5-2 CHAPTER 5 Accounting for Merchandise Operations

due to the recession and debt crisis. As a result, Carrefour's poor economic conditions made consumers extremely price-
increases in emerging markets have only served to offset conscious. As a result, the company has seen a significant drop
declines in Europe. in customer traffic.
Management has experienced upheaval, with three new Nobody said retailing is easy, but at number two in the
chief executive officers during a seven-year period. Inves- world, Carrefour has no intention of throwing in the towel. The
tors in recent years have withdrawn support for the company, company recently launched a makeover of 500 superstores in
resulting in a drop in Carrefour's share price of two-thirds in Europe, and it continues to look for expansion opportunities in
less than five years. At times, the company has struggled stra- countries that have good growth opportunities. Recently, the
tegically. Recently, it decided to quit using temporary price company opened its first store in India. Lars Olofsson, CEO
cuts to promote products. Instead, Carrefour sets prices low of Carrefour, declared: "The opening of this first store marks
on certain key items. It also decided to not set its prices as Carrefour's entry into the Indian market and will be followed
low as those of bargain stores, such as E.Leclerc (FRA). shortly by the opening of other Cash & Carry stores. This first
Carrefour's management felt that the additional services the step is essential to allow the Carrefour teams to fully under-
company provides would enable it to charge slightly higher stand the specificities of the Indian market and then build our
prices than bargain stores without losing customers. However, presence in other formats."

Chapter Outline
LEARNING O B J E C T I V E S

LO 1 Describe merchandising • Operating cycles DOIT! 1 Merchandising

operations and inventory systems. • Flow of costs Operations and Inventory
Systems

L0 2 Record purchases under a • Freight costs DOIT! 2 Purchase Transactions

perpetual inventory system. • Purchase returns and
allowances
• Purchase discounts
• Summary of purchasing
transactions

L0 3 Record sales under a • Sales returns and allowances DOIT! 3 Sales Transactions
perpetual inventory system. • Sales discounts

L0 4 Apply the steps in • Adjusting entries DOIT! 4 Closing Entries

the accounting cycle to a • Closing entries
merchandising company.
• Summary of merchandising
entries

L0 5 Prepare financial statements • Income statement DOIT! 5 Financial Statement

for a merchandising company. • Classified statement of financial Classifications
position

Go to the Review and Practice section at the end of the chapter for a review of key concepts
and practice applications with solutions.
 Merchandising Operations and Inventory Systems 5-3

Merchandising Operations and Inventory Systems

LEARNING O B J E C T I V E 1
Describe merchandising operations and inventory systems.

Metro (DEU), Carrefour (FRA), and Tesco (GBR) are called merchandising compa-
nies because they buy and sell merchandise rather than perform services as their primary
source of revenue. Merchandising companies that purchase and sell directly to consumers
are called retailers. Merchandising companies that sell to retailers are known as wholesal-
ers. For example, retailer Walgreens (USA) might buy goods from wholesaler Grupo Casa
SA de C V (MEX). Retailer Office Depot (USA) might buy office supplies from wholesaler
Corporate Express (NLD). The primary source of revenue for merchandising companies is
the sale of merchandise, often referred to simply as sales revenue or sales. A merchandising
company has two categories of expenses: cost of goods sold and operating expenses.
Cost of goods sold is the total cost of merchandise sold during the period. This expense
is directly related to the revenue recognized from the sale of goods. Illustration 5.1 shows the
income measurement process for a merchandising company. The items in the two blue boxes
are unique to a merchandising company; they are not used by a service company.

ILLUSTRATION 5.1
Sales Less Income measurement process

1
Revenue for a merchandising company

Cost of Equals Gross Less

Goods Sold Profit

1
Operating E
quals
Net
Income
Expenses *
(Loss)

Operating Cycles
The operating cycle of a merchandising company ordinarily is longer than that of a service
company. The purchase of merchandise inventory and its eventual sale lengthen the cycle.
Illustration 5.2 shows the operating cycle of a service company.

