Tools for Business Decision Making, 3rd Ed.
Kimmel, Weygandt, Kieso
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Chapter 5
Merchandising Operations
After studying Chapter 5, you should be able to:
 Identify the differences between a service enterprise and a merchandising company.
 Explain the recording of purchases under a perpetual inventory system.
 Explain the recording of sales revenues under a perpetual inventory system.
 Distinguish between a single-step and a multiple-step income statement.
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Chapter 5
Merchandising Operations
After studying Chapter 5, you should be able to
 Determine the cost of goods sold under a periodic system.
 Explain the factors affecting the profitability.
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Differences Between a Service
Enterprise and a Merchandising Company

In a merchandising company, the primary source of revenues is the sale of merchandise, referred to as sales revenue or sales.

Unlike expenses for a service company, expenses for a merchandising company are divided into two categories:

Cost of goods sold - the total cost of merchandise sold during the period.

Operating expenses - selling and administrative expenses.
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
Sales revenue or sales = sale of merchandise

Cost of goods sold = total cost of merchandise sold
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Page 202 in book
Sales
Revenue
Less
Cost of
Goods Sold
Equals
Gross
Profit
Less
Operating
Expenses
Equals
Net Income
(Loss)
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the average time it takes to go from cash to cash in producing revenues.
TO
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 ordinarily longer than than that of a service company;
 purchase of merchandise and its sale lengthens the cycle.
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Receive Cash
Service Company
Perform Services
Cash
Accounts
Receivable
Accounts
Receivable
Merchandising Company
Receive Cash Buy Inventory
Cash
Sell Inventory
Merchandise


Perpetual - detailed inventory system in which the cost of inventory is maintained and the records continuously show the inventory that should be on hand

Periodic -inventory system in which detailed records are not maintained and the cost is goods sold is determined only at end of accounting period
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Comparing Periodic and
Perpetual Inventory Systems
Inventory Purchased Item Sold
End of
Period
No Entry
Record Purchase of Inventory
Record Revenue and compute and record Cost of Goods
Inventory Purchased
Item Sold
End of
Period
Periodic
Record Purchase of Inventory
Record Revenue Only Compute and record Cost of
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Goods Sold

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and electronic scanners have enabled many companies to install perpetual inventory systems
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
All costs of getting the inventory to company and ready to sell

+Freight-In

+Special Permits

Only costs associated with merchandise purchased for resale not assets acquired for use, such as supplies
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On May 4 the company bought $ 3,800 worth of merchandise from PW Audio Supply, Inc.
Task:Record the purchase by getting information from the Purchase Invoice .
The Purchase Invoice is a copy of the sales invoice.
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•
1. Seller
• 2.Invoice Date
• 3.Purchaser
• 4.Salesperson
•
5.Credit terms
•
6.Freight terms
• 7.Goods sold: catalog no.,description, quantity, price per unit
• 8.Total invoice price
Invoice No. 731
Firm Name: Sauk Stero
Attention o f James Hoover, Purchasing Agent
Address 125 Main Street
City Chelsea Stat e Illinois Zip 60915
Date5/4/04 Salesperson Maone Terms 2/10,n/30 Freight Paid by Buyer
Catalog No. Description QTY Price Amount
A2547Z48
Production Model
Circuits
8 300 1,500
IMPORTANT
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:
ALL RETURNS MUST BE MADE WITHIN 10 DAYS TOTAL $3,800

