CHAPTER THREE

ACCOUNTING CYCLE FOR MERCHANDISING BUSINESS

3.1 Characteristics of merchandising business

A business that purchases and sells goods is called a merchandising business. A merchandising
business that sells to those who use or consume the goods is called a retail merchandising
business. A business that buys and resells merchandise to retail merchandising businesses is
called a wholesale merchandising business. Service and merchandising businesses use many of
the same accounts. A merchandising business has additional accounts on the balance sheet and
income statement to account for the purchase and sale of merchandise. Merchandises are
products or goods which are acquired to resale for others. The other name of merchandise is
inventory. Merchandising enterprise acquires merchandise for resale to customers. It is the
selling of merchandise. Thus in a case of merchandising company, the accounting systems deals
with the purchases and selling of merchandises. Merchandise transactions are recorded in the
accounts, using the rules of debit and credit that we described and illustrated in chapter two.
The various businesses that sales electronics materials and stationary items in Ethiopia are called
merchandising companies because they buy and sell merchandise rather than perform services as
their primary source of revenue. The primary source of revenues 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.
3.2 Accounting for purchases of merchandises
Purchase in merchandising firm refers to the purchase of goods for resell purpose. Then,
accounting for purchases is all about how buyers make a record when goods are acquired for
resale.
The merchandise purchased for resale is recorded in purchase account of the ledger. The
purchase account is used only to record merchandise acquired for resale, while assets acquired
for use in operation of the firm, such as supplies, equipment, should be debited to specific asset
accounts rather than to purchases account.
Purchase account is a temporary account with a normal balance of debit side. At the end of the
period the balance of purchase account shows the total cost of the merchandise purchased during
the period and reported as expense (cost of goods sold). Therefore, purchase account serves to
accumulate cost of purchases and closed to income summary account at the end of the period.

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Purchase of merchandise can be made on account or cash bases. If purchase is made for cash,
the purchase balance will increase and shown by debiting purchase account and cash balance will
decrease and shown by crediting cash. On the other hand, if a purchase is made on credit, both
purchases as well as liability accounts of the buyer will increase, this shown by debiting purchase
account and crediting liability account.
Example: Assume the following transactions for Alex stationary shop;
January 2, 2012: Purchased merchandise of Br 10,000 for cash
January 4, 2012: Purchase merchandise of Br 4,000 on account
January 8, 2012: Made another purchase of merchandise costing Br 4,300 of which
Br 3,500 in cash and the remaining on credit.
January 10, 2012: Purchase office supplies of Br 2,000 that used for business operation
for an agreement to pay in the near future.
Required: Pass the necessary journal entries for Alex Stationary shop?
Solution
January 2, 2012 purchases……………………………………….. 10,000
Cash…………………………….………………… 10,000
January 4, 2012 purchases……………………………………….. 4,000
Accounts Payable…………………………….…… 4,000
January 8, 2012 purchases……………………………………….. 4,300
Cash…………………………………………….....3,500
Accounts Payable…………………………….……. 800
January 10, 2012 Supplies……………………………………….. 2,000
Accounts Payable…………………………….…… 2,000

3.2.1 Purchase Return and Allowance

When the merchandising enterprise get the purchased merchandise are defective,
unsatisfactory/inferior quality or wrong specification, may return the goods to the supplier(seller)
for reduction of liability, if purchase was made on account or for cash refund, if purchase was
made initially on cash. This transaction is called purchase returns. Whereas, the merchandising
enterprise may choose to keep the purchased merchandise and request (ask) price reduction,
price adjustment for those defective goods. This transaction is a purchase allowance.
The buyer initiates request for reduction of amount payable or cash refund by issuing a debit
memorandum. It is a form used issued by the buyer to inform a seller that a debit has been made
to sellers account (cash or account payable) because of unsatisfactory merchandise.
Then, this directly return of purchased merchandise as well as request of price adjustment for
unsatisfactory merchandise represents a reduction in the cost of goods purchased for resale and

