WILEY

IFRS EDITION
Prepared by
Coby Harmon
University of California, Santa Barbara
5-1 Westmont College
 PREVIEW OF CHAPTER 5

Financial Accounting
IFRS 3rd Edition
Weygandt ● Kimmel ● Kieso
5-2
 Merchandising Operations
Learning
Objective 1
Merchandising Companies Identify the
differences between
Buy and Sell Goods service and
merchandising
companies.
Retailer

Wholesaler Consumer

The primary source of revenues is referred to as

sales revenue or sales.
5-3 LO 1
 Merchandising Operations

Income Measurement
Not used in a
Sales Less
Illustration 5-1
Service business.
Revenue Income measurement process for a
merchandising company

Cost of Equals Gross Less

Goods Sold Profit

Operating Equals Net

Cost of goods sold is the total Income
Expenses
cost of merchandise sold during (Loss)
the period.

5-4 LO 1
 Operating Cycles
Illustration 5-2
The operating
cycle of a
merchandising
company
ordinarily is longer
than that of a
service
company.

Illustration 5-3

5-5 LO 1
 Flow of Costs
Illustration 5-4

Companies use either a perpetual inventory system or a periodic

inventory system to account for inventory.
5-6 LO 1
 Flow of Costs

PERPETUAL SYSTEM
◆ Maintain detailed records of the cost of each inventory
purchase and sale.

◆ Records continuously show inventory that should be on

hand for every item.

◆ Company determines cost of goods sold each time a

sale occurs.

5-7 LO 1
 Flow of Costs

PERIODIC SYSTEM
◆ Do not keep detailed records of the goods on hand.

◆ Cost of goods sold determined by count at the end of

the accounting period.

◆ Calculation of Cost of Goods Sold:

Beginning inventory € 100,000

Add: Purchases, net 800,000
Goods available for sale 900,000
Less: Ending inventory 125,000
Cost of goods sold € 775,000

5-8 LO 1
 Flow of Costs

ADVANTAGES OF THE PERPETUAL SYSTEM

◆ Traditionally used for merchandise with high unit
values.

◆ Shows the quantity and cost of the inventory that

should be on hand at any time.

◆ Provides better control over inventories than a periodic

system.

5-9 LO 1
 Recording Purchases of Merchandise
Learning Objective 2
Explain the recording of
◆ Made using cash or credit (on purchases under a perpetual
inventory system.
account).

◆ Normally record when

goods are received from
the seller.

◆ Purchase invoice should

support each credit
purchase.

Illustration 5-6
Sales invoice used as purchase
invoice by Sauk Stereo
5-10
 Recording Purchases of Merchandise
Illustration 5-6
Illustration: Sauk Stereo (the
buyer) uses as a purchase
invoice the sales invoice
prepared by PW Audio Supply,
Inc. (the seller). Prepare the
journal entry for Sauk Stereo for
the invoice from PW Audio
Supply.

May 4 Inventory 3,800

Accounts Payable 3,800

5-11 LO 2
 Freight Costs

Ownership of the goods

passes to the buyer when the
public carrier accepts the
goods from the seller.

Ownership of the goods

remains with the seller until
the goods reach the buyer.

Illustration 5-7
Shipping terms
Freight costs incurred by the seller are an
operating expense.
5-12 LO 2
 Freight Costs

Illustration: Assume upon delivery of the goods on May 6, Sauk

Stereo pays Public Freight Company €150 for freight charges,
the entry on Sauk Stereo’s books is:

May 6 Inventory 150

Cash 150

Assume the freight terms on the invoice in Illustration 5-6 had

required PW Audio Supply to pay the freight charges, the entry
by PW Audio Supply would have been:

May 4 Freight-Out (Delivery Expense) 150

Cash 150
5-13 LO 2
 Purchase Returns and Allowances

Purchaser may be dissatisfied because goods are damaged

or defective, of inferior quality, or do not meet specifications.

Purchase Return Purchase Allowance

Return goods for credit if the May choose to keep the
sale was made on credit, or merchandise if the seller will
for a cash refund if the grant a reduction from the
purchase was for cash. purchase price.

5-14 LO 2
 Purchase Returns and Allowances

Illustration: Assume Sauk Stereo returned goods costing

€300 to PW Audio Supply on May 8.

May 8 Accounts Payable 300

Inventory 300

5-15 LO 2
 Purchase Returns and Allowances

Question
In a perpetual inventory system, a return of defective
merchandise by a purchaser is recorded by crediting:
a. Purchases
b. Purchase Returns
c. Purchase Allowance
d. Inventory

5-16 LO 2
 Purchase Discounts

Credit terms may permit buyer to claim a cash discount

for prompt payment.
Example: Credit terms
Advantages: may read 2/10, n/30.
◆ Purchaser saves money.