ILLUSTRATION 5.2
Service Company
Operating cycle for a service
company
Receive Cash Perform Services
Cash
1

^^^^1AIL
[&\
t Accounts
Receivable
5-4 CHAPTER 5 Accounting for Merchandise Operations

Illustration 5.3 shows the operating cycle o f a merchandising company.

ILLUSTRATION 5.3
Merchandising Company
Operating cycle for a
merchandising company 7 ^A
Receive Cash Buy Inventory
Cash
MAIL
i L

Sell Inventory

Accounts
Receivable Inventory

Note that the added asset account for a merchandising company is the Inventory account.
Companies report inventory as a current asset on the statement o f financial position.

Flow of Costs
The flow o f costs for a merchandising company is as follows. Beginning inventory plus the
cost o f goods purchased is the cost o f goods available for sale. As goods are sold, they are
assigned to cost o f goods sold. Those goods that are not sold by the end o f the accounting
period represent ending inventory. Illustration 5.4 describes these relationships. Companies
use one o f two systems to account for inventory: a perpetual inventory system or a periodic
inventory system.

ILLUSTRATION 5.4
Flow of costs Beginning Cost of Goods
Inventory Purchased

\
Cost of Goods
Available for Sale

Cost of
/ \
Ending
Goods Sold Inventory

Perpetual System
H E L P F U L HINT In a perpetual inventory system, companies keep detailed records o f the cost o f each inven-
Even under perpetual inven- tory purchase and sale (see Helpful Hint). These records continuously—perpetually—show
tory systems, companies take the inventory that should be on hand for every item. For example, a Toyota (JPN) dealership
a physical inventory count. has separate inventory records for each automobile, truck, and van on its lot and showroom
This is done as a control pro- floor. Similarly, a Morrisons (GBR) grocery store uses bar codes and optical scanners to keep
cedure to verify inventory a daily running record o f every box o f cereal and every jar of j e l l y that it buys and sells. Under
levels, in order to detect theft a perpetual inventory system, a company determines the cost o f goods sold each time a sale
or "shrinkage." occurs.
 Merchandising Operations and Inventory Systems 5-5

Periodic System
In a periodic inventory system, companies do not keep detailed inventory records of the
goods on hand throughout the period. Instead, they determine the cost of goods sold only at
the end of the accounting period—that is, periodically. At that point, the company takes a
physical inventory count to determine the cost of goods on hand.
To determine the cost of goods sold under a periodic inventory system, the following
steps are necessary:

1. Determine the cost of goods on hand at the beginning of the accounting period.
2. Add to it the cost of goods purchased.
3. Subtract the cost of goods on hand as determined by the physical inventory count at the
end of the accounting period.

Illustration 5.5 graphically compares the sequence of activities and the timing of the cost
of goods sold computation under the two inventory systems.

ILLUSTRATION 5.5
Inventory Purchased Item Sold End of Period
Comparing perpetual and
periodic inventory systems

Perpetual No entry

Record purchase Record revenue

of inventory and
compute and record
cost of goods sold

Inventory Purchased Item Sold End of Period

Compute and
Periodic —• record cost
of goods sold
Record purchase Record revenue
of inventory only

Advantages of the Perpetual System

Companies that sell merchandise with high unit values, such as automobiles, furniture,
and major home appliances, have traditionally used perpetual systems. The growing use of
computers and electronic scanners has enabled many more companies to install perpetual
inventory systems. The perpetual inventory system is so named because the accounting
records continuously—perpetually—show the quantity and cost of the inventory that should
be on hand at any time.
A perpetual inventory system provides better control over inventories than a peri-
odic system. Since the inventory records show the quantities that should be on hand, the
company can count the goods at any time to see whether the amount of goods actually
on hand agrees with the inventory records. I f shortages are uncovered, the company can
investigate immediately. Although a perpetual inventory system requires both additional
clerical work and expense to maintain the subsidiary records, a computerized system can
minimize this cost. Much of Amazon.corn's (USA) success is attributed to its sophisti-
cated inventory system.
Some businesses find it either unnecessary or uneconomical to invest in a computerized
perpetual inventory system. Many small merchandising businesses now use basic account-
ing software, which provides some of the essential benefits of a perpetual inventory system.
-6 CHAPTER 5 Accounting for Merchandise Operations

Also, managers of some small businesses still find that they can control their merchandise
and manage day-to-day operations using a periodic inventory system.
Because of the widespread use of the perpetual inventory system, we illustrate it in
this chapter. We discuss and illustrate the periodic system in Appendix 5B.

