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Accounting
Principles
Second Canadian Edition
Weygandt · Kieso · Kimmel · Trenholm
Prepared by:
Carole Bowman, Sheridan College
CHAPTER
5
ACCOUNTING FOR
MERCHANDISING
OPERATIONS
MERCHANDISING COMPANY


A merchandising company is an enterprise
that buys and sells goods to earn a profit.
1. Wholesalers sell to retailers.
2. Retailers sell to consumers.
A merchandiser’s primary source of
revenue is sales, whereas a service
company’s primary source of revenue is
service revenue.
OPERATING CYCLES FOR A
SERVICE COMPANY AND A
MERCHANDISING COMPANY
Service Company
Receive
Cash
Cash
Perform
Services
Accounts
Receivable
Merchandising Company
Receive
Cash
Cash
Buy
Inventory
Sell Inventory
Accounts
Receivable
Merchandise
Inventory
ILLUSTRATION 5-1
INCOME MEASUREMENT PROCESS
FOR A MERCHANDISING COMPANY
Sales
Revenue
Less
Equals
Cost of
Goods Sold
Gross
Profit
Less
Equals
Operating
Expenses
Net
Income
(Loss)
INVENTORY SYSTEMS
Merchandising entities may use either (or both)
of the following inventory systems:
1. Perpetual – where detailed records of each
inventory purchase and sale are maintained.
Cost of goods sold is calculated at the time of
each sale.
2. Periodic – detailed records are not
maintained. Cost of goods sold is calculated
only at the end of the accounting period.
This chapter covers the perpetual method.
RECORDING COST OF
GOODS PURCHASED



When merchandise is purchased for resale
to customers, the account, Merchandise
Inventory, is debited for the cost of the
goods.
Purchases may be made for cash or on
account (credit).
The purchase is normally recorded
by the purchaser when the goods
are received from the seller.
PURCHASES OF
MERCHANDISE
General Journal
Date Account Title and Explanation Ref
May 4 Merchandise Inventory
Accounts Payable
To record goods purchased on
account, terms n/30.
Debit
3,800
For purchases on account, Merchandise
Inventory is debited and Accounts Payable is
credited. For cash purchases, Merchandise
Inventory is debited and Cash is credited.
J1
Credit
3,800
FREIGHT COSTS



The sales agreement should indicate whether the seller or
the buyer is to pay the cost of transporting the goods to the
buyer’s place of business.
FOB Shipping Point
1. Goods delivered to shipping point by seller
2. Buyer pays freight costs from shipping
point to destination
FOB Destination
1. Goods delivered to destination
by seller
2. Seller pays freight costs
ACCOUNTING FOR
FREIGHT COSTS


Merchandise Inventory is debited by the buyer, if
the buyer pays the freight bill (FOB shipping
point).
Freight Out (or Delivery Expense) is debited by the
seller, if the seller pays the freight bill (FOB
destination).
ACCOUNTING FOR
FREIGHT COSTS
General Journal
Date Account Title and Explanation
May 4 Merchandise Inventory
Cash
To record payment of freight.
Ref
Debit
150
J1
Credit
When the purchaser directly incurs the freight
costs, the account Merchandise Inventory is
debited and Cash is credited.
150
PURCHASE RETURNS AND
ALLOWANCES

A purchaser may be dissatisfied with
merchandise received because the goods
1. are damaged or defective,
2. are of inferior quality, or
3. are not in accord with the
purchaser’s specifications.
PURCHASE RETURNS AND
ALLOWANCES
General Journal
Date Account Title and Explanation
May 8 Accounts Payable
Merchandise Inventory
To record return of goods.
Ref
Debit
300
J1
Credit
For purchases returns and allowances that were
originally made on account, Accounts Payable is
debited and Merchandise Inventory is credited.
For cash returns and allowances, Cash is debited
and Merchandise Inventory is credited.
300
QUANTITY DISCOUNTS
• Volume purchase terms may permit the
buyer to claim a quantity discount.
• The merchandise inventory is simply
recorded at the discounted cost.
PURCHASE DISCOUNTS



Credit terms may permit the buyer to claim
a cash discount for the prompt payment of
a balance due.
The buyer calls this discount a
purchase discount.
A purchase discount is based on
the invoice cost less any returns
and allowances granted.
SALES TRANSACTIONS

Revenues are reported when earned in
accordance with the revenue recognition
principle. In a merchandising company.
revenues are earned when the goods are
transferred from seller to buyer.
SALES TRANSACTIONS
General Journal
Date Account Title and Explanation
May 4 Accounts Receivable
Sales
To record credit sale.
May 4 Cost of Goods Sold
Merchandise Inventory
To record cost of merchandise
sold.
Ref
Debit
3,800
J1
Credit
3,800
2,400
2,400
1. The first entry records the sale of goods to a
customer at the retail (selling) price.
2. The second entry releases the goods from inventory
at cost and charges the goods to cost of goods sold.
SALES TAXES
•
•
Sales tax is expressed as a percentage of the sales
price on selected goods sold to customers by a
retailer. They are collected on most revenues, and
paid on many costs.
Sales taxes may include the federal goods and
services tax (GST) and the provincial sales tax
(PST), if any. These two taxes have been combined
into one harmonized sales tax (HST) in some
Atlantic Provinces.
SALES TAXES ON REVENUES
• The retailer collects the tax from the
customer when the sale occurs, and
periodically (usually monthly) remits the
collections to the Receiver General.
• Sales taxes are not revenue but are a current
liability until remitted.
SALES RETURNS AND
ALLOWANCES


Sales Returns occur when customers are
dissatisfied with merchandise and are
allowed to return the goods to the seller for
credit or a refund.
Sales Allowances occur when
customers are dissatisfied, and the
seller allows a deduction from
the selling price.
SALES RETURNS AND
ALLOWANCES
The normal balance of Sales Returns
and Allowances is a debit.
 Sales Returns and Allowances is a contra
revenue account to the Sales account.

