Financial Accounting: Tools for Business

Decision Making
Ninth Edition
Kimmel ● Weygandt ● Kieso

Chapter 5
Merchandising Operations and the
Multiple-Step Income Statement
Prepared by
COBY HARMON
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Chapter Outline
Learning Objectives
LO 1 Describe merchandising operations and inventory
systems.
LO 2 Record purchases under a perpetual inventory system.
LO 3 Record sales under a perpetual inventory system.
LO 4 Prepare a multiple-step income statement and a
comprehensive income statement.
LO 5 Determine cost of goods sold under a periodic
inventory system.
LO 6 Compute and analyze gross profit rate and profit
margin.
Copyright ©2019 John Wiley & Sons, Inc. 2
Learning Objective 1
Describe Merchandising Operations
and Inventory Systems

LO1 Copyright ©2019 John Wiley & Sons, Inc. 3

Merchandising Operations and
Inventory Systems
Merchandising Companies
Buy and Sell Goods
Retailer

The primary source of revenues is referred to as sales revenue or sales.

LO1 Copyright ©2019 John Wiley & Sons, Inc. 4

Measuring Income for a Merchandising Company

Cost of goods sold is the

total cost of merchandise
sold during the period.

LO1 Copyright ©2019 John Wiley & Sons, Inc. 5

Operating Cycles

LO1 Copyright ©2019 John Wiley & Sons, Inc. 6

Flow of Costs and Systems

Companies use either a perpetual inventory system or a

periodic inventory system to account for inventory.
LO1 Copyright ©2019 John Wiley & Sons, Inc. 7
Perpetual Inventory System
A company
• Maintains detailed records of the cost of each
inventory purchase and sale
• Maintains inventory records such that inventory that
should be on hand is continuously updated
• Determines cost of goods sold each time a sale occurs

LO1 Copyright ©2019 John Wiley & Sons, Inc. 8

Periodic Inventory System
A company
• Does not keep detailed records of goods on hand
• Determines cost of goods sold determined by a count
• Calculates its cost of goods sold as
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

LO1 Copyright ©2019 John Wiley & Sons, Inc. 9

Advantages of the Perpetual System
• Traditionally used for merchandise with high unit
values
• Shows quantity and cost of inventory that should
be on hand at any time
• Provides better control over inventories than a
periodic system

LO1 Copyright ©2019 John Wiley & Sons, Inc. 10

Do It! 1: Merchandising Operations
and Inventory Systems
Indicate whether the following statements are true or false. If false,
indicate how to correct the statement.
1. The primary source of revenue for a merchandising False
company results from performing services for (service
customers. company)
2. The operating cycle of a service company is usually
shorter than that of a merchandising company. True

3. Sales revenue less cost of goods sold equals gross True

profit.
False
4. Ending inventory plus the cost of goods purchased (Beg. Inventory
equals cost of goods available for sale. + Cost of goods
purchased)
LO1 Copyright ©2019 John Wiley & Sons, Inc. 11
Learning Objective 2
Record Purchases Under a Perpetual
System

LO2 Copyright ©2019 John Wiley & Sons, Inc. 12

Recording Purchases Under a Perpetual
System
• Made using cash or credit
(on account)
• Normally record when
goods are received from
the seller
• Purchase invoice should
support each credit
purchase

LO2 Copyright ©2019 John Wiley & Sons, Inc. 13

Record Purchases of Merchandise
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

LO2 Copyright ©2019 John Wiley & Sons, Inc. 14

Freight Costs (1 of 2)

Ownership of the goods Ownership of the goods

passes to the buyer when the remains with the seller until
public carrier accepts the the goods reach the buyer.
goods from the seller.

Freight costs incurred by the seller are an operating expense.

LO2 Copyright ©2019 John Wiley & Sons, Inc. 15

Freight Costs (2 of 2)
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

If the freight terms had required PW Audio Supply to pay

the freight charges, the entry by PW Audio Supply would be:
May 4 Freight-Out (or Delivery Exp) 150
Cash 150

LO2 Copyright ©2019 John Wiley & Sons, Inc. 16

Purchase Returns and Allowances
Purchaser may be dissatisfied because goods are
damaged or defective, of inferior quality, or do not meet
specifications.
Purchase Return
Return goods for credit if the sale was made on credit, or
for a cash refund if the purchase was for cash.
Purchase Allowance
May choose to keep the merchandise if the seller will
grant a reduction of the purchase price.