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recorded in a separate account called purchase return and allowance. It is a contra account to
purchase with a normal balance of credit side.
The reason behind using a separate purchase return and allowance account instead of directly
crediting purchase account is to enable management to identify the amount of return and
allowance that have been proven unsatisfactory.
Example: Assume the following transactions are for ABC merchandising company;
January 2: Purchased merchandise of Br 8,000 on account
January 4: Out of merchandise purchased on January 2, having a value of Br 400 were
Defective and returned to sellers
January 10: made another purchase for cash of Br 4,000
January 18: ABC merchandising company Br 1,000 of purchase was made on January 10
was found to be inferior
Quality and ask price reduction of Br 200.
Required: Make the necessary journal entries for purchase and returns by ABC Merchandise
Company
January 2, purchases……………………………………….. 8,000
Accounts Payable…………………………….…… 8,000
January 4, Accounts Payable ……………………………….... 400
Purchase return and allowance ……………………...400
January 10, purchases……………………………………….. 4,000
Cash…………………………………………....4,000
January 18, Cash ……………………………………………...... 200
Purchase return and allowance ………………..……...200

3.2.2 Purchase Discounts

The buyer and seller of merchandise made an agreement regarding to when payment shall be
made. That is if cash paid immediately at the time of sale, it is a cash term / net cash term.
Otherwise, the buyer allowed a certain period of time for payment, it is a credit term. The time
between the date of delivery (sale) and the date of payment refers a credit period. It is the period
started from the date of sale (invoice) until payment is made.
Example: For credit terms;
 Net 30 days (n/30): the payment will be due within 30 days because the buyer given 30 days
credit period to pay.
 Net 45 days: the payment will be paid within 45 days because the buyer given 45 days credit
period to pay.
 Net end of the month (n/EOM): the payment will be paid by the end of the month in which the
sale was made

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However, as a means of encouraging payment before the end of the credit period, the sellers may
offer a cash discount for the early payment of cash. That is making certain percent deductions
from the invoice, if it is paid within a specified time. For example: if an invoice for 10,000
provides for terms 1/10, n/30, the customer has two alternatives; either to pay 9, 900 in 10 days
or pay 10,000 in 30 days.
The cash discount is a purchase discount for the purchaser and sales discount for the seller of
the merchandise.
3.2.3 Purchase discount
It is a contra purchase account that is an account reduces purchase balance. Then, for the purpose
of providing information regarding the total amount of discount taken during the period, it is
recorded in a separate account called purchase discount account.
Example: The following transactions are for Sifan merchandising Company
December 3: Purchased merchandise costing Br 40,000 on account and a credit term were 2/15,
n/30.
December 18: Paid its liability for December3 purchase on account
Required: Pass the required journal entries for Sifan merchandising Company on; December 3
and December 18.
December 3, purchases……………………………………….. 40,000
Accounts Payable…………………………….…… 40,000
December 18, Accounts Payable ……………………….….... 40,000
Purchase discount………………..……………….…....800
Cash…………………………………………………39,200
Example: The following transactions were for ABC merchandising company;
On December 10: Acquired merchandises of Br 20,000 on account under terms 2/10, n/45.
On December 15: Out of goods purchased on December 10, merchandise having a value of Br
800 was wrong specification and returned to the seller.
On December 20: Paid for purchases made on December 10.
Required: Make the required journal entries on December 10, December 15, and December 20?
December 3, purchases……………………………………….. 20,000
Accounts Payable…………………………….…… 20,000
December 15, Accounts Payable ……………………………….... 800
Purchase return and allowance ………………..……...800
December 20, Accounts Payable ……………………….…...... 19,200
Purchase discount………………..……………….…....384
Cash…………………………………………………18,816

