtracting Purchases Returns and Allowances and
Purchases Discounts from Cost of Delivered Goods.
Accounting 20
13
Lesson 10
•
In the periodic method, the Inventory account changes only at the end of the period,
when a physical count is made.
•
The beginning inventory is the same as the ending inventory from the last
accounting period.
•
Purchases refers only to merchandise bought for resale to customers and it has a
debit balance.
Do You Understand?
Merchandising business - a business that buys finished goods and sells them at increased
prices.
Merchandise inventory - merchandise or goods acquired for resale; a current asset on a
balance sheet of a merchandising firm.
Cost of goods sold - a large expense of any merchandising firm; represents the amount
paid for the goods that were sold.
Gross profit from sales - the result of matching sales revenue with the cost of goods sold.
Perpetual inventory - a system of calculating the cost of goods sold and of updating the
Inventory account immediately after the sale or purchase of an inventory item.
Periodic inventory - a system of calculating the cost of all goods sold during the period,
based on a physical count, at the end of the period.
Physical inventory - the actual counting of inventory items at the end of an accounting
period.
Sales return - return of goods by a customer to the seller.
Sales allowance - a reduction in the original sales price for slightly inferior or unsuitable
goods.
Sales discount - cash discount deducted from the sales invoice.
Purchases - an expense account under the periodic inventory method.
Accounting 20
14
Lesson 10
Purchases Returns and Allowances - are goods which are unsatisfactory when they are
received by a business. These goods may be returned to the wholesaler or a lower price
may be negotiated.
Purchases Discounts - is a discount for a business to pay a bill before the due date.
Purchases Returns and Allowances and Purchases Discounts - are contra expense
accounts and are therefore credited.
Transportation-in (freight-in) - an expense account under the periodic inventory method.
Conclusion
Accounting for a merchandising operation is no different from accounting for a service type
business. A merchant just uses a few more accounts. Therefore, it requires more journal
entries.
When a customer returns a sale to your store, you will always debit Sales Returns and
Allowances and credit either Cash or Accounts Receivable.
When you return merchandise to one of your suppliers, always debit either Cash or
Accounts Payable and credit Purchases Returns and Allowances.
In the next section, you will learn how to handle accounts more efficiently.
Self Test
1.
2.
3.
4.
5.
P 12-1, page 486 of the text
P 12-2, page 486
P 12-3, page 489
MC 12-2, page 490
P 12-6, page 501
Accounting 20
15
Lesson 10
P 12-1a, b, c, d, e
a.
Net Sales = __________________________________________________________________
__________________________________________________________________
__________________________________________________________________
b.
Net Sales = __________________________________________________________________
__________________________________________________________________
__________________________________________________________________
__________________________________________________________________
c.
Net Sales = __________________________________________________________________
__________________________________________________________________
__________________________________________________________________
__________________________________________________________________
d.
Net Sales = __________________________________________________________________
__________________________________________________________________
__________________________________________________________________
__________________________________________________________________
__________________________________________________________________
e.
Net Sales = __________________________________________________________________
__________________________________________________________________
__________________________________________________________________
__________________________________________________________________
__________________________________________________________________
__________________________________________________________________
Key Figure to Check: Net Sales = Gross Sales - (Sales Returns & Allowances + Sales
Discounts)
Accounting 20
16
Lesson 10
P 12-2a
P 12-2b
P12-2c
Accounting 20
17
Lesson 10
P 12-2d
P 12-2e
Accounting 20
18
Lesson 10
P12-3
Accounting 20
Key Figure to Check: Cost of Goods Sold is $128 520.
19
Lesson 10
MC 12-2a Key Figure to Check: use the format of a partial Income Statement to
compute the missing item in each part below.
MC 12-2b
Accounting 20
20
Lesson 10
MC 12-2c
Key Figure to Check: use the format of a partial Income Statement to compute two
missing items.
Accounting 20
21
Lesson 10
P 12-6a, b
Date
20__
19__
Accounting 20
Account Title & Explanation
22
Post
Ref.
Debit
Credit
Lesson 10
P12-6a, b (continued)
Date
20__
19__
Accounting 20
Account Title & Explanation
23
Post
Ref.