LO2 Copyright ©2019 John Wiley & Sons, Inc. 17

Recording 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

LO2 Copyright ©2019 John Wiley & Sons, Inc. 18

Purchase Returns and Allowances (1 of 2)
Review 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

LO2 Copyright ©2019 John Wiley & Sons, Inc. 19

Purchase Returns and Allowances (2 of 2)
Review 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

LO2 Copyright ©2019 John Wiley & Sons, Inc. 20

Nature of Purchase Discounts
• Credit terms may permit buyer to claim a cash
discount for prompt payment.
• Advantages:
• Purchaser saves money
• Seller shortens the operating cycle by converting
the accounts receivable into cash earlier

Example: Credit terms may read 2/10, n/30.

LO2 Copyright ©2019 John Wiley & Sons, Inc. 21

Common Purchase Discounts
2/10, n/30
2% discount if paid within 10 days, otherwise net amount
due within 30 days

1/10 EOM
1% discount if paid within first 10 days of next month

n/10 EOM
Net amount due within the first 10 days of the next
month

LO2 Copyright ©2019 John Wiley & Sons, Inc. 22

Accounting for Purchase Discounts (1 of 2)
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.
Discount = $3,500 × 2% = $70

May 14 Accounts Payable 3,500

Inventory 70
Cash 3,430

LO2 Copyright ©2019 John Wiley & Sons, Inc. 23

Accounting for Purchase Discounts ( 2 of 2)
Illustration: If Sauk Stereo failed to take the discount, and
instead made full payment of $3,500 on June 3, what would
the journal entry be?

Jun 3 Accounts Payable 3,500

Inventory 70

LO2 Copyright ©2019 John Wiley & Sons, Inc. 24

Cost of Not Taking a Purchase Discount
Should discounts be taken when offered?
Discount of 2% on $3,500 $70.00
$3,500 borrowed 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 × 36.5% × 20) ÷ 365 = $70

LO2 Copyright ©2019 John Wiley & Sons, Inc. 25

Summary of Purchasing Transactions
Inventory
Debit Credit
May 4 Purchase 3,800 300 May 8 Return
May 6 Freight-in 150 70 May 14 Discount

3,580

LO2 Copyright ©2019 John Wiley & Sons, Inc. 26

Do It! 2: Purchase Transactions
On September 5, De La Hoya Company buys merchandise on
account from Junot Diaz Company. The purchase price of the
goods is $1,500. On September 8, De La Hoya returns defective
goods with a selling price of $200. Record the transactions on the
books of De La Hoya Company.

Sept. 5 Inventory 1,500

Accounts Payable 1,500

Sept. 8 Accounts Payable 200

Inventory 200

LO2 Copyright ©2019 John Wiley & Sons, Inc. 27

Learning Objective 3
Record Sales Under a Perpetual System

LO3 Copyright ©2019 John Wiley & Sons, Inc. 28

Recording Sales Under a Perpetual
Inventory System
• Sales may be made on credit or for cash
• Sales revenue, like service revenue, is recorded when
the performance obligation is satisfied
• Performance obligation is satisfied when goods are
transferred from seller to buyer
• A sales invoice should support each credit sale

LO3 Copyright ©2019 John Wiley & Sons, Inc. 29

Sales Invoice
A sales invoice
should
support each
credit sale.

LO3 Copyright ©2019 John Wiley & Sons, Inc. 30

Entries to Record Sales
Record the Revenue
Accounts Receivable XXX Selling
Sales Revenue Price
XXX
Record the Expense
Cost of Goods Sold XXX
Cost
Inventory
XXX

LO3 Copyright ©2019 John Wiley & Sons, Inc. 31

Recording Sales on Account
Illustration: PW Audio Supply records the sale of $3,800 on
May 4 to Sauk Stereo on account as follows. The
merchandise cost PW Audio Supply $2,400.