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3.3 Accounting for Sales of merchandise
In accordance with the revenue recognition principle, companies record sales revenue when the
performance obligation is satisfied. Typically, the performance obligation is satisfied when the
goods transfer from the seller to the buyer. At this point, the sales transaction is complete and the
sales price established.
Sales can be made on cash basis or on credit basis. Sales of merchandise on cash recorded as a
debit to cash and credit to sales account, while sales made on account recorded as debit to
account receivable and credit to sales account.
Example
On October 4: BCD Merchandise Company sold merchandise for Br 30,000 in cash to
ABC Merchandise Company
On October 10: BCD Merchandise Company also sold merchandise totaling Br 24, 000 on credit
to XYZ merchandising Company
On October 22: BCD Merchandise Company made another sale of merchandise for CDE
Merchandising Company having a value of Br 40,000 of which one fourth was
paid in cash and the remaining on account
Required: Make the necessary journal entries for both the seller and buyer merchandising
Company on October 4, October 10 and October22.
Solution
October 4, Cash ……………………………………….. 30,000
Sales revenue…………………………….…… 30,000
October 10, Account receivable………………………….. 24,000
Sales revenue……………………….…….…… 24,000
October 22, Cash……………………………….…….10,000
Account receivable………………….….. 30,000
Sales revenue……………………………… 40,000
3.3.1 Sales discount
Sales discount is a price reduction (discount) taken by the buyer for early payment of invoices
and it is a discount (price reduction) offered by the seller to early payment of credit invoices.
Hence, what is purchase discount for buyer is sales discount for seller.
As discussed previously, purchase discount is computed on net purchases, like wise sales
discount should also be computed on net sales, sales minus sales return and allowance.
Example
On January 1: Z merchandising company has sold merchandise for Br 10,000 for ABC
Company on account, terms of sale was 2/14, n/30.
On January 15: Z Company collects cash from customers for sales made on January 1.

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Required: Pass the necessary journal entries for Z Merchandising Company for the month of
January?
January 1, Account receivable………………………….. 10,000
Sales revenue……………………….…….…… 10,000
January 15, Cash……………………………….…….9,800
Sales discount………………………...…...200
Account receivable………………….….. 10,000

3.3.2 Sales return and allowance

Sales return refers to merchandise that customers return to the seller after a sale because of
defects and other reasons while sales allowance refers to reduction in the price merchandise
already sold to customers. Therefore, what is sales return and allowance for seller is purchase
return and allowance for the buyer.
Because managers need information about return and allowance to solve the problem, to record
sales return and allowance a separate contra sales account called sales return and allowance is
used instead of directly reducing sales (debiting sales).
In connection to sales return and allowance, the seller usually prepares a credit memorandum
to inform buyer that credit has been made to buyer’s account (cash and account receivable).
Example: The following transactions were for ABC merchandising company;
On October 4: Sold merchandise for Br 10,000 on cash basis for Alex trading.
On October 8: The Company made another sale of Br 12,000 on account for BCD Company.
On October 10: Merchandise having a value of Br 200 is returned from October 4 sales.
On October 14: From October 8 sales goods sold for Br 1,000 were returned because of defect.
Required: Make the required journal entries on October 4,October 8,October 10 and October 14.
Solution
October 4, Cash ……………………………………….. 10,000
Sales revenue…………………………….…… 10,000
October 8, Account receivable………………………….. 12,000
Sales revenue……………………….…….…… 12,000
October 10, Sales return and allowance……………….…….200
Cash …………………………………………….. 200
October 14, Sales return and allowance……………….…….200
Account receivable ………………………….……….. 200

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Trade discount
To attract more clients and to increase the volume of sales suppliers of merchandise arrange
trade discount. It is a deduction from the list price of merchandise. Its main objective is to induce
clients to purchase in large quantity.
When the available trade discounts are taken, purchase of merchandise recorded net of trade
discount i.e. on final price.
Example: IKA sold 500 T.V. sets, each with a list price of Birr 80, on January 17, 2001 for
cash. It gave the customer a 30% trade discount, as the customer was a very loyal one. Record
the sale.
Answer:
List price of goods (80 X 500) Birr 40,000
Less: Trade discount (30 % of 40,000) (12,000)
Invoice price 28,000
Journal entry:
Cash……………………..28,000
Sale………………………28,000

Transportation Costs
Once merchandise has been bought or sold it has to be moved from the seller’s place to the
buyer’s place. A third party comes in to the scene here: the transportation company (or shipper)
who moves the goods between the two places. So, the question is who is going to pay to the
freighter (transportation) company. Who covers the transportation costs depends, as you might
have guessed, on the agreement between the buyer and seller.