On May 4 the company bought $ 3,800 worth of merchandise from PW Audio Supply, Inc.
Merchandise
Inventory
May 4 3,800
Accounts
Payable
May 4 3,800
Freight-out
GENERAL JOURNAL Debit Credit
May 4 Merchandise Inventory 3,800
Accounts Payable 3,800
To record goods purchased on account.
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Purchases Returns and Allowances
On May 8 the company returned $300 worth of merchandise to PW Audio Supply, Inc.
Merchandise
Inventory
May 4 3,800 May 8 300
Accounts
Payable
May 8 300 May 4 3,800
Freight-out
GENERAL JOURNAL Debit Credit
May 8 Accounts Payable 300
Merchandise Inventory 300
To record goods returned that were purchased on account.
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Freight Costs - On Incoming
Inventory
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Freight Costs - On Incoming Inventory
On May 6 the company paid $ 150 to have the merchandise inventory delivered to them.
Merchandise
Inventory
May 4 3,800 May 8 300
May 6 150
Freight-Out Cash
May 6 150
GENERAL JOURNAL Debit Credit
May 6 Merchandise Inventory 150
Cash 150
To record payment of freight.
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Freight Costs-on outgoing inventory
On May 6 the seller company paid $ 150 to have merchandise inventory delivered to the buyer.
Merchandise
Inventory Freight-Out
May 6 150
Cash
May 6 150
GENERAL JOURNAL Debit Credit
May 6 Freight-Out 150
Cash 150
To record payment of freight on goods sold.
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• Credit terms of a purchase on account may permit the buyer to claim a cash discount for prompt payment.
•
Credit terms specify the amount of cash discounts and the time period during which they are offered.
•
2/10,n/30
• 1/10 EOM
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Review - Company purchased $3800 of merchandise and returned $300. The credit terms are 2/10, n/30 and the invoice was paid within the discount period
Original Invoice $3,800
-Returns 300
Amount due before discount $3,500
2% discount 70
Net due $3,430
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Purchases Discounts
Review - Company purchased $3800 of merchandise and returned $300. The credit terms are 2/10, n/30 and the invoice was paid within the discount period.
Merchandise
Inventory
Accounts
Payable
May 4 3,800 May 8 300 May 8 300 May 4 3,800
May 6 150 May 14 70 May 14 3,500
Cash
May 6 150
May 14 3430
GENERAL JOURNAL Debit Credit
May 14 Accounts Payable 3,500
Cash 3,430
Merchandise Inventory 70
To record payment within discount period. 27

Payment of Invoice
Review - Company purchased $3800 of merchandise and returned $300. The credit terms are 2/10, n/30 and the invoice was NOT paid within the discount period.
Merchandise
Inventory
Accounts
Payable Cash
May 4 3,800 May 8 300 May 8 300 May 4 3,800
Jun 3 3,500
Jun 3 3,500
GENERAL JOURNAL Debit Credit
June 3 Accounts Payable 3,500
Cash 3,500
To record payment NOT within discount period. 28

a business document that provides written evidence of a credit sale.
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•
1. Seller
• 2.Invoice Date
• 3.Purchaser
• 4.Salesperson
•
5.Credit terms
•
6.Freight terms
• 7.Goods sold: catalog no.,description, quantity, price per unit
• 8.Total invoice price
Invoice No. 731
Firm Name: Sauk Stero
Attention o f James Hoover, Purchasing Agent
Address 125 Main Street
City Chelsea Stat e Illinois Zip 60915
Date 5/4/04 Salesperson Maone Terms 2/10,n/30 Freight Paid by Buyer
Catalog No. Description QTY Price Amount
A2547Z48
Production Model
Circuits
8 300 1,500
IMPORTANT
:
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ALL RETURNS MUST BE MADE WITHIN 10 DAYS TOTAL $3,800

 are recorded when earned-revenue recognition principle
 must be supported by a business documentwritten evidence

2 entries are made for each sale
 one to record sale
 one to record cost of merchandise sold
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Sales - under a perpetual system
Assume a sale of $ 3,800 ON ACCOUNT
For merchandise having a cost of $2,400
Cash
Accounts
Receivable
May 4 3,800
Merchandise
Inventory
May 4 2,400
Sales
May 4 3,800
Sales Returns &
Allowances
Cost of Goods
Sold
May 4 2,400
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Flip side of purchase returns and allowance
On buyer’s books
GENERAL JOURNAL Debit Credit
May 8 Accounts Payable 300
Merchandise Inventory 300
To record goods returned that were purchased on account.
On seller’s books
GENERAL JOURNAL Debit Credit
May 8 Sales Returns and Allowance 300
Accounts Receivable 300
To record return of goods delivered to Sauk Stero.
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Sales - under a perpetual system
Assume a sale of $ 3,800 ON ACCOUNT
For merchandise having a cost of $2,400
Cash
Accounts
Receivable
May 4 3,800
Merchandise
Inventory
May 4 2,400
Sales
May 4 3,800
Sales Returns &
Allowances
Cost of Goods
Sold
May 4 2,400
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What Is the Sales Returns and Allowances Account?