May 4 Accounts Receivable 3,800

Sales Revenue 3,800

Cost of Goods Sold 2,400

Inventory 2,400

LO3 Copyright ©2019 John Wiley & Sons, Inc. 32

Sales Returns and Allowances
• “Flip side” of purchase returns and allowances
• Contra revenue account to Sales Revenue with a
normal debit balance
• Sales revenue is not reduced (debited) because
 Would obscure importance of sales returns and
allowances as a percentage of sales
 Could distort comparisons

LO3 Copyright ©2019 John Wiley & Sons, Inc. 33

Recording Sales Returns and Allowances (1 of
2)
Illustration: Prepare the entry PW Audio Supply would make
to record the credit for returned goods that had a $300
selling price with a $140 cost. The goods were not defective.

May 8 Sales Returns and Allowances 300

Accounts Receivable 300

Inventory 140
Cost of Goods Sold 140

LO3 Copyright ©2019 John Wiley & Sons, Inc. 34

Recording Sales Returns and Allowances (2 of
2)
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
Inventory 50
Cost of Goods Sold 50

LO3 Copyright ©2019 John Wiley & Sons, Inc. 35

Sales Returns and Allowances (1 of 2)
Review 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.

LO3 Copyright ©2019 John Wiley & Sons, Inc. 36

Sales Returns and Allowances (2 of 2)
Review 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.

LO3 Copyright ©2019 John Wiley & Sons, Inc. 37

Sales Discounts
• Offered to customers to promote prompt payment of
the balance due
• Contra revenue account to Sales Revenue with a
normal debit balance

LO3 Copyright ©2019 John Wiley & Sons, Inc. 38

Recording Sales 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 PW Audio Supply
makes to record the receipt on May 14.
[($3,800 − $300) × 2%]
May 14 Cash 3,430
Sales Discounts 70
Accounts Receivable 3,500

LO3 Copyright ©2019 John Wiley & Sons, Inc. 39

Do It! 3: Sales Transactions (1 of 2)
On September 5, De La Hoya Company buys merchandise on
account from Junot Diaz Company. The selling price of the
goods is $1,500, and the cost to Diaz Company was $800. On
September 8, De La Hoya returns goods with a selling price
of $200 and a fair value of $30. Record the sale on the books
of Junot Diaz Company.
Sept. 5 Accounts Receivable 1,500
Sales Revenue 1,500

Cost of Goods Sold 800

Inventory 800

LO3 Copyright ©2019 John Wiley & Sons, Inc. 40

Do It! 3: Sales Transactions (2 of 2)
On September 5, De La Hoya Company buys merchandise on
account from Junot Diaz Company. The selling price of the
goods is $1,500, and the cost to Diaz Company was $800. On
September 8, De La Hoya returns goods with a selling price
of $200 and a fair value of $30. Record the return on the
books of Junot Diaz Company.
Sept. 8 Sales Returns and Allowances 200
Accounts Receivable 200

Inventory 30
Cost of Goods Sold 30

LO3 Copyright ©2019 John Wiley & Sons, Inc. 41

Learning Objective 4
Prepare a Multiple-Step Income
Statement and a Comprehensive
Income Statement

LO4 Copyright ©2019 John Wiley & Sons, Inc. 42

Single-Step Income Statement (1 of 2)
• Subtract total expenses from total revenues
• All data classified into two categories
• Revenues
• Expenses
• Two reasons for using the single-step format:
1. Company does not realize any profit or income
until total revenues exceed total expenses
2. Form is simple and easy to read

LO4 Copyright ©2019 John Wiley & Sons, Inc. 43

Single-Step Income Statement (1 of 2)
Recreational Equipment
Income Statement (in thousands)
Blank For the year ended
Blank December 31, blank January 2,
Blank 2016 blank 2016
Revenues blank

Net sales $2,557,543 blank $2,423,221

Expenses blank

Cost of goods sold 1,460,433 blank 1,388,125

Payroll-related expenses 494,820 blank 478,474
Occupancy, general and administrative 420,898 blank 381,147
Patronage refunds and other 121,401 blank 121,853
Income taxes 21,716 blank 18,250
Blank 2,519,268 blank 2,387,849
Net income $ 38,275 blank $ 35,372