The terms of a sale should indicate when the ownership (title) of the merchandise passes to the
buyer. This point determines which party, the buyer or the seller, must pay the transportation
costs. Thus, the term of the agreement between buyer and seller include provisions concerning:
1) When the ownership (title) of the merchandise passes to the buyer; and
2) Which party is to bear the cost of delivering the merchandise to the buyer.
If ownership passes to the buyer when seller delivers the merchandise to the shipper, the buyer
absorbs transportation cost and the term is said to be FOB Shipping Point . FOB Shipping Point
means the seller place the merchandise “free on board” and the buyer responsible for the
transportation cost beyond that point.

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If ownership passes to buyer when the merchandise is received by the buyer, the seller assume
cost of transportation and the term is said to be FOB Destination. The shipping point is presented
as follow:
FOB Shipping Point FOB Destination
Ownership (title) passes to the buyer
when merchandise is Delivered to shipper Delivered to buyer
…………………………………………
.
Transportation cost are borne (paid) by
……………………………… Buyer Seller

When merchandise is purchased on terms of FOB shipping point, transportation cost paid by the
buyer should be debited to Transportation In or Freight In account and credited to cash.
The balance of transportation in account should be added to net purchases to determine the total
cost of merchandise purchased.
If the seller prepay the transportation cost and add them to the invoice, the buyer will debit
transportation in for transportation cost.
Example : On June 10, Durban Co. purchased merchandise of $900 from Bell Corp. on account,
terms of FOB shipping point, 2/10, n/30, with prepaid transportation cost of $50 added to the
invoice. The entry by Durban Co. could be as follows:
Purchases…………………………………………..900
Transportation in……………………………….……50
AP…………………………………………………………..950
When the agreement states that the seller is to bear the delivery costs (FOB destination), the
amounts paid by the seller for delivery are debited to transportation out (it is expense account
and presented as selling expense).
3.4 Merchandise transactions using Perpetual and Periodic inventory systems
Merchandise transactions are recorded in the accounts, using the rules of debit and credit that are
described and illustrated in Chapter 2. There are two inventory systems to account for
inventories or merchandising transactions:
1. Perpetual inventory system
2. Periodic inventory system
1. Perpetual inventory system
 In a perpetual inventory system, the cost of goods sold and the decrease in inventory is
continuously recorded at the time of each sale.

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  In this way, the amount of goods available for sale and the amount sold are continuously
(perpetually) updated in the inventory records.
 In a perpetual inventory system, each purchase is recorded in inventory account.
 Purchase discounts, purchase return and allowances are recorded in inventory account.
2. Periodic inventory system
 In a periodic inventory system, the inventory does not show the amount of goods
available for sale and the amount sold at the time of each sale.
 Instead, physical inventory count is used to determine the cost of goods on hand at the
end of the period and the cost of goods sold during the period.
 The purchase of inventory is recorded in the purchase account.
 Sales are recorded in the same manner as in the perpetual inventory system.
 However, cost of goods sold is not recorded on the date of sale.
 Purchase discounts, purchase return and allowances are recorded in a separate account
called purchase discount, purchase return and allowances account respectively.
Example: The following transactions were for XYZ merchandising company;
On May 4: XYZ merchandising company purchased merchandise of Br 3,800 from Bell
Company. On account, terms of FOB shipping point, 2/10, n/30.
XYZ Company’s book
May 4: Purchase ………. 3,800 May 4: Inventory………. 3,800
Accounts Payable…….. 3,800 Accounts Payable….. 3,800

On May 6: XYZ merchandising company paid a transportation cost of Br 150.

May 6: Freight in ………. 150 May 6: Inventory………. 150
Cash …………..….. 150 Cash ……..………….. 150

On May 8: Out of goods purchased on May 4, merchandise having a value of Br 300 was
wrong specification and returned to the seller.

May 8 Accounts Payable ………. 300 May 8: Accounts Payable ………. 300
Purchase return and allowance …… 300 Inventory………….….... 300

On May 14: Paid for purchases made on May 4.