◆ Seller shortens the operating cycle by converting the

accounts receivable into cash earlier.

5-17 LO 2
 Purchase Discounts

2/10, n/30 1/10 EOM n/10 EOM

2% discount if 1% discount if Net amount due

paid within 10 paid within first 10 within the first 10
days, otherwise days of next days of the next
net amount due month. month.
within 30 days.

5-18 LO 2
 Purchase Discounts

Illustration: Assume Sauk Stereo pays the balance due of

€3,500 (gross invoice price of €3,800 less purchase returns
and allowances of €300) on May 14, the last day of the
discount period. Prepare the journal entry Sauk Stereo
makes on May 14 to record the payment.

May 14 Accounts Payable 3,500

Inventory 70
Cash 3,430

(Discount = €3,500 x 2% = €70)

5-19 LO 2
 Purchase Discounts

Illustration: If Sauk Stereo failed to take the discount, and

instead made full payment of €3,500 on June 3, the journal
entry would be:

June 3 Accounts Payable 3,500

Cash 3,500

5-20 LO 2
 Purchase Discounts

Should discounts be taken when offered?

Discount of 2% on €3,500 €70.00
€3,500 invested at 10% for 20 days 19.18
Savings by taking the discount €50.82

Example: 2% for 20 days = Annual rate of 36.5%

€3,500 x 36.5% x 20 ÷ 365 = €70

5-21 LO 2
 Summary of Purchasing Transactions

Inventory
Debit Credit

4th - Purchase 3,800 300 8th - Return

6th - Freight-in 150 70 14th - Discount

Balance 3,580

5-22 LO 2
 Recording Sales of Merchandise
Learning Objective 3
Explain the recording of
◆ Made using cash or credit (on account). sales revenue under a
perpetual inventory system.
◆ Sales revenue, like service
revenue, is recorded when
the performance obligation
is satisfied.

◆ Performance obligation is
satisfied when the goods
are transferred from the
seller to the buyer.

◆ Sales invoice should

support each credit sale.
Illustration 5-6
5-23 LO 3
 Recording Sales of Merchandise

Journal Entries to Record a Sale

#1 Cash or Accounts Receivable XXX Selling

Sales Revenue XXX Price

#2 Cost of Goods Sold XXX

Cost
Inventory XXX

5-24 LO 3
 Recording Sales of Merchandise

Illustration: PW Audio Supply records the sale of €3,800 on

May 4 to Sauk Stereo on account (Illustration 5-6) as follows
(assume the merchandise cost PW Audio Supply €2,400).

May 4 Accounts Receivable 3,800

Sales Revenue 3,800

4 Cost of Goods Sold 2,400

Inventory 2,400

5-25 LO 3
 Sales Returns and Allowances

◆ “Flip side” of purchase returns and allowances.

◆ Contra-revenue account to Sales Revenue (debit).

◆ Sales not reduced (debited) because:

► Would obscure importance of sales returns and

allowances as a percentage of sales.

► Could distort comparisons.

5-26 LO 3
 Sales Returns and Allowances

Illustration: Prepare the entry PW Audio Supply would make

to record the credit for returned goods that had a €300 selling
price (assume a €140 cost). Assume the goods were not
defective.

May 8 Sales Returns and Allowances 300

Accounts Receivable 300

8 Inventory 140
Cost of Goods Sold 140

5-27 LO 3
 Sales Returns and Allowances

Illustration: Assume the returned goods were defective

and had a scrap value of €50, PW Audio would make the
following entries:

May 8 Sales Returns and Allowances 300

Accounts Receivable 300

8 Inventory 50
Cost of Goods Sold 50

5-28 LO 3
 ACCOUNTING ACROSS THE ORGANIZATION
Merchandiser’s Accounting Causes Alarm
Accounting for merchandising transactions is not always as easy as it might
first appear. Recently, Tesco (GBR) announced that it had overstated profits
by £263 million over a three-year period. The error related to how Tesco
accounted for amounts received from suppliers for promotional activities of
those companies’ products. When a retailer runs advertisements promoting a
particular product, the producer of that product shares part of the advertising
cost. Typically, the producer pays the merchandiser its share of the advertising
cost as much as a year before the advertisement is run. The questions
become, how should these amounts be reported by the merchandiser at the
time it receives the funds, and when should these amounts affect income? The
scandal surrounding this accounting treatment was serious enough that it
caused the company’s chairman to resign, and an outside auditing firm was
brought in to investigate. One analyst commentated that “we can never recall a
period so damaging to the reputation of the company.”
Source: Jenny Anderson, “Tesco Chairman to Step Down as Overstatement of Profit
Grows,” The New York Times Online (October 23, 2014).