LO4 Copyright ©2019 John Wiley & Sons, Inc. 44

Nature of the Multiple-Step Income Statement

• Highlights of net income

• Three important line item
1. gross profit
2. income from operations
3. net income

LO4 Copyright ©2019 John Wiley & Sons, Inc. 45

 Recreational Equipment
Components Income Statement (in thousands)

of the Blank
For the Year Ended
December 31, January 2,

Multiple-Step Blank
Net sales
2016
$2,557,543
2016
$2,423,221
Income Cost of goods sold
Gross profit
1,460,433
1,097,110
1,388,125
1,035,096
Statement Operating expenses
Payroll-related expenses 494,820 478,474
Occupancy, general and
administrative 420,898 381,147
Total operating expenses 915,718 859,621
Income from operations 181,392 175,475
Other revenues and gains
Other revenues 0 0
Other expenses and losses
Patronage refunds and other 121,401 121,853
Income before income taxes 59,991 53,622
Income taxes 21,716 18,250
Net income $ 38,275 $ 35,372

LO4 Copyright ©2019 John Wiley & Sons, Inc. 46

 PW Audio Supply, Inc.
Income Statement
For the Year Ended December 31, 2022
Multiple- Sales Blank

Step Income
Service revenue Blank $480,000
Less: Sales returns and allowances $12,000 Blank
Sales discounts 8,000 Blank 20,000

Statement Net sales

Cost of goods sold
Gross profit
Blank
Blank
Blank
460,000
316,000
144,000
(1 of 6) Operating expenses Blank
Salaries and wages expense 64,000 Blank
Utilities expense 17,000 Blank
Key Items: Advertising expense 16,000 Blank
Depreciation expense 8,000 Blank
Freight-out 7,000
• Sales Insurance expense 2,000
Blank
Blank
Total operating expenses Blank 114,000
Income from operations 30,000
Other revenues and gains Blank
Interest revenue 3,000 Blank
Gain on disposal of plant assets 600 Blank 3,600
Other expenses and losses Blank
Interest expense 1,800 Blank
Casualty loss from vandalism 200 Blank 2,000
Income before income taxes Blank 31,600
Income tax expense Blank 10,100
Net income Blank $ 21,500

LO 4 Copyright ©2018 John Wiley & Son, Inc. 47

 PW Audio Supply, Inc.
Income Statement
For the Year Ended December 31, 2022
Multiple- Sales Blank

Step Income
Service revenue Blank $480,000
Less: Sales returns and allowances $12,000 Blank
Sales discounts 8,000 Blank 20,000

Statement Net sales

Cost of goods sold
Gross profit
Blank
Blank
460,000
316,000
144,000
(2 of 6)
Blank
Operating expenses Blank
Salaries and wages expense 64,000 Blank

Key Items: Utilities expense

Advertising expense
17,000
16,000
Blank
Blank
Depreciation expense 8,000 Blank
• Sales Freight-out 7,000 Blank
Insurance expense 2,000 Blank
Total operating expenses 114,000
• Gross Profit
Blank
Income from operations 30,000
Other revenues and gains Blank
Interest revenue 3,000 Blank
Gain on disposal of plant assets 600 Blank 3,600
Other expenses and losses Blank
Interest expense 1,800 Blank
Casualty loss from vandalism 200 Blank 2,000
Income before income taxes Blank 31,600
Income tax expense Blank 10,100
Net income Blank $ 21,500

LO4 Copyright ©2018 John Wiley & Son, Inc. 48

 PW Audio Supply, Inc.
Income Statement
For the Year Ended December 31, 2022
Multiple- Sales Blank

Step Income
Service revenue Blank $480,000
Less: Sales returns and allowances $12,000 Blank
Sales discounts 8,000 Blank 20,000

