Chapter 5
Merchandising Operations
Merchandising Operations
 Previously we have only been looking at service companies
 Like lawn care or Painting for example
 This chapter we shift focus to those who sell goods
 Like Canadian Tire or Mountain Equipment Co-op for example
Revenue & Expenses
 Revenue for a merchandising company is called
Sales Revenue
 Expenses are split into 2 categories
1. Operating expenses (same as service
company)
2. Cost of Goods Sold or COGS
 COGS is the total cost of the merchandise sold
during the period
Gross Profit
 Gross Profit is the difference between the sales revenue and
the COGS
Gross
Profit
Sales
Revenue
COGS
Example: Bought bike for $125, sold for $300
175
300
125
Net Income Equations Expanded
Revenue
Cost of
Goods
Sold
Gross
Profit
Operating
Expenses
Net
Income / Loss
Inventory Systems
We Will Use
This One!!!!!
 Perpetual Inventory
 Always have an up to date inventory
 Update COGS with every transaction
 Growing in popularity, especially for bigger companies as it is
automated and gives real time information
 Periodic Inventory
 Calculate inventory at the end of the period
 Update COGS at the end of the period
 Still used, usually in smaller companies that don’t want to spend
the money on an automated system
How We Record Buying Inventory
 Every purchase should have a business document to support
it, used by buyer and seller
 Receipt, Invoice, Purchase Order, etc
 When merchandise is purchased for resale the asset that is
debited is called Merchandise Inventory
 If other assets are purchased, but not for resale they go into
their own corresponding asset account, like supplies or
equipment for example
Example
Bought 5 TVs on account at $500 each for the purpose or resale
Merchandise Inventory
Accounts Payable
$2 500
$2 500
Buying Inventory
Subsidiary Inventory Records
 Merchandise Inventory is a catch all account that contains all
of the goods that a company has available for sale
 However when a company offers more than 1 good for sale
(and they usually do) it is nice to know how many of each
item you have available for sale
 To keep this information organizations keep a subsidiary
inventory ledger, that has separate accounts for each item or
sku (stock keeping unit) to keep track of how much is
available
 You can have subsidiary ledgers for any group of accounts
that share a common characteristic, like inventory, or
accounts receivable
Buying Inventory
Freights Costs
 Eddie’s Canoes manufactures a high quality all wood canoe
and is located in Newstadt, Ontario. Eddie’s has sold 20
canoes to Grand River Outfitters, located in Kitchener
Ontario. The travel time between the two businesses is
approximately 1.5 hours.
 The shipping costs to hire a truck to deliver the goods is
$800
 The insurance cost to insure the load while in transit against
damage is $100
 Who should pay for these fees?
Buying Inventory
Freights Costs Cont.
 Go back to the business document, that is where the terms of
the sale will be listed
 If the purchase order had said FOB destination, which means
that the seller is responsible for the delivery of the goods
 However, the purchase states FOB shipping point, so the
buyer is responsible for the delivery
 When buying goods for resale and you incur freight fees your
journal entry will look like this, because the freight is part of
the inventory we are getting ready to sell
Merchandise Inventory
$900
Cash
$900
Buying Inventory
Purchase Returns and Allowances
 Buyers may want to return goods if the goods are
not what they wanted, goods are damaged or
defective, etc
 Seller can either accept the good back and give a
refund or offer an allowance for the buyer to
keep the good (like 25% off for example)
Buying Inventory
Purchase Returns and Allowances Cont.
 One of the canoes Grand River bought from Eddie cost
$1 200, and was supposed to be blue, but instead it was red
 Grand River complained and Eddie said that he would either
issue a full refund or Grand River could keep the canoe for
15% off
Return
Accounts Payable
$1 200
Merchandise Inventory
$1 200
OR
Allowance
Accounts Payable
$ 180
Merchandise Inventory
$180
Buying Inventory
Discounts
 2 types of discounts can be offered
1. Quantity
2. Purchase
Quantity discount is when there is a price or percentage
reduction when a large amount is purchased, when buying this
way you reduce the cost of your inventory and therefore your
COGS
Purchase discount is incentive some companies offer to get
their money sooner, these terms are on the business document
and look like this 2/10, n/30 which means 2% off is paid in 10
days and the total is due in 30 days, taking advantage of this
discount reduces the inventory cost and therefore COGS
Buying Inventory
Discounts Cont.
 Eddie’s usually sells their canoes for $1500, but for orders
over 10 they sell them for $1200.
 Grand River’s journal entry looks like this:
Merchandise Inventory
$24 000
Accounts Payable
$24 000
 Eddie’s policy is 4/7, n/30, and Grand River’s pays the full
bill on the 6th day, and the journal entry looks like this:
Accounts Payable
$24 000
Merchandise Inventory
$960
Cash
$23 040
Summary of all that has happened
while buying inventory
 Initial purchase of product $24 000
 Freight Costs of $900
 Purchase allowance of $180
 Purchase discount of $960
Merchandise Inventory
24 000
900
23 760
180
960
Total
Practice Questions
 Pages 258-259
 BE5-1, BE5-2, BE5-3, BE5-4, BE5-5
 Page 260 EP5-2
Selling Inventory
 Revenue is recorded when it is earned, sales revenue
is no different
 Each sale should be supported by a business
document
 Because we are working in a perpetual inventory
system we need to make 2 entries for every sale
1. Record the sales revenue
Dr Cash/AR and Cr Sales Revenue
2. Record cost of the merchandise sold
Dr COGS and Cr Merchandise Inventory
Selling Inventory Cont.
