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Chapter # 5
Accounting For Merchandizing
Companies
Merchandising Company
Merchandising companies, in contrast to service-type
business, earn revenue by selling goods rather than
services.
Inventory
The goods that a merchandising company
sells to its customers are called inventory
(or Merchandise)
Operation Cycle of Merchandizing
Company
1. Purchase of
Merchandise
Inventory
Cash
2. Sale of Merchandise
on Account
3. Collection of
the Receivables
Account
Sale
of Merchandise
on account
Receivable
Merchandising companies Vs Manufacturing
companies

Companies that manufacture their inventories or produce
their goods are called manufacturing companies.

Merchandising companies purchase their inventories
from other business organization in a ready-to-sell
condition.
Retailer and Wholesalers
Merchandising business may be carrying on into two
ways;
1.
Retailer is a business that sells their inventory directly
to the public.
2.
Wholesalers buy large quantities of merchandise from
several different manufacturers and then resell this
merchandise to many different retailers.
Cost of Goods Sold
The cost of inventory or merchandise the company
resell to its customers is normally term as Cost of
Goods Sold.
Computer Barn
INCOME STATEMENT
For the year ended Dec, 31st 2008
______________________________________________
Revenue from sales………………
Less: Cost of goods sold………...
$ 900,000
$ 540,000
Gross Profit……………………….
Less: Expenses……………………
$ 360,000
$ 270,000
Net Income………………………..
$ 90,000
Approaches used in Accounting for
Merchandising Transactions
1.
Perpetual Inventory System
2.
Periodic Inventory System
Perpetual Inventory System
The basic characteristic of perpetual inventory system is that the
inventory account is continuously updated for all purchase and
sales of merchandise
Perpetual means Continuous and up-to-date.



In perpetual inventory system merchandizing transactions are
recorded as they occur.

When merchandise is purchased one entry is required.

When inventory is sold two entries are necessary.
One entry for the sales of inventory and
Other to recognize the cost of goods sold
1.
2.
When Inventory is purchased

At the time of purchasing the inventory one entry is required.

For example: August 1st 10 Regent CX-21 computer monitors
were purchased for $ 6,000 on cash.

The entry will be ;
Description
R/No
Dr.
Cr.
$ 6,000
Inventory
…..
Cash
$ 6000
When inventory is sold

Two entries are required here one for recognizing the
revenue and other for recognizing the related cost.

For example business sold inventory for $ 2,000 on cash,
which cost was $ 1,200
Description
R/No
Cash
Dr.
Cr.
$ 2,000
Sales (Inventory)
_____________________________________
Cost of Goods Sold
Inventory
$2,000
…..
$ 1,200
$ 1,200
When Inventory is purchased

At the time of purchasing the inventory one entry is required.

For example: August 1st 10 Regent CX-21 computer monitors
were purchased for $ 6,000 on account from Okawa Wholesale
Co, payment is due in 30 days.

The entry will be ;
Description
R/No
Cr.
$ 6,000
Inventory (monitors)
…..
Accounts Payable
Dr.
$ 6000
When Inventory is purchased

When amount is paid to supplier….

The entry will be ;
Description
R/No
Cr.
$ 6,000
Accounts Payable
…..
Cash
Dr.
$ 6000
When inventory is sold on credit

Two entries are required here one for recognizing the revenue and
other for recognizing the related cost.

For example business sold inventory for $ 2,000 on account,
which cost was $ 1,200
Description
R/No
Account Receivable
Sales (Inventory)
_____________________________________
Cost of Goods Sold
Inventory
Dr.
Cr.
$ 2,000
$2,000
…..
$ 1,200
$ 1,200
When inventory is sold on credit

When amount is received from customer….

The entry will be ;
Description
R/No
Dr.
Cr.
$ 2,000
Cash
…..
Account Receivable
$ 2000
General Ledger Vs Subsidiary Ledgers

General Ledgers are normally used to prepare financial
statements

Subsidiary Ledgers provide more information that is required to
prepare General Ledger
 It shows the separately the individual items which comprise
the balance of a general ledger account.
Inventory Subsidiary Ledger
Item________________________
Description _________________
Location ___________________
Date
Primary Supplier ________________
Second Supplier _________________
Inventory Level: Min ____ Max _____
Purchased
Units
Unit
Cost
Sold
Total
Units
Unit
Cost
Balance
Cost of
Good
Sold
Units
Unit
Cost
Total
Approaches for merchandizing transactions