Statement Net sales

Cost of goods sold
Gross profit
Blank
Blank
Blank
460,000
316,000
144,000
(3 of 6) Operating expenses Blank
Salaries and wages expense 64,000 Blank
Utilities expense 17,000 Blank
Key Items: Advertising expense
Depreciation expense
16,000
8,000
Blank
Blank
Freight-out 7,000 Blank
• Sales Insurance expense 2,000 Blank
Total operating expenses Blank 114,000
Income from operations 30,000
• Gross Profit Other revenues and gains Blank
Interest revenue 3,000 Blank
Gain on disposal of plant assets 600 3,600
• Operating Other expenses and losses
Blank
Blank
Interest expense 1,800
Expenses Casualty loss from vandalism 200
Blank
Blank 2,000
Income before income taxes Blank 31,600
Income tax expense Blank 10,100
Net income Blank $ 21,500

LO 4 Copyright ©2018 John Wiley & Son, Inc. 49

 PW Audio Supply, Inc.
Income Statement
For the Year Ended December 31, 2022
Multiple- Sales Blank

Step Income
Service revenue Blank $480,000
Less: Sales returns and allowances $12,000 Blank
Sales discounts 8,000 Blank 20,000

Statement Net sales

Cost of goods sold
Gross profit
Blank
Blank
Blank
460,000
316,000
144,000
(4 of 6) Operating expenses Blank
Salaries and wages expense 64,000 Blank
Utilities expense 17,000
Key Items: Advertising expense 16,000
Blank
Blank
Depreciation expense 8,000 Blank
• Sales Freight-out
Insurance expense
7,000
2,000
Blank
Blank
Total operating expenses Blank 114,000
• Gross Profit Income from operations 30,000
Other revenues and gains Blank
Interest revenue 3,000
• Operating Gain on disposal of plant assets 600
Blank
Blank 3,600
Expenses Other expenses and losses
Interest expense 1,800
Blank
Blank
Casualty loss from vandalism 200 Blank 2,000
• Nonoperating Income before income taxes Blank 31,600
Income tax expense 10,100
Activities Net income
Blank
Blank $ 21,500

LO 4 Copyright ©2018 John Wiley & Son, Inc. 50

Nonoperating Activities (5 of 6)
Revenues and expenses and gains and losses unrelated to
company’s main line of operations. Examples include:
Other Revenues and Gains
• Interest revenue from notes receivable and marketable securities
• Dividend revenue from investments in capital stock
• Rent revenue from subleasing a portion of the store
• Gain from the sale of property, plant, and equipment
Other Expenses and Losses
• Interest expense on notes and loans payable
• Casualty losses from such causes as vandalism and accidents
• Loss from sale of property, plant, and equipment
• Loss from strikes by employees and suppliers
LO4 Copyright ©2019 John Wiley & Sons, Inc. 51
 PW Audio Supply, Inc.
Income Statement
For the Year Ended December 31, 2022
Multiple- Sales Blank

Step Income
Service revenue Blank $480,000
Less: Sales returns and allowances $12,000 Blank
Sales discounts 8,000 Blank 20,000

Statement Net sales

Cost of goods sold
Gross profit
Blank
Blank
Blank
460,000
316,000
144,000
(6 of 6) Operating expenses Blank
Salaries and wages expense 64,000 Blank

Key Items: Utilities expense

Advertising expense
17,000
16,000
Blank
Blank
Depreciation expense 8,000 Blank
• Sales Freight-out 7,000 Blank
Insurance expense 2,000 Blank
Total operating expenses 114,000
• Gross Profit
Blank
Income from operations 30,000
Other revenues and gains Blank
Interest revenue 3,000
• Operating Gain on disposal of plant assets 600
Blank
Blank 3,600
Other expenses and losses
Expenses Interest expense 1,800
Blank
Blank
Casualty loss from vandalism 200 Blank 2,000
Income before income taxes 31,600
• Nonoperating Income tax expense
Blank
Blank 10,100
Net income $ 21,500
Activities Blank

• Net Income
LO 4 Copyright ©2019 John Wiley & Son, Inc. 52
Multiple-Step Income Statement (1 of 2)
Review 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.

LO4 Copyright ©2019 John Wiley & Sons, Inc. 53

Multiple-Step Income Statement (2 of 2)
Review 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.