May 14: Accounts Payable ....3,500 May 14: Accounts Payable ....3,500
Purchase discount…………....70 Inventory …….………..…....70
Cash…………………………3,430 Cash……………..………3,430
Bell Company’s book
On May 4: Bell Company sold merchandise of Br 3,800 for XYZ Company on account with
terms of FOB shipping point, 2/10, n/30 and the cost to this inventory was Br2,400.
May 4: Account receivable…… 3,800 May 4: Account receivable…..3,800
Sales revenue…… 3,800 Sales revenue……………3,800
May 4: No entry for cost of goods sold May 4:Cost of goods sold.. 2,400
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 Inventory ……………..… 2,400

On May 8: Merchandise having a value of Br 300 is returned from May 4 sales and the cost
to this inventory was Br140.
May 8: Sales return and allowance…300 May 8: Sales return and allowance..300
Account receivable …………300 AR……..………………..…300
May 8: No entry for cost of goods sold May 8: Inventory….... 140
Cost of goods sold ……… 140
May 14: Bell Company collects cash from XYZ Company for sales made on May 4.
May 14: Cash…………….3, 430 May 14: Cash…………….3, 430
Sales discount……70 Sales discount…….70
Account receivable……3,500 Account receivable..…3,500

3.5 Financial Statements for a Merchandising Business

The basic financial statement for merchandising enterprise includes income statement,
statement of financial position, statement of owner’s equity, and statement of cash flow, are
similar to those of service enterprise. For corporation type of merchandise enterprise the
financial statement includes statement of retained earnings rather than statement of owner’s
equity. The basic difference between the financial statement of merchandise enterprise and
service enterprise is the income statement section of cost of goods sold and the balance sheet
section of inventory.
Income Statement
There are two widely used forms for the income statement: multiple – step and single – step.
Multiple – Step forms of Income Statement
The multiple – step income statement is so called because of its many sections, sub sections and
intermediate balances. Such as:
1. Revenue from sales: the total of all charges to customers for merchandise sold, both on
account and cash, is reported in this section. Sales return and allowances and sales discounts
are deducted from the gross amount to yield net sales.
2. Cost of goods sold: this section is for the determination of cost of goods sold. The other name
of cost of goods sold is cost of merchandise sold or cost of sales.
3. Gross Profit: the excess of the net revenue from sales over the cost of merchandise sold is
called gross profit or gross margin. It is called gross because operating expenses must be
deducted from it.
4. Operating Expenses: for retail business, operating expenses can be sub divide in to two
categories: selling and administrative expenses. Selling expenses are incurred directly and
entirely in connection with sale of merchandise. They include such expenses such as: salaries
for sales man, store supplies used, depreciation of the store equipment and advertisement cost.

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 Administrative expenses or general expenses incurred in the administration of the business,
such as: office salaries, depreciation of office equipment, and office supplies used rent
expenses, insurance expenses etc.
5. Income from Operations: the excess of gross profit over total operating expenses is called
income from operation. If operating expenses are greater than gross profit, the excess is called
loss from operations.
6. Other Income: revenue sources other than the principal activities of the business are classified
as other income, or non-operating income. Such as: income from rent, interest income and
gain from sales of plant assets.
7. Other expenses: expenses that are not associated with operations of the business, such as
interest expenses and loss from disposals (sales) of the business plant assets.
The two categories of non-operating items are offset against each other on the income
statement. If the total of other income exceeds the total of other expenses, the difference is
added to income from operations. If the total of other expenses exceeds the difference is
subtracted from income from operations.
8. Net Income or: the final figure on the income statement is net income (or net loss).

Single – Step form of Income Statement

In single – step income statement the total expenses deducted from the totals of revenues. An
objection (disadvantage) of the single – step form of income statement is the relationships as of
gross profit to sales and income from operations to sales are not as readily determinable as they
are when the multiple – step form of income statement
In the following pages single – step income statement and multiple – step income statement for
pw Audio supply illustration is presented as follows respectively:
Single – step income statement
XYZ SUPPLY
Income Statement
For the Year Ended December 31, 2017
Revenues:
Net Sales………………………………………………………………………….$XXX
Expenses:
Cost of goods Sold………………………………………..…XXX
operating expenses …………………………………………..XXX
Total Expenses……………………………………………………………………XXX
Net Income…………………………………………………………………………$XXX