5-29
LO 3
 Sales Discount

◆ Offered to customers to promote prompt payment of

the balance due.

◆ Contra-revenue account (debit) to Sales Revenue.

5-30 LO 3
 Sales Discount

Illustration: Assume Sauk Stereo pays the balance due of

€3,500 (gross invoice price of €3,800 less purchase returns
and allowances of €300) on May 14, the last day of the
discount period. Prepare the journal entry PW Audio Supply
makes to record the receipt on May 14.

May 14 Cash 3,430

Sales Discounts 70 *
Accounts Receivable 3,500

* [(€3,800 – €300) X 2%]

5-31 LO 3
 Recording Sales of Merchandise
Learning Objective 4
Explain the steps in the
Adjusting Entries accounting cycle for a
merchandising company.

◆ Generally the same as a service company.

◆ One additional adjustment to make the records agree with

the actual inventory on hand.

◆ Involves adjusting Inventory and Cost of Goods Sold.

5-32 LO 4
 Adjusting Entries

Illustration: Suppose that PW Audio Supply has an unadjusted

balance of €40,500 in Merchandise Inventory. Through a physical
count, PW Audio determines that its actual merchandise inventory
at year-end is €40,000. The company would make an adjusting
entry as follows.

Cost of Goods Sold 500

Inventory 500

5-33 LO 4
 Closing Entries

5-34 LO 4
 Closing Entries

5-35 LO 4
 Forms of Financial Statements
Learning Objective 5
Prepare an income
Income Statement statement for a
merchandiser.

◆ Primary source of information for evaluating a

company’s performance.

◆ Format is designed to differentiate between the various

sources of income and expense.

5-36 LO 5
Income
Statement
The income statement
is a primary source of
information for
evaluating a
company’s
performance.

5-37 Illustration 5-14 LO 5

Income
Statement
Key Items:
◆ Net sales

5-38 Illustration 5-14 LO 5

Income
Statement
Key Items:
◆ Net sales
◆ Gross profit

5-39 Illustration 5-14 LO 5

Income
Statement
Key Items:
◆ Net sales
◆ Gross profit

Illustration 5-11
Gross profit rate formula
and computation

5-40 Illustration 5-14 LO 5

Income
Statement
Key Items:
◆ Net sales
◆ Gross profit
◆ Operating
expenses

5-41 Illustration 5-14 LO 5

Income
Statement
Key Items:
◆ Net sales
◆ Gross profit
◆ Operating
expenses
◆ Other income
and expense

5-42 Illustration 5-14 LO 5

Income
Statement
Key Items:
◆ Net sales
◆ Gross profit
◆ Operating
expenses
◆ Other income
and expense

5-43 Illustration 5-14 LO 5

Income
Statement
Key Items:
◆ Net sales
◆ Gross profit
◆ Operating
expenses
◆ Other income and
expense
◆ Interest expense

5-44 Illustration 5-14 LO 5

Income
Statement
Key Items:
◆ Net sales
◆ Gross profit
◆ Operating
expenses
◆ Other income and
expense
◆ Interest expense
◆ Net income

5-45 Illustration 5-14 LO 5

 COMPREHENSIVE INCOME

Includes certain adjustments to pension plan assets, gains and

losses on foreign currency translation, and unrealized gains and
losses on certain types of investments.

Illustration 5-15
Separate statement of net Reported in a combined statement of net income
income and comprehensive
income and comprehensive income, or in a separate
schedule that reports only comprehensive income.
5-46 LO 5
 ACCOUNTING ACROSS THE ORGANIZATION
Online Sales Stall in India
India is well known for its large pool of excellent software engineers. Therefore, it
may come as a surprise that online merchandise sales are only starting to take
hold in this country. The reason for the delay compared to many other countries is
that, until recently, consistent Internet access was limited to a small portion of the
Indian population. But, experts predict that by 2015 up to 200 million Indians will
have Internet access. To take advantage of this, two software engineers started the
online merchandising company Flipkart (IND). Their goal is “to be the Amazon.
com of India.” Sales hit $20 million in a recent year, but the company faces many
barriers to both growth and profitability. First, few Indians have credit cards, so
many transactions must be done in cash. And, while the company has a book
catalog of over 100 million titles, it is very difficult to deliver those books (or
anything else) over India’s poorly maintained roads. As a consequence, even if
Internet access improves rapidly, online merchandisers need to see improvements
in the banking and transportation systems in India for sales to really take off.
Source: Amol Sharma, “Dot-Coms Begin to Blossom in India,” Wall Street Journal (April
12, 2011).