Debit
Credit
Lesson 10
Cash
110
Inventory
105
Equipment
Accounts Payable/
Fredericton Wholesalers 202
Accounts Payable/
Johnston Bros. Ltd
105
Accounts Payable/
Moncton Sales & Service 204
Purchases Discounts 503
Purchases
501
Purchases R & A
502
Transportation-In 504
Utilities Expense
510
Accounting 20
24
110
Extra Form
Lesson 10
P 12-6c
Accounting 20
25
Lesson 10
Answers For Self Test
P 12-1a
Revenue from Sales:
Net Sales
$8 000
P 12-1b
Revenue from Sales:
Gross Sales
Less: Sales Returns and Allowances
Net Sales
$8 000
1 200
P 12-1c
Revenue from Sales:
Gross Sales
Less: Sales Returns and Allowances
Net Sales
P 12-1d
Revenue from Sales:
Gross Sales
Less: Sales Returns and Allowances
Sales Discounts
Net Sales
P 12-1e
Revenue from Sales:
Gross Sales
Less: Sales Returns
Sales Allowances
Sales Discounts
Net Sales
$974
413
$388
422
298
P 12-2a
Cost of Goods Sold:
Beginning Inventory
Net Purchases
Cost of Goods Available for Sale
Less: Ending Inventory
Cost of Goods Sold
Accounting 20
$8 000
453.00
26
$6 800
$7 547
$8 000
1 387
$6 613
$8 000
1 108
0
50 000
50 000
20 000
$6 892
$30 000
Lesson 10
P 12-2b
Cost of Goods Sold:
Beginning Inventory
Net Purchases
Cost of Goods Available for Sale
Less: Ending Inventory
Cost of Goods Sold
$ 57 000
50 000
107 000
38 000
$69 000
P 12-2c
Cost of Goods Sold:
Beginning Inventory
Net Purchases
Cost of Goods Available for Sale
Less: Ending Inventory
Cost of Goods Sold
$ 43 500
50 000
93 500
0
$93 500
P 12-2d
Cost of Goods Sold:
Beginning Inventory
Net Purchases
Cost of Goods Available for Sale
Less: Ending Inventory
Cost of Goods Sold
$ 37 000
50 000
87 000
56 987
$30 013
P 12-2e
Cost of Goods Sold:
Beginning Inventory
Net Purchases
Cost of Goods Available for Sale
Less: Ending Inventory
Cost of Goods Sold
Accounting 20
27
$ 110 000
50 000
160 000
132 000
$28 000
Lesson 10
P 12-3
ACME Widget Company
Statement of Cost of Goods Sold
For the Period Ended Month, Year
Cost of Goods Sold:
Beginning Inventory
Purchases
Add: Freight-in
Cost of Delivered Goods
Less: Purchases Returns & Allowances
Net Purchases
Cost of Goods Available for Sales
Less: Ending Inventory
Cost of Goods Sold
$20 000.00
$130 000.00
1 020.00
131 020.00
500.00
130 520.00
150 520.00
22 000.00
$128 520.00
MC 12-2a
Cost of Goods Sold:
Beginning Inventory
Purchases
Add: Freight-in
Net Purchases
Cost of Goods Available for Sale
Less: Ending Inventory
Cost of Goods Sold
$62.00
7.00
$23.00
69.00
92.00
16.00
$76.00
MC 12-2b
Cost of Goods Sold:
Beginning Inventory
Purchases
Add: Freight-in
Cost of Delivered Goods
Less: Purchases R & A
$37.00
Purchase Discounts
24.00
Net Purchases
Cost of Goods Available for Sale
Less Ending Inventory
Cost of Goods Sold
Accounting 20
28
$588.00
63.00
651.00
61.00
$437.00
590.00
1 027.00
378.00
$649.00
Lesson 10
MC 12-2c
Gross Sales
Less: Sales Discounts
Sales R & A
Net Sales
Cost of Goods Sold
Gross Profit from Sales
$ 5.00
10.00
Beginning Inventory
Purchases
Purchases R& A
Net Purchases
Cost of Goods Available for Sale
Ending Inventory
Cost of Goods Sold
Accounting 20
$313.00
15.00
$160.00
9.00
29
298.00
200.00
98.00
$110.00
151.00
261.00
61.00
$200.00
Lesson 10
P 12-6a, b
General Journal
DATE
20__
Mar. 4
ACCOUNT TITLE AND EXPLANATION
Purchases
Page 1
POST
REF.