LO4 Copyright ©2019 John Wiley & Sons, Inc. 54

Comprehensive Income Statement
Presents items not included in the determination of net
income.
Items included in comprehensive income are either reported
in a combined statement of net income and comprehensive
income, or in a separate comprehensive income statement.
PW Audio Supply, Inc.
Comprehensive Income Statement
For the Year Ended December 31, 2022

Net income
Other comprehensive income $21,500
Unrealized holding gain on investment securities (net of $400 tax) 2,300
Comprehensive income $23,800

LO4 Copyright ©2019 John Wiley & Sons, Inc. 55

Do It! 4: Multiple-Step Income
Statement (1 of 3)
The following information is available for Art Center Corp. for the
year ended December 31, 2022.
Other revenues and gains $ 8,000 Sales revenue $462,000
Other expenses and losses 3,000 Operating expenses 187,000
Cost of goods sold 147,000 Sales discounts 20,000
blank blank Other comprehensive
income 10,000

Prepare a multiple-step income statement and comprehensive

income statement for Art Center Corp. The company has a tax rate of
25%. This rate also applies to other comprehensive income.
LO4 Copyright ©2019 John Wiley & Sons, Inc. 56
Do It! 4: Art Center Corp.
Income Statement
Multiple- Sales
For the Year Ended December 31, 2022

Step
Blank
Service revenue Blank $462,000
Sales discounts 20,000
Income Net sales
Blank

Blank 442,000
Statement Cost of goods sold
Gross profit
Blank

Blank
147,000
295,000
(2 of 3) Operating expenses 187,000
Blank
Income from operations Blank 108,000
Prepare a Other revenues and gains $8,000 Blank
multiple-step Other expenses and losses 3,000 Blank 5,000
Income before income taxes 113,000
income Income tax expense
Blank
28,250
Blank
statement. Net income Blank $ 84,750
Tax rate is 25%.

LO 4 Copyright ©2019 John Wiley & Sons, Inc. 57

Do It! 4: Multiple-Step Income
Statement (3 of 3)
Prepare a comprehensive income statement.
Tax rate is 25%.
Art Center Corp.
Comprehensive Income Statement
For the Year Ended December 31, 2022
Net income Blank $84,750
Other comprehensive income
(net of $2,500 tax) Blank 7,500
Comprehensive income Blank $92,250

LO4 Copyright ©2019 John Wiley & Sons, Inc. 58

Learning Objective 5
Determine Cost of Goods Sold Under a
Periodic Inventory System

LO5 Copyright ©2019 John Wiley & Sons, Inc. 59

Periodic Inventory System
• No running account of changes in inventory is
maintained
• Ending inventory determined by physical count
• Cost of goods sold not determined until the end of
the period

LO5 Copyright ©2019 John Wiley & Sons, Inc. 60

Cost of Goods Sold under a Periodic System
PW Audio Supply, Inc.
Cost of Goods Sold
For the Year Ended December 31, 2022

Cost of goods sold

Inventory, January 1 $ 36,000
Purchases $325,000
Less: Purchase returns and allowances $10,400
Purchase discounts 6,800 17,200
Net purchases 307,800
Add: Freight-in 12,200
Cost of goods purchased 320,000
Cost of goods available for sale 356,000
Inventory, December 31 40,000
Cost of goods sold $316,000

LO5 Copyright ©2019 John Wiley & Sons, Inc. 61

Do It! 5: COGS—Periodic System (1 of 2)
Aerosmith Company’s accounting records show the following at
the year-end December 31, 2022.
Purchase Discounts $ 3,400 Freight-In $ 6,100
Purchases 162,500 Beginning Inventory 18,000
Ending Inventory 20,000 Purchase Returns and
Allowances 5,200

Assuming that Aerosmith Company uses the periodic system,

compute (a) cost of goods purchased and (b) cost of goods sold.