Perpetual Inventory System
Aug. 1
Purchased 10 Regent CX-21 computer monitors on
account from Okawa Wholesale Company. The
monitors cost $ 600 each, for a total of $ 6,000,
payment is due in 30 days.
Aug. 7
Sold 2 monitors on account to RJ Travel Agency at
a retail sales price of $ 1,000 each, for a total of
$ 2,000. Payment is due in 30 days.
Sep. 1
Paid the $ 6,000 account payable to Okawa
Wholesale Company .
Sep. 7
Collected the $2,000 from RJ Travel Agency.
Ledger Accounts
Inventory Subsidiary Ledger
Item:
Regent CX-21
Description: Gray Scale Monitor
Location: Store room 2
Date
Primary Supplier: Okawa Whole Sale
Second Supplier: Forbs Incorporations
Inventory Level: Min ____ Max _____
Purchased
Sold
Balance
Units
Unit
Cost
Total
Units
Unit
Cost
Cost of
Good
Sold
Units
Unit
Cost
Total
1st Sep
10
$ 600
$ 6,000
--------
-------
-------
10
$ 600
$ 6,000
7th Aug
------
------
-------
2
$ 600
$ 1,200
8
$ 600
$ 4,800
Taking a Physical Inventory

The basic characteristic of perpetual inventory system is that the
inventory account is continuously updated for all purchase and sales
of merchandise.

But at the end of accounting period it may be possible that the
inventory as shown in the record may not be equal to the physical
inventory.

This difference occurred due to shrinkage ( breakage, spoilage,
employees theft & shoplifting etc).

In order to ensure the accuracy of perpetual inventory records, most
businesses take a complete physical count of the merchandise on
hand at the end of accounting period.

This procedure is called “taking a physical inventory”
For example:



Assume that at year end the inventory account of Computer Barn
shows an inventory with a cost of $ 72,200.
A physical count, however, reveals that some of the merchandise
listed in the accounting records is missing, the items actually on hand
have a total cost of $70,000.
Computer Barn would make to following adjusting entry to adjust its
Inventory Controlling account:
Date
Description
Cost of Goods Sold……………….
Inventory…………….
L/F
Dr
Cr
$ 2,200
$ 2,200
Closing Inventories in Perpetual Inventory
System

Revenues, expenses and drawings are temporary accounts and
need to close in income summary at the end of each accounting
period

Here we will close the Sales account with the income summary
account just like the other revenues accounts

And cost of goods sold account is to be closed with income
summary account as other expenses accounts
Periodic Inventory System
This method is totally alternative to the Perpetual Inventory System
In this system, no efforts is made either to update the Inventory
account or to record the cost of goods sold as transactions occur
through out the year.
In this method inventory records are updated “periodically” normally
at the end of accounting period.
In this method when the inventory is purchased only one entry for
the normal purchases is required to pass and
At the time of sales only one entry for normal sales is made
The cost of goods sold and entry for this is normally done at the end
of accounting period
Periodic Inventory System
When the inventory purchased the entry will be like;
Date
Description
L/F
Purchases……………….
Cash…………….
Dr
Cr
$ 2,200
$ 2,200
When the inventory is sold the entry would be;
Date
Description
Cash……………….
Sales…………….
L/F
Dr
Cr
$ 2,200
$ 2,200
Periodic Inventory System
At the year’s end cost of goods calculated as follows;
Beginning inventory…………………………………
Add: Purchases during the year…………………..
$ 12,000
130,000
Total cost of inventory available for sale………...
Less: cost of Closing Inventory…………………..
142,000
8,000
Cost of goods/ inventory sold……………………..
$ 134,000
For example, if a business had merchandise costing $12,000 on hand at the
beginning of the year. During the year, it purchased additional merchandise at cost
of $130,000. Therefore, merchandise with a total cost of $142,000 was available for
sale during the year. At year end merchandise with a cost of $8,000 remains on
hand.
Thus merchandise which had cost $134,000 is no longer on hand, and is presumed
to have been sold.
Periodic Inventory System
So at the year end, when the cost of goods is being calculated then
entry for such cost of goods sold will be;
Date
Description
Cost of Goods Sold……………….
Inventory…………….
L/F
Dr
Cr
$ 134,000
$ 134,000
Accounting Terminologies
1.
2.
3.
4.
5.
6.
7.
8.
9.
Current Assets
Plant and Equipment (Fixed Assets)
Current Liabilities
Long Term Liabilities
Liquidity of Assets
Liquidity of Liabilities
Credit Terms and Cash Discounts
Purchases Return and Allowances
Sales Return and Allowances
Transactions relating to purchases
Credit terms and Cash Discount
Credit Terms
(2/10, n/30)
2 = Percentage of Discount
10 = Discount Period
n = Net time period
30 = Number of due days
Example of Net Invoice Price
Nov 3: Star Computers purchase 100 PC Monitors from PC products. The cost
of these Monitors is $100 each, for a total of $10,000. However, PC products
offers credit terms of (2/10, n/30). If Star Computers pays for this purchase
within the discount period, it will have to pay only $9,800 or 98% of the full
invoice price. Therefore Star Computer will record this purchase as follows:
Date
Description
Nov 3
Inventory………………..
Accounts Payable (PC Products)
L/F
Dr
Cr
$ 9,800
$ 9,800
When Cash is paid to the invoice after the expiration of Discount Period
Date
Dec 2
Description
Accounts Payable (PC Products)
Purchase Discount Lost
Cash……………………
L/F
Dr
Cr
$ 9,800
200
$ 10,000
Example of Gross Invoice Price