 Merchandise Inventory currently 20 canoes
24 000 + 900 (freight) – 960 (purchase discount)
=23 940 / 20 =1197
=19 at 1197
=1 at 1197 – 180 (purchase allowance on blue canoe) = 1017
 Sold a red canoe for $1 800 cash
Cash
1 800
Revenue
1 800
Sold Canoe for Cash
COGS
1 197
Merchandise Inventory
1 197
To record cost of goods sold to cash customer, invoice #25
Selling Inventory
Freight Costs
 As mentioned earlier in the Buying Inventory Section the party
responsible for the cost of freight is negotiated and noted on the
business document
 FOB shipping point means buyer pays to pick goods up
 FOB destination means seller pays to deliver goods
 When seller pays for freight they will increase the price to
compensate and set up a Freight out or delivery expense
account to record fees incurred this way
Grand River Outfitters sells a canoe FOB customer’s house
Delivery Expense
$100
Accounts Payable
$100
Shipped a canoe to customer’s house, invoice #29
Selling Inventory
Sales Returns and Allowances
 Buyers sometimes want to return goods because of a




variety of reasons
When sales are returned or allowances given the revenue
needs to be decreased
Want to keep track of this amount in a separate account
Use a contra revenue account called Sales Returns and
Allowances
Must reverse the second journal entry to decrease
COGS and increase Merchandise Inventory if the good is
still able to be sold
Selling Inventory
Sales Returns and Allowances Cont.
 Sold a canoe, for 1800
 It was returned because the customer did not like the model
and wanted to upgrade at a later date, it had not been used
and is still fine quality for sale
Sales Returns and Allowances
$1 800
Cash
$1 800
To record canoe returned, put back into inventory, invoice #17
Merchandise Inventory
$1 197
Cost of Goods Sold
$1 197
To record the cost of goods returned
Selling Inventory
Sales Returns and Allowances Cont.
 Sold a canoe for $2 200 cash, FOB customer’s house
 Did not buy insurance for shipping and the canoe fell off the
truck and was crushed by a transport truck, customer
canceled order
Sales Return and Allowances
$2 200
Cash
$2 200
To record canoe returned, invoice #21
Loss Expense
$1 197
COGS
$1197
To record canoe damaged, invoice #21
Selling Inventory
Discounts
 As mentioned earlier we have quantity discount and sales
discount (when from seller’s perspective)
 No entry is needed for quantity discount, the sales
revenue would just be reported as less on the initial
journal entry
 Sales discount account is a contra revenue account
 Sold canoe for $2 000, 2/8, n30, customer paid on 7th
day
Cash
$1960
Sales Discount
$40
Accounts Receivable
$2000
To record collection of invoice #7 within discount period
Practice Questions
 Page 258-259 BE 6, 7
 Page 260 E5-3
 Page 264 P5-2A
Completing the Accounting Cycle
Adjusting Entries
 The adjusting entries for a Merchandising company is the
same as for a service company, with one exception
 Inventory needs to by physically verified
 If some stock is missing an adjusting entry needs to be made
 Inventory shows that Grand River should have 14 canoes, but
a physical count reveals they only have 13
COGS
$1197
Merchandise Inventory
$1197
To record the difference between inventory records and
physical units on hand
Completing the Accounting Cycle
Closing Entries
 Same as a service company, just a few new temporary






accounts
Sales
Sales returns and allowances
Sales Discount
COGS
Freight Out
All of which are closed to the Income Summary
Practice Questions
 Page 259 BE 8, 9
 Page 261-262 E5-4, E5-5, E5-6
Multiple-Step Income Statement
 More useful that single-step because it highlights more
information
1. Net Sales (sales – returns allowances and sales
discounts)
2. Gross Profit (Net sales – COGS)
3. Income from Operations (Gross Profit – Operating
Expenses)
4. Non-Operating Activities (gains or losses outside of
normal operations)
5. Net Income (income from operation + nonoperating income)
Grand River's Outfitters
Income Statement
Year ended January 31 2013
Sales Revenue
Sales
$ 200,000
Less: Sales returns and allowances
$
4,500
Sales discounts
$
3,750
$
8,250
Net Sales
$ 191,750
Cost of Goods Sold
$ 80,320
Gross profit
$ 111,430
Operating Expense
Salaries expense
$ 45,250
Rent expense
$ 12,000
Utilities expense
$
1,500
Amortization expense
$
750
Total operating expense
$ 59,500
Income from operations
$ 51,930
Other Revenues
Interest Revenue
$
750
Gain on sail of property
$ 150,000
Total non-operating revenues
$ 150,750
Other Expenses
Legal fees from property sale
$ 50,000
Moving Expense
$
Total non-operating expenses
$ 55,000
5,000
Net from non-operating expenses
$ 95,750
Net Income
$ 147,680
Practice Questions
 Page 259 BE 10
 Page 262 E5-7, E5-9
Profitability Ratios
 Gross Profit Margin
 Profit Margin
Gross Profit Margin
 More useful than Gross Profit, because it takes into account
Net Sales
 The higher the better
Gross Profit
Net Sales
Gross Profit Margin
$220 000
$845 000
26%
$125 000
$275 000
45.5%
Profit Margin
 Explains how much of every dollar in sales is profit
 Higher is better
Net Income
Net Sales
Profit Margin
$110 000
$845 000
13%
$65 000
$ 275 000
23.6%
Practice Questions
 Page 259 BE 11, 12
 Page P5-4A (a & b only)