LO5 Copyright ©2019 John Wiley & Sons, Inc. 62

Do It! 5: COGS—Periodic System (2 of 2)
Solution
Beginning Inventory Blank $ 18,000 Blank

Purchases $ 162,500 Blank Blank

Purchase Returns and Allowances − 5,200 Blank Blank

Purchase Discounts − 3,400 Blank Blank

Freight-In + 6,100 160,000 (a)

Goods Available for Sale Blank 178,000 Blank
Ending Inventory Blank − 20,000 Blank
Cost of Goods Sold Blank $158,000 (b)

LO5 Copyright ©2019 John Wiley & Sons, Inc. 63

Learning Objective 6
Compute and Analyze Gross Profit Rate
and Profit Margin

LO6 Copyright ©2019 John Wiley & Sons, Inc. 64

Gross Profit Rate (1 of 2)
• May be expressed as a percentage by dividing the
amount of gross profit by net sales
• Possible causes of a decline in the rate
• Selling products with a lower “markup”
• Increased competition may result in a lower selling
price
• Company forced to pay higher prices to its suppliers
without being able to pass these costs on to its
customers

LO6 Copyright ©2019 John Wiley & Sons, Inc. 65

Gross Profit Rate (2 of 2)

The gross profit rate often differs across retailers because of

differences in the nature of their goods.

LO6 Copyright ©2019 John Wiley & Sons, Inc. 66

Profit Margin (1 of 2)
• Measures the percentage of each dollar of sales that
results in net income
• How do the gross profit rate and profit margin ratio
differ?
• Gross profit rate measures the margin by which
selling price exceeds cost of goods sold
• Profit margin ratio measures the extent by which
selling price covers all expenses (including cost of
goods sold)

LO6 Copyright ©2019 John Wiley & Sons, Inc. 67

Profit Margin (2 of 2)

Possible causes of a decline in the rate may be caused by a change

in
• The amount of operating expenses relative to sales, or
• The amount of other items relative to sales

LO6 Copyright ©2019 John Wiley & Sons, Inc. 68

Do It! 6: Gross Profit Rate
Rachel Rose, Inc. reported the following in its income statements.
2022 2021
Net sales $80,000 $120,000
Cost of goods sold 40,000 60,000
Operating expenses 14,000 28,000
Income tax expense 8,000 12,000
Net income $18,000 $20,000

Determine the company’s gross profit rate.

2022 2021
($80,000  $40,000) ($120,000  $60,000)
50% 50%
$80,000 $120,000
LO6 Copyright ©2019 John Wiley & Sons, Inc. 69
Do It! 6: Profit Margin
Rachel Rose, Inc. reported the following in its income statements.
2022 2021
Net sales $80,000 $120,000
Cost of goods sold 40,000 60,000
Operating expenses 14,000 28,000
Income tax expense 8,000 12,000
Net income $18,000 $20,000

Determine the company’s profit margin.

2022 2021
$18, 000 $20, 000
22.5% 16.7%
$80, 000 $120, 000
LO6 Copyright ©2019 John Wiley & Sons, Inc. 70
Learning Objective 7
Record Purchases and Sales of
Inventory Under a Periodic Inventory
System

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Appendix 5A Periodic Inventory System
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 sold during the period
• Record purchases in Purchases account
• Purchase returns and allowances, purchase
discounts, and freight costs are recorded in separate
accounts
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Recording Purchases of Merchandise
Illustration: PW Audio Supply records the sale of $3,800 on
May 4 to Sauk Stereo on account as follows. The
merchandise cost PW Audio Supply $2,400. Sauk Stereo
records the $3,800 purchase as:

May 4 Purchases 3,800

Accounts Receivable 200

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Freight Costs Paid by the Purchaser
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

LO7 Copyright ©2019 John Wiley & Sons, Inc. 74

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

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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

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Recording Sales of Merchandise
Illustration: PW Audio Supply, records the sale of $3,800 of
merchandise to Sauk Stereo on May 4 for sales invoice No.
731 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.