When Inventory was purchased entry will be;
Date
Nov 3
Description
L/F
Inventory………………..
Accounts Payable (PC Products)
Dr
Cr
$ 10,000
$ 10,000
When amount is paid within discount period, entry will be;
Date
Nov 3
Description
Accounts Payable (PC Computers)
Cash………………………………
Purchase Discount Taken…...
L/F
Dr
Cr
$ 10,000
$ 9,800
200
Classified Financial Statements
In classified Financial Statements items with certain
characteristics are placed together in a group, or
“Classification”
1.
2.
Classified Balance Sheet
Classified Income Statement
Classified Balance Sheet
In a Classified Balance Sheet assets are normally
presented into three groups
1.
2.
3.
4.
5.
6.
Current Assets
Plant and equipment (Fixed Assets)
Other Assets
Current Liabilities
Long Term Liabilities
Owner’s Equity
Classified Balance Sheet
Star Computers
Balance Sheet
As on Dec 31st, 2008
Current Assets:
Cash…………………………………………………………………………….
Notes Receivable…………………………………………………………….
Account Receivable…………………………………………………………
Inventory………………………………………………………………………
Prepaid Expenses……………………………………………………………
Total Current Assets………………………………………………………….
Plant and Equipment:
Furniture………………………………………………………………………
Land……………………………………………………………………………
Building……………………………………………………………………….
Total Plant and Equipment…………………………………………………..
Other Assets:
Land held as a future building site……………………………………….
Total Assets……………………………………………………………………..
$ 30,000
15,000
25,000
9,500
4,500
84,000
20,000
90,000
70,000
180,000
80,000
344,000
Classified Balance Sheet (Continued)
Current Liabilities:
Notes Payable…………………………………………………………………….
Accounts Payable………………………………………………………………..
Outstanding expenses………………………………………………………….
Total Current Liabilities…………………………………………………………..
$ 22,000
10,000
4,000
36,000
Long Term Liabilities:
Bank Loan…………………………………………………………………………
44,000
Owner’s Equity:
Brain Capital……………………………………………………………………..
264,000
Total Liabilities and owner’s equity…………………………………………...
344,000
Classified Income Statement
An Income Statement can be prepared either in
multiple-steps or in single-step format.
Multiple-steps Income Statement
1.
2.
3.
4.
5.
6.
7.
Net Sales
Cost of goods sold
Gross profit
Operating expenses
Operating Income
Non-operating Items
Net Income
Multiple-step Income Statement
Star Computers
Income Statement
For the period ended, Dec 31st, 2008
Net Sales ……………………………………………………………………………..
Less: Cost of Goods Sold …………………………………………………………
Gross Income ……………………………………………………………………….
Less: Operating Expenses
Selling Expenses:
Sales salaries and commissions ……………………. $ 78,800
Advertising ……………………………………………… 42,000
Delivery Expenses …………………………………….. 14,200
Total Selling Expenses……………………………………………. 135,000
General & Administrative Expenses:
Administrative & Office Salaries ……………………… 73,000
Refreshment Expenses ………………………………… 6,500
Depreciation: Building ………………………………… 8,500
Total General & Administrative Expenses……………………… 88,000
Total Operating Expenses…………………………………………………………..
Operating Income…………………………………………………………………….
$ 900,000
(540,000)
360,000
(223,000)
137,000
Operating Income ………………………………………………………………….
Add (Less): Non-Operative Items
Interest revenues……………………………………………………… $ 3,000
Purchase discount lost…………………………………................... (1,200)
137,000
Net Income ………………………………………………………………………….
138,800
1,800
Single Step Income Statement
Star Computers
Income Statement
For the period ended, Dec 31st, 2008
Revenues:
Net Sales…………………………………………………………………………………..
Interest Earned…………………………………………………………………………..
Total Revenue……………………………………………………………………….
Less: Costs and Expenses:
Cost of Goods Sold…………………………………………………… $ 540,000
Selling Expenses……………………………………………………… 135,000
General & Administrative Expenses………………………………
88,000
Purchase Discount Lost…………………………………………….
1,200
Total Costs and Expenses…………………………………………………………
( 764,200)
Net Income……………………………………………………………………………….
$ 138,800
$ 900,000
3,000
903,000
End of Chapter 5