5-47
LO 5
 Inventory Presentation in the Classified
Statement of Financial Position

Illustration 5-16
Assets section of a classified statement of financial position

5-48 LO 5
 Worksheet for a Merchandising
APPENDIX 5A
Company
Learning
Objective 6
Using a Worksheet Prepare a worksheet
for a merchandising
company.
As indicated in Chapter 4, a worksheet enables
companies to prepare financial statements before they
journalize and post adjusting entries. The steps in preparing a
worksheet for a merchandising company are the same as for a
service company. Illustration 5A-1 shows the worksheet for PW
Audio Supply (excluding nonoperating items). The unique
accounts for a merchandiser using a perpetual inventory
system are in red.

5-49 LO 6
 Illustration 5A-1
Worksheet for
merchandising company

5-50 LO 6
 APPENDIX 5B Periodic Inventory System
Learning
Objective 7
Determining Cost of Goods Sold Explain the recording
of purchases and
Under a Periodic System sales of inventory
under a periodic
inventory system.
◆ No running account of changes in
inventory.

◆ Ending inventory determined by physical count.

◆ Cost of goods sold not determined until the end of the

period.

5-51 LO 7
 Determining Cost of Goods Sold
Under a Periodic System Illustration 5B-2
Cost of goods sold for a
merchandiser using a periodic
inventory system

Illustration 5B-2

5-52 LO 7
 Recording Merchandise Transactions

◆ Record revenues when sales are made.

◆ Do not record cost of merchandise sold on the date of
sale.
◆ Physical inventory count determines:
► Cost of merchandise on hand and
► Cost of merchandise sold during the period.

◆ Record purchases in Purchases account.

◆ Purchase returns and allowances, Purchase discounts,
and Freight costs are recorded in separate accounts.

5-53 LO 7
 Recording Purchases of Merchandise

Illustration: On the basis of the sales invoice (Illustration 5-6)

and receipt of the merchandise ordered from PW Audio Supply,
Sauk Stereo records the €3,800 purchase as follows.

May 4 Purchases 3,800

Accounts Payable 3,800

5-54 LO 7
 Recording Purchases of Merchandise

FREIGHT COSTS
Illustration: If Sauk pays Public Freight Company €150
for freight charges on its purchase from PW Audio Supply on
May 6, the entry on Sauk’s books is:

May 6 Freight-In (Transportation-In) 150

Cash 150

5-55 LO 7
 Recording Purchases of Merchandise

PURCHASE RETURNS AND ALLOWANCES

Illustration: Sauk Stereo returns €300 of goods to PW Audio
Supply and prepares the following entry to recognize the
return.

May 8 Accounts Payable 300

Purchase Returns and Allowances 300

5-56 LO 7
 Recording Purchases of Merchandise

PURCHASE DISCOUNTS
Illustration: On May 14 Sauk Stereo pays the balance due on
account to PW Audio Supply, taking the 2% cash discount
allowed by PW Audio for payment within 10 days. Sauk
Stereo records the payment and discount as follows.

May 14 Accounts Payable 3,500

Purchase Discounts 70
Cash 3,430

5-57 LO 7
 Recording Sales of Merchandise

Illustration: PW Audio Supply, records the sale of €3,800 of

merchandise to Sauk Stereo on May 4 (sales invoice No. 731,
Illustration 5-6) as follows.

May 4 Accounts Receivable 3,800

Sales Revenue 3,800

No entry is recorded for cost of goods sold at the time of the

sale under a periodic system.

5-58 LO 7
 Recording Sales of Merchandise

SALES RETURNS AND ALLOWANCES

Illustration: To record the returned goods received from Sauk
Stereo on May 8, PW Audio Supply records the €300 sales
return as follows.

May 8 Sales Returns and Allowances 300

Accounts Receivable 300

5-59 LO 7
 Recording Sales of Merchandise

SALES DISCOUNTS
Illustration: On May 14, PW Audio Supply receives payment
of €3,430 on account from Sauk Stereo. PW Audio honors the
2% cash discount and records the payment of Sauk’s account
receivable in full as follows.

May 14 Cash 3,430

Sales Discounts 70
Accounts Receivable 3,500

5-60 LO 7
 Recording Sales of Merchandise

COMPARISON OF ENTRIES

Illustration 5B-3
Comparison of entries for perpetual and periodic inventory systems

5-61 LO 7
 Recording Sales of Merchandise

COMPARISON OF ENTRIES

Illustration 5B-3
Comparison of entries for perpetual and periodic inventory systems

5-62 LO 7
Illustration 5B-5
Worksheet for
merchandising
company—periodic
inventory system

5-63 LO 7