Investor Insight
Improving Its Share control problems. To reduce investor concerns, the company
Annpal implemented a perpetual inventory system to improve its con-
trol over inventory. In addition, the company stated that it would
Investors are often eager to invest perform a physical inventory count every quarter until it felt that
in a company that has a hot new its perpetual inventory system was reliable,
product. However, when a fast-
ilk. v, ~
growing snowboard-maker issued
ordinary shares to the public If a perpetual system keeps track of inventory on a daily basis,
S-vuSLiS* S for the first time, some investors why do companies ever need to do a physical count? (Go to
expressed reluctance to invest in it the book's companion website for this answer and additional
© Ben Blankenburg/iStockphoto because of a number of accounting questions.)

DO IT! 1 I Merchandising Operations and Inventory Systems ACTION PLAN

• Review merchandising
Indicate whether the following statements are true or false. I f false, indicate how to correct the
concepts.
statement.
• Understand the flow of
1. The primary source of revenue for a merchandising company results from performing services
costs in a merchandising
for customers.
company.
2. The operating cycle of a service company is usually shorter than that of a merchandising company.
3. Sales revenue less cost of goods sold equals gross profit.

4. Ending inventory plus the cost of goods purchased equals cost of goods available for sale.

Solution
1. False. The primary source of revenue for a service company results from performing services for
customers. 2. True. 3. True. 4. False. Beginning inventory plus the cost of goods purchased
equals cost of goods available for sale.
Related exercise material: BE5.1, and DO IT! 5.1, E5.1.

Recording Purchases Under a Perpetual System

LEARNING OBJECTIVE 2
Record purchases under a perpetual inventory system.

Companies purchase inventory using cash or credit (on account). They normally record
purchases when they receive the goods from the seller. Every purchase should be supported
by business documents that provide written evidence of the transaction. Each cash purchase
should be supported by a canceled check or a cash register receipt indicating the items pur-
chased and amounts paid. Companies record cash purchases by an increase in Inventory and
a decrease in Cash.
Buyer
 Problems 5-47

July 1 Purchased suitcases on account for £1,620 from Trunk Manufacturers, FOB destination,
terms 2/10, n/30. The appropriate party also made a cash payment of £100 for freight on
this date.
3 Sold suitcases on account to Satchel World for £2,200. The cost of suitcases sold was
£1,400.
9 Paid Trunk Manufacturers in full.
12 Received payment in full from Satchel World.
17 Sold suitcases on account to Lady GoGo for £1,400. The cost of the suitcases sold was
£1,030.
18 Purchased suitcases on account for £1,900 from Holiday Manufacturers, FOB shipping
point, terms 1/10, n/30. The appropriate party also made a cash payment of £125 for freight
on this date.
20 Received £300 credit (including freight) for suitcases returned to Holiday
Manufacturers.
21 Received payment in full from Lady GoGo.
22 Sold suitcases on account to Vagabond for £2,400. The cost of suitcases sold was £1,350.
30 Paid Holiday Manufacturers in full.
31 Granted Vagabond £200 credit for suitcases returned costing £120.

Ready-Set-Go's chart of accounts includes the following: No. 101 Cash, No. 112 Accounts Receivable,
No. 120 Inventory, No. 201 Accounts Payable, No. 401 Sales Revenue, No. 412 Sales Returns and
Allowances, No. 414 Sales Discounts, and No. 505 Cost of Goods Sold.

Instructions
Journalize the transactions for the month of July for Ready-Set-Go using a perpetual inventory system.

P5.2 (LO 2, 3, 5) Vree Distributors completed the following merchandising transactions in the month Journalize, post, and prepare
of April. At the beginning of April, the ledger of Vree showed Cash of €8,000 and Owner's Capital of a partial income statement.
€8,000.

