CHAPTER5

Accounting for
Merchandising
Operations

5-1
 PreviewofCHAPTER5

5-2
 Merchandising Operations

Merchandising Companies
Buy and Sell Goods

Wholesaler Retailer Consumer

The primary source of revenues is referred to as

sales revenue or sales.
5-3 SO 1 Identify the differences between service and merchandising companies.
 Merchandising Operations

Income Measurement
Not used in a
Service business.

Illustration 5-1

Cost of goods sold is the total

cost of merchandise sold during
the period.

5-4 SO 1 Identify the differences between service and merchandising companies.

 Merchandising Operations
Illustration 5-2

Operating
Cycles
The operating cycle
of a merchandising
company ordinarily
is longer than that of
a service
company.

5-5 SO 1 Identify the differences between service and merchandising companies.

 Merchandising Operations

Flow of Costs
Illustration 5-3

Companies use either a perpetual inventory system or a periodic inventory

system to account for inventory.

5-6 SO 1 Identify the differences between service and merchandising companies.

 Merchandising Operations

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.
◆ Company determines cost of goods sold each time a
sale occurs.

5-7 SO 1 Identify the differences between service and merchandising companies.

 Merchandising Operations

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 sale900,000
Less: Ending inventory 125,000
Cost of goods sold $ 775,000
5-8 SO 1
 Merchandising Operations

Flow of Costs
Additional Consideration
Perpetual System:
◆ Traditionally used for merchandise with high unit
values.
◆ Provides better control over inventories.
◆ Requires additional clerical work and additional cost
to maintain inventory records.

5-9 SO 1 Identify the differences between service and merchandising companies.

5-10
 Recording Purchases of Merchandise

◆ Made using cash or credit (on account).

Illustration 5-5

◆ Normally recorded when

goods are received.

◆ Purchase invoice should

support each credit
purchase.

5-11 SO 2 Explain the recording of purchases under a perpetual inventory system.

 Recording Purchases of Merchandise
Illustration 5-5
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

5-12 SO 2 Explain the recording of purchases under a perpetual inventory system.

 Recording Purchases of Merchandise

Freight Costs – Terms of Sale Illustration 5-6

Shipping terms

Seller places goods Free On

Board the carrier, and buyer
pays freight costs.

Seller places goods Free On

Board to the buyer’s place of
business, and seller pays
freight costs.

Freight costs incurred by the seller are an operating expense.

5-13
SO 2
 Recording Purchases of Merchandise

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

Stereo pays Acme 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 5-5 had

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

May 4 Freight-out 150

Cash 150
5-14 SO 2 Explain the recording of purchases under a perpetual inventory system.
 Recording Purchases of Merchandise

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 an allowance
purchase was for cash. (deduction) from the
purchase price.

5-15 SO 2 Explain the recording of purchases under a perpetual inventory system.

 Recording Purchases of Merchandise

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 SO 2 Explain the recording of purchases under a perpetual inventory system.

 Recording Purchases of Merchandise

Purchase Discounts
Credit terms may permit buyer to claim a cash discount for
prompt payment.

Advantages: Example: Credit

terms may read 2/10,
◆ Purchaser saves money. n/30.
◆ Seller shortens the operating cycle.

5-17 SO 2 Explain the recording of purchases under a perpetual inventory system.

 Recording Purchases of Merchandise

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 SO 2 Explain the recording of purchases under a perpetual inventory system.

 Recording Purchases of Merchandise

Illustration: Assume that on May 8 Sauk Stereo returned to

PW Audio Supply goods costing $300.

May 8 Accounts payable 300

Inventory 300

5-19 SO 2 Explain the recording of purchases under a perpetual inventory system.

 Recording Purchases of Merchandise

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 to record its May 14 payment.

May 14 Accounts payable 3,500

Inventory 70
Cash 3,430

(Discount = $3,500 x 2% = $70)

5-20 SO 2 Explain the recording of purchases under a perpetual inventory system.

 Recording Purchases of Merchandise

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

5-21 SO 2 Explain the recording of purchases under a perpetual inventory system.

 Recording Purchases of Merchandise

Purchase Discounts
Should discounts be taken when offered?

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

(365/20 = 18.25 twenty-day periods x 2% = 36.5%)

5-22 SO 2 Explain the recording of purchases under a perpetual inventory system.

 Recording Purchases of Merchandise

Summary of Purchasing Transactions

4th - Purchase $3,500 $300 8th - Return

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

Balance $3,580

5-23 SO 2 Explain the recording of purchases under a perpetual inventory system.

 Recording Sales of Merchandise

◆ Made using cash or credit (on account).

Illustration 5-5

◆ Normally recorded when

earned, usually when goods
transfer from seller to
buyer.

◆ Sales invoice should

support each credit sale.

SO 3 Explain the recording of sales revenues

5-24
under a perpetual inventory system.
 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

SO 3 Explain the recording of sales revenues

5-25
under a perpetual inventory system.
 Recording Sales of Merchandise

Illustration: Assume PW Audio Supply records its May 4

sale of $3,800 to Sauk Stereo on account (Illustration 5-5) 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

SO 3 Explain the recording of sales revenues

5-26
under a perpetual inventory system.
5-27
 Recording Sales of Merchandise

Sales Returns and Allowances

◆ “Flipside” of purchase returns and allowances.

◆ Contra-revenue account (debit).

◆ Sales not reduced (debited) because:

► Would obscure importance of sales returns and

allowances as a percentage of sales.