501
Cash
DEBIT
CREDIT
1 200
101
1 200
Purchased merchandise for cash.
7
Purchases
501
Accts. Pay./Johnston Bros. Ltd.
5 400
203
5 400
Acquired merchandise on terms of 2/10, n/60.
7
Transportation-in (Freight-In)
502
Cash
73
101
73
Issued cheque 217 to Saint Hubert Express Co.
for freight charges on purchases from Johnston
Bros. Ltd.
8
Equipment
110
18 399
Cash
101
6 300
Accts. Pay./Moncton Sales and Service
204
12 099
Acquired new equipment by paying $6300 cash with
the balance on terms of n/30.
9
Accts.Pay./Johnston Bros. Ltd.
203
Purchases Returns and Allowances
503
672
672
Returned for a full refund goods purchased on
Mar. 7.
Accounting 20
30
Lesson 10
Mar. 11
Purchases
501
Accts. Pay./Fredericton Wholesalers
8 300.00
202
8 300.00
Acquired merchandise on terms of 4/5, 2/15, n/30.
15
Purchases
501
Cash
4 577.00
101
4 577.00
Acquired merchandise for cash from
Ridgetown Mfg. Ltd.
17
Accts. Pay./Johnston Bros. Ltd.
203
4 728.00
Cash
101
4 633.44
Purchases Discounts
504
94.56
Paid account in full with cheque 218,
less 2% discount.
22
Utilities Expense
510
Cash
101
325.00
325.00
Paid utilities for March with CH 219.
26
Accts. Pay./Fredericton Wholesalers
202
8 300.00
Cash
101
8 134.00
Purchases Discounts
504
166.00
Paid account in full with CH 220, less 2%
discount.
Accounting 20
31
Lesson 10
P 12-6b
Cash
Inventory
105
Equipment
110
110
20__
Mar. 4 1 200.00
7
73.00
8 6 300.00
15 4 577.00
17 4 633.44
22
325.00
26 8 134.00
Mar. 31
Bal.
25
242.44
Accounts Payable/
Fredericton Wholesalers
202
20__
20__
Mar. 26 8
Mar. 11 8 300.00
300.00

20__
Mar. 1
000.00
20__
Mar. 8 18
399.00
9
Accounts Payable/
Johnston Bros. Ltd.
203
20__
Mar. 9
672.00
17
829.00
20__
Mar. 7
400.00
Accounts Payable/
Moncton Sales & Service
204
20__
Mar. 8
5
12 900.00
4

Purchases
501
20__
Mar. 4
200.00
7
400.00
11
300.00
15
577.00
Purchase R & A
Purchases Discounts
503
502
20__
Mar. 9
1
672.00
5
20__
Mar. 17
94.56
26
166.00
8
Mar. 31
Bal.
260.56
4
Mar. 31 19 477.00
Transportation-In
504
20__
Accounting 20
Utilities Expense
510
20__
32
Lesson 10
Mar. 7
73.00
Accounting 20
Mar.22
325.00
33
Lesson 10
P 12-6c
Halifax Mfg. Co.
Statement of Cost of Goods Sold
For the Month Ended March 31, 20__
Cost of Goods Sold:
Inventory, March 1, 20__
Purchases
Add: Freight-in
Cost of Delivered Goods
Less: Purchase Returns and Allowances
Purchases Discounts
Net Purchases
Cost of Goods Available for Sale
Less: Inventory, March 31, 20__
Cost of Goods Sold
Accounting 20
$ 9 000.00
$19 477.00
73.00
19 550.00
$672.00
260.56
932.56
18 617.44
27 617.44
9 300.00
$18 317.44
34
Lesson 10