Contra Revenue Account to sales

Used to show how much came in on returns and allowances
Excessive returns and allowances suggest:
 inferior merchandise
 inefficiencies in filing orders
 errors in billing customers
 mistakes in delivery or shipment of goods
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
Contra Revenue Account to sales

Used to disclose amount of cash discounts taken by customers
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Flip side of purchase discounts
On buyer’s books
GENERAL JOURNAL Debit Credit
May 14 Accounts Payable 3,500
Cash 3,430
Merchandise Inventory 70
To record payment within discount period
On seller’s books
GENERAL JOURNAL Debit Credit
May 14 Cash
Sales Discounts
3,430
70
Accounts Receivable 3500
To record collection within discount period.
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
Single-step income statement

Multiple-step income statement
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One step… subtract total expenses from total revenues
Revenues $10,000
Expenses 3,000
Net income $ 7,000
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PW AUDIO, Inc.
Single-step Income Statement
For the Year Ended December 31, 2004
Sales
Interest Revenue
Gain on Sale of equipment
Total Revenues
$460,000
3,000
600
$463,600
Expenses
Cost of goods sold
Selling expenses
Administrative expenses
Interest expense
Casualty Loss from vandalism
Income tax expense
Total expenses
Net income
$316,000
76,000
38,000
1,800
200
10,100
442,100
$ 21,500
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PW AUDIO SUPPLY, INC.
Multi-step Income Statement For the Year Ended
December 31, 2004
Sales revenues
Sales
Less: Sales returns and allowance
Sales discounts
Net sales
Cost of goods sold
Gross profit
Operating expenses
Selling expenses:
Store salaries expense $45,000
Advertising expense 16,000
Depreciation expense 8,000
$12,000
8,000
Freight-out 7,000
Total selling expenses
Administrative expenses
Salaries expense $19,000
Utilities expense 17,000
$76,000
Insurance Expense 2,000
Total administrative expenses 38,000
Total operating expenses
Income from operations
$ 480,000
20,000
460,000
316,000
$ 144,000
114,000

PW AUDIO SUPPLY, INC.
Multi-step Income Statement
For the Year Ended December 31, 2004
Income from operations (continued)
Other revenues and gains
Interest revenue $ 3,000
Gain on sale of equipment 600
$ 30,000
$ 3,600
Other expenses and losses
Interest expense $ 1,800
Casualty loss from vandalism 200
2,000 1,600
31,600
Income before income income taxes
Income tax expense 10,100
Net income $21,500
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Cost of Goods Sold -
Periodic Method
A running account of changes in inventory is not maintained.
Separate accounts use to record freight costs, returns and discounts
Cost of goods sold and ending inventory are calculated at end of period.
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PW AUDIO SUPPLY, INC.
Cost of Goods Sold
For the Year Ended December 31, 2004
Cost of goods sold
Inventory, January 1 $ 36,000
Purchases
Less Purchase returns and allowances $10,400
$325,000
Purchase discounts 6,800
Net purchases
Add: Freight-in
17,200
307,800
12,200
Cost of goods purchased
Cost of goods available for sale
320,000
356,000
Inventory, December 31 40,000
Cost of goods sold 316,000
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Gross Profit
Net Sales
Company’s gross profit expressed as a percentage
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Measures the percentage of each dollar of sales that results in net income
Profit Margin Ratio =
Net Income
Net Sales
Higher value suggests favorable return on each dollar of sales.
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