RECORDING SALES RETURNS
AND ALLOWANCES
General Journal
Date Account Title and Explanation
May 8 Sales Returns and Allowances
Accounts Receivable
To record returned goods.
May 8 Merchandise Inventory
Cost of Goods Sold
To record cost of goods
returned.
Ref
Debit
300
J1
Credit
300
140
140
1. The first entry reduces the balance owed by the customer
and records the goods returned at retail price.
2. The second entry records the physical return of goods to
inventory at cost and removes the goods from the cost
of goods sold account.
QUANTITY DISCOUNTS
• A quantity discount is the offer of a cash
discount to a customer in return for a volume
sale.
• Quantity discounts result in a sales price
reduction. They are not separately journalized.
Instead the sale is recorded at the reduced
price.
SALES DISCOUNTS


A sales discount is the offer of a cash discount
to a customer in exchange for the prompt
payment of a balance due.
Similar to Sales Returns and Allowances,
Sales Discounts is also a contra revenue
account with a normal debit balance.
COMPLETING THE
ACCOUNTING CYCLE


A merchandising company requires the same
types of adjusting entries as a service company,
with one additional adjustment for inventory to
ensure the recorded inventory amount agrees
with the actual quantity on hand.
A physical count is an important control feature
since a perpetual system indicates what should
be there but a count will determine what is
actually there.
COMPLETING THE
ACCOUNTING CYCLE



A merchandising company also requires the
same types of closing entries as a service
company.
The additional accounts that need to be closed
out in a merchandising account include Sales,
Sales Returns and Allowances, Cost of Goods
Sold, and Freight Out.
Merchandise Inventory is an asset account and
is not closed at the end of the period.
ILLUSTRATION 5-9
STATEMENT PRESENTATION OF
SALES REVENUE SECTION
As contra revenue accounts, sales returns and
allowances (and sales discounts, if any) are
deducted from sales in the income statement to
arrive at Net Sales.
HIGHPOINT ELECTRONIC
Income Statement (Partial)
For the Year Ended December 31, 2002
Sales revenue
Sales
$ 480,000
Less: Sales returns and allowances
20,000
Net sales
$ 460,000
ILLUSTRATION 5-10
CALCULATION OF GROSS PROFIT
Gross profit is calculated by deducting cost of
goods sold from net sales as follows:
Net
Net sales
sales
Cost
Cost of
of goods
goods sold
sold
Gross
Gross profit
profit
$$ 460,000
460,000
316,000
$ 144,000
100%
69%
31%
Gross profit is often expressed as a
percentage of sales.
ILLUSTRATION 5-12
CALCULATION OF NET INCOME
Net income is calculated by deducting operating
expenses from gross profit as follows:
Gross profit
Operating expenses
Net income
$ 144,000
114,000
$ 30,000
Net income is the “bottom line” of a
company’s income statement.
ILLUSTRATION
5-14
This is the format
of a multi-step
income statement
that has both
operating and nonoperating
activities.
As shown, the nonoperating activities
are reported
immediately after
the company’s
primary operating
activities.
HIGHPOINT ELECTRONIC
Income Statement
For the Year Ended December 31, 2002
Sales revenue
Sales
Less: Sales returns and allowances
Net sales
Cost of goods sold
Gross profit
Operating expenses
Selling expenses
Salaries expense
$
Advertising expense
Amortization expense
Freight out
Total selling expenses
Administrative expenses
Rent expense
$
Utilities expense
Insurance expense
Total administrative expenses
Total operating expenses
Income from operations
Other revenue and gains
Interest revenue
$
Gain on sale of equipment
Total non-operating revenue and gain
Other expenses and losses
Interest on expense
$
Casualty loss from vandalism
Total non-operating expense and loss
Net non-operating revenue
Net income
$ 480,000
20,000
460,000
316,000
144,000
45,000
16,000
8,000
7,000
$ 76,000
19,000
17,000
2,000
38,000
114,000
30,000
3,000
600
$
3,600
1,800
200
2,000
$
1,600
31,600
CLASSIFIED BALANCE SHEET
HIGHPOINT ELECTRONIC
Balance Sheet (partial)
December 31, 2002
Assets
On the balance sheet,
Current assets
merchandise inventory is
Cash
reported as a current asset
Accounts receivable
and appears immediately
Merchandise inventory
below accounts receivable.
Prepaid insurance
This is because current
assets are listed in the
Total current assets
order of their liquidity.
Capital assets
Store equipment
$ 80,000
Less: Accumulated amortization
24,000
Total assets
$
9,500
16,100
40,000
1,800
67,400
56,000
$ 123,400
USING THE INFORMATION IN THE
FINANCIAL STATEMENTS
Inventory is particularly important because:
• It is a large current asset
on the balance sheet
• It becomes a large
expense on the income
statement
• It is vulnerable to theft or
misuse
USING THE INFORMATION IN THE
FINANCIAL STATEMENTS
A balancing act is needed to ensure that
a sufficient, but not excessive, quantity of
inventory is on hand.
 Two ratios help evaluate the
management of inventory:

•
•
Inventory turnover
Days sales in inventory
INVENTORY TURNOVER
Inventory turnover =
Cost of goods sold
Average inventory
DAYS SALES IN INVENTORY
Days sales in inventory =
365 days
Inventory turnover
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