► Could distort comparisons.

SO 3 Explain the recording of sales revenues

5-28
under a perpetual inventory system.
 Recording Sales of Merchandise

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

SO 3 Explain the recording of sales revenues

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under a perpetual inventory system.
 Recording Sales of Merchandise

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

SO 3 Explain the recording of sales revenues

5-30
under a perpetual inventory system.
 Recording Sales of Merchandise

Question
The cost of goods sold is determined and recorded each
time a sale occurs in:
a. periodic inventory system only.
b. a perpetual inventory system only.
c. both a periodic and perpetual inventory system.
d. neither a periodic nor perpetual inventory system.

SO 3 Explain the recording of sales revenues

5-31
under a perpetual inventory system.
5-32
 Recording Sales of Merchandise

Sales Discount
◆ Offered to customers to promote prompt payment.

◆ “Flipside” of purchase discount.

◆ Contra-revenue account (debit).

SO 3 Explain the recording of sales revenues

5-33
under a perpetual inventory system.
 Recording Sales of Merchandise

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%]

SO 3 Explain the recording of sales revenues

5-34
under a perpetual inventory system.
 Completing the Accounting Cycle

Adjusting Entries
◆ 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.

5-35 SO 4 Explain the steps in the accounting cycle for a merchandising company.
 Completing the Accounting Cycle

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

5-36 SO 4 Explain the steps in the accounting cycle for a merchandising company.
 Completing the Accounting Cycle

Closing
Entries

5-37 SO 4 Explain the steps in the accounting cycle for a merchandising company.
 Completing the Accounting Cycle

Closing Entries

5-38 SO 4 Explain the steps in the accounting cycle for a merchandising company.
 Forms of Financial Statements

Multiple-Step Income Statement

◆ Shows several steps in determining net income.

◆ Two steps relate to principal operating activities.

◆ Distinguishes between operating and non-operating

activities.

5-39 SO 5 Distinguish between a multiple-step and a single-step income statement.

 Forms of Financial Statements Illustration 5-13

Income
Statement
Presentation
of Sales

5-40 SO 5 Distinguish between a multiple-step and a single-step income statement.

 Forms of Financial Statements Illustration 5-13

Gross Profit

Key Items:
◆ Net sales
◆ Gross profit
◆ Gross profit
rate

Illustration 5-10

5-41 SO 6 Explain the computation and importance of gross profit.

 Forms of Financial Statements Illustration 5-13

Operating
Expenses

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

5-42
 Forms of
Financial
Statements

Key Items:
◆ Net sales
◆ Gross profit
◆ Operating
expenses
◆ Non-operatin
g activities
◆ Net income

Illustration 5-13
5-43
 Forms of
Financial
Statements

Key Items:
◆ Net sales
◆ Gross profit
◆ Operating
expenses
◆ Non-operatin
g activities
◆ Net income

Illustration 5-12
5-44
 Forms of Financial Statements

Question
The multiple-step income statement for a merchandiser
shows each of the following features except:
a. gross profit.
b. cost of goods sold.
c. a sales revenue section.
d. investing activities section.

5-45
 Forms of Financial Statements

Single-Step Income Statement

◆ Subtract total expenses from total revenues

◆ Two reasons for using the single-step format:

1. Company does not realize any profit until total

revenues exceed total expenses.

2. Format is simpler and easier to read.

5-46 SO 5 Distinguish between a multiple-step and a single-step income statement.

 Forms of Financial Statements

Single-Step Income Statement

Illustration 5-14

5-47 SO 5 Distinguish between a multiple-step and a single-step income statement.

 Forms of Financial Statements

Classified Balance Sheet

Illustration 5-15

5-48 SO 5 Distinguish between a multiple-step and a single-step income statement.

 APPENDIX5A
Periodic Inventory System
◆ 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.

SO 7 Explain the recording of purchases and sales of

5-49
inventory under a periodic inventory system.
 Periodic Inventory System

Determining Cost of Goods Sold

Illustration 5A-2

5-50 SO 7
 Periodic Inventory System

Recording Purchases of Merchandise

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

SO 7 Explain the recording of purchases and sales of

5-51
inventory under a periodic inventory system.
 Periodic Inventory System

Freight Costs
Illustration: If Sauk pays Haul-It 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

SO 7 Explain the recording of purchases and sales of

5-52
inventory under a periodic inventory system.
 Periodic Inventory System

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

SO 7 Explain the recording of purchases and sales of

5-53
inventory under a periodic inventory system.
 Periodic Inventory System

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

SO 7 Explain the recording of purchases and sales of

5-54
inventory under a periodic inventory system.
 Periodic Inventory System

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 5-5) 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.

SO 7 Explain the recording of purchases and sales of

5-55
inventory under a periodic inventory system.
 Periodic Inventory System

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 4 Sales returns and allowances300

Accounts receivable 300

SO 7 Explain the recording of purchases and sales of

5-56
inventory under a periodic inventory system.
 Periodic Inventory System

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

SO 7 Explain the recording of purchases and sales of

5-57
inventory under a periodic inventory system.
 Periodic Inventory System

Comparison of Entries—Perpetual Vs. Periodic

Illustration 5A-3

SO 7 Explain the recording of purchases and sales of

5-58
inventory under a periodic inventory system.
 Periodic Inventory System

Comparison of Entries—Perpetual Vs. Periodic

Illustration 5A-3

SO 7 Explain the recording of purchases and sales of

5-59
inventory under a periodic inventory system.