Apr. 2 Purchased merchandise on account from Walker Supply €6,200, terms 1/10, n/30.
4 Sold merchandise on account €5,500, FOB destination, terms 1/10, n/30. The cost of the
merchandise sold was €3,400.
5 Paid €240 freight on April 4 sale.
6 Received credit from Walker Supply for merchandise returned €500.
11 Paid Walker Supply in full, less discount.
13 Received collections in full, less discounts, from customers billed on April 4.
14 Purchased merchandise for cash €3,800.
16 Received refund from supplier for returned goods on cash purchase of
April 14, €500.
18 Purchased merchandise from Benjamin Glassware €4,500, FOB shipping point,
terms 2/10, n/30.
20 Paid freight on April 18 purchase €160.
23 Sold merchandise for cash €7,400. The merchandise sold had a cost of €4,120.
26 Purchased merchandise for cash €2,300.
27 Paid Benjamin Glassware in full, less discount.
29 Made refunds to cash customers for defective merchandise €90. The returned merchandise
had a fair value of €30.
30 Sold merchandise on account €3,400, terms n/30. The cost of the merchandise sold was
€1,900.

Vree's chart of accounts includes the following: No. 101 Cash, No. 112 Accounts Receivable, No.
120 Inventory, No. 201 Accounts Payable, No. 311 Owner's Capital, No. 401 Sales Revenue, No. 412
Sales Returns and Allowances, No. 414 Sales Discounts, No. 505 Cost of Goods Sold, and No. 644
Freight-Out.

Instructions
a. Journalize the transactions using a perpetual inventory system.
b. Enter the beginning cash and owner's capital balances, and post the transactions. (Use J l for the
journal reference.)
c Prepare the income statement through gross profit for the month of April 2020. c. Gross profit €6,765
 Expand Your Critical Thinking 5-5]

Comprehensive Accounting Cycle Review

ACR5 On December 1, 2020, Jurczyk Distributing had the following account balances.

Debit Credit
Cash € 7,200 Accumulated Depreciation—
Accounts Receivable 4,600 Equipment € 2,200
Inventory 12,000 Accounts Payable 4,500
Supplies 1,200 Salaries and Wages Payable 1,000
Equipment 22,000 Owner's Capital 39,300
€47,000 €47,000

During December, the company completed the following summary transactions.

Dec. 6 Paid € 1,600 for salaries and wages due employees, of which €600 is for December and € 1,000
is for November salaries and wages payable.
8 Received €2,100 cash from customers in payment of account (no discount allowed).
10 Sold merchandise for cash €6,600. The cost of the merchandise sold was €4,100.
13 Purchased merchandise on account from Gong Co. €9,000, terms 2/10, n/30.
15 Purchased supplies for cash €2,000.
18 Sold merchandise on account €12,000, terms 3/10, n/30- The cost of the
merchandise sold was €8,400.
20 Paid salaries and wages €1,800.
23 Paid Gong Co. in full, less discount.
27 Received collections in full, less discounts, from customers billed on December 18.

Adjustment data:
1. Accrued salaries and wages payable €800.
2. Depreciation €200 per month.
3. Supplies on hand €1,700.
4 Inventory on hand December 31 8,400
Instructions
a. Journalize the December transactions using a perpetual inventory system.
b. Enter the December 1 balances in the ledger T-accounts and post the December transactions. Use
Cost of Goods Sold, Depreciation Expense, Salaries and Wages Expense, Sales Revenue, Sales
Discounts, and Supplies Expense.
c. Journalize and post adjusting entries.
d. Prepare an adjusted trial balance. d. Totals €65,600
e. Prepare an income statement and an owner's equity statement for December and a classified e. Net income €840
statement of financial position at December 31.

Expand Your Critical Thinking

Financial Reporting Problem: TSMC, Ltd. (TWN)

CT5.1 The financial statements of T S M C are presented in Appendix A at the end of this textbook. The
complete annual report, including the notes to the financial statements, is available at the company's
website.

Instructions
Answer the following questions using TSMC's consolidated income statement.
a- What was the percentage change in (1) sales (net revenue) and in (2) net income from 2015 to
2016?