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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

LO7 Copyright ©2019 John Wiley & Sons, Inc. 78

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

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Comparison of Entries—
Perpetual vs. Periodic (1 of 2)

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Comparison of Entries—
Perpetual vs. Periodic (2 of 2)

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Learning Objective 8
Appendix 5B
Prepare Adjusting Entries for Credit
Sales with Returns and Allowances

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Adjusting Entries for Credit Sales with
Returns and Allowances (1 of 5)
Illustration: On January 1, Rainbow Company sells 100 pairs
of shoes for $100 each on account to Tanner Inc. Rainbow
allows Tanner to return any unused shoes within 45 days of
purchase. The cost of each product is $60. Rainbow records
the sale as follows.
Jan. 1 Accounts Receivable 10,000
Sales Revenue 10,000

Cost of Goods Sold 6,000

Inventory 6,000

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Adjusting Entries for Credit Sales with
Returns and Allowances (2 of 5)
Illustration: On January 24, Tanner returns two pairs of
shoes with a selling price of $100 each and a cost of $60
each because they were the wrong color. Rainbow records
the return as follows.
Jan. 24 Sales Returns and Allowances 200
Accounts Receivable 200

Inventory 120
Cost of Goods Sold 120

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Adjusting Entries for Credit Sales with
Returns and Allowances (3 of 5)
Illustration: On January 31, Rainbow prepares monthly financial
statements and estimates that it is likely that one more pair of
shoes will be returned. The selling price is $100 per pair with a
unit cost of $60. Rainbow records two adjusting entries to account
for this estimate.
Jan. 31 Sales Returns and Allowances 100
Allowance for Sales Returns and Allowances 100

Estimated Inventory Returns 60

Cost of Goods Sold 60

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Adjusting Entries for Credit Sales with
Returns and Allowances (4 of 5)
Illustration: On February 18, Tanner returns another pair of shoes
to Rainbow. The selling price is $100 per pair with a unit cost of
$60. If Tanner has not already paid Rainbow for the shoes,
Rainbow records the entry as follows.

Feb. 18 Allowance for Sales Returns and Allowances 100

Accounts Receivable 100
Inventory 60
Estimated Inventory Returns 60

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Adjusting Entries for Credit Sales with
Returns and Allowances (5 of 5)
Illustration: If Tanner had initially paid for the shoes in cash
or paid its balance due on a credit purchase prior to
returning the shoes on February 18, Rainbow would credit
Accounts Payable rather than Accounts Receivable as shown
in the following entry.
Jan. 31 Allowance for Sales Returns and Allowances 100
Accounts Payable 100
Inventory 60
Estimated Inventory Returns 60

LO8 Copyright ©2019 John Wiley & Sons, Inc. 87

Learning Objective 9
Compare the Accounting for
Merchandising Under GAAP and
IFRS

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A Look at IFRS (1 of 4)
Similarities
• Under both GAAP and IFRS, a company can choose to use
either a perpetual or a periodic inventory system.
• The definition of inventories is basically the same under GAAP
and IFRS.
• Basic accounting entries for merchandising are the same under
both GAAP and IFRS.

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A Look at IFRS (2 of 4)
Similarities
• Both GAAP and IFRS require that income statement
information be presented for multiple years.
• For example, IFRS requires that 2 years of income
statement information be presented, whereas GAAP
requires 3 years.

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A Look at IFRS (3 of 4)
Differences
• Under GAAP, companies generally classify income statement
items by function.
• Classification by function leads to descriptions like
administration, distribution, and manufacturing.
• Under IFRS, companies classify expenses either by nature or
by function.
• Classification by nature leads to descriptions such as the
following: salaries, depreciation expense, and utilities
expense.
• If a company uses the functional-expense method, disclosure
by nature is required in the notes to the financial statements.
LO9 Copyright ©2019 John Wiley & Sons, Inc. 91
A Look at IFRS (4 of 4)
Differences
• Presentation of the income statement under GAAP follows
either a single-step or multiple-step format. IFRS does not
mention a single-step or multiple-step approach.
• Under IFRS, revaluation of land, buildings, and intangible
assets is permitted.
• The initial gains and losses resulting from this revaluation
are reported as adjustments to equity, often referred to as
other comprehensive income. The effect of this difference
is that the use of IFRS results in more transactions affecting
other comprehensive income.

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Copyright
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from the use of the information contained herein.

Copyright ©2019 John Wiley & Sons, Inc. 93