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Multiple – step income statement
XYZ SUPPLY
Income Statement
For the Year Ended December 31, 2017
Sales:
Sales revenue…………………………………………… $XXX
Less: Sales returns and allowances…………. XXX
Sales discounts……………………….. XXX (XXX)
Net sales………………………………………....………………….……… XXX
Inventory, January 1 ……………………………………….………………....$XXX
Purchases……………………….……………….…....…. $XXX
Less: Purchase returns and allowances ……. $XXX
Purchase discounts ……………………. XXX (XXX)
Net purchases …..…………………………...…………………………........XXX
Add: Freight-in..…………………...…………………………………...…….....XXX
Cost of goods purchased………………………………………………..........XXX
Cost of goods available for sale…………………………………………...... XXX
Less: Inventory, December 31 ……………………………………………..….XXX
Cost of goods sold………………………………………………………..….$XXX
Gross profit…………………………………………….……………………. XXX
Operating expenses:
Salaries and wages expense …………….XXX
Utilities expense………………………….XXX
Advertising expense ……………………..XXX
Depreciation expense…………………….. XXX
Freight-out ………………………………...XXX
Insurance expense……………………...….. XXX
Total operating expenses…………………………………………………….. (XXX)
Net income (Income from operations)………………………………..………...XXX
Statement of Financial Position
The arrangement of assets on the left hand side of the statement of financial position and,
liabilities and owner’s equity on the right hand side of the statement of financial position is
called account form. The arrangement of the three section of the statement of financial
position in the downward sequence called report form.

XYZ SUPPLY
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 Statement of Financial Position
December 31, 2017
Assets:
Plant asset………………………………….…………...…… $XXX
Less: Accumulated depreciation – equipment……………… XXX $ XXX
Current assets:
Prepaid insurance…………………………………………...…. XXX
Inventory……………………………………………….……. XXX
Accounts receivable………………………………………….. XXX
Cash………………………………………………………...….XXX XXX
Total assets……………………………....………………………………………. $XXX
Equity and Liabilities:
Equity
Share capital- ordinary……………………………….. $XXX
Retained earnings………………………………………XXX
Total stockholder’s equity $XXX
Liabilities
Salaries and wages payable…………………………..…XXX
Accounts payable ……………………………………..XXX
Total liabilities……………………………………………………………………….…..XXX
Total equity and liabilities……………………………………………………. $XXX

Cost of merchandise sold

For merchandising enterprises that uses the periodic system, the cost of merchandise sold during
the period is reported in a separate section in the income statement. Merchandise business using
this inventory system reports the cost of merchandise sold, the beginning and ending inventories
in the income statement in the following manner

Cost of merchandise sold

Beginning inventory……………………………………………………...........xxx

Purchases…………………………………………. xx

Less purchase discount and allowance……………xx

Net purchases…………………………………………………xxx

Add: Freight in …………………………………………….......xx

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Cost of merchandise purchased…………………………………………………xxx

Merchandise available for sale…………………………………………………..xxx

Less merchandise inventory on hand at the

End of the period (Ending inventory)……………………………………………xxx

Cost of merchandise sold………………………………………………………..xxxx

Or CGS=BI+ Cost of merchandise purchased- EI=BI +CMP–EI

Cost of merchandise purchased= net purchase + transportation in

CGAFS= BI + CMP

CGAFS= Cost of goods available for sale

CGAFS-EI=CGS

Note - Purchase returns & allowances and purchase discounts are deducted from the total
purchases to yield the net purchases.

- Transportation costs are added to the net purchases to yield cost of merchandise purchased.

- The beginning inventory id added to the cost of merchandise purchase to yield the merchandise
available for sale

- Ending inventory is subtracted from merchandise available for sale to yield cost of merchandise
sold.

Given

Beginning inventory………….. ……. $60,000

Purchase ……………………………...$500,000

Purchase return and allowance………..$15000

Purchase discount………………………$3560

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Freight in ………………………………..$10,440

Ending inventory…………………….......$75,000

Sales………………………………………$653,200

A, Determine the net purchase

B, determine the cost of merchandise purchased

C, cost of merchandise available for sale

D, cost of goods sold

E, gross profit

SOLUTION

Purchase – (Purchase discount +purchase return and allowance&) =$500,000-(3560+15000)

 Net purchase=$481440
 Cost of merchandise purchased=NP+TC $481440+10,440= $491,880
 CMP+CBI=CGAFS =$491,880+60,000=$551,880
 CGS=CGAFS-CEI =$551,880-75000=$476,880
 Gross profit=sale-CGS =$653,200-476,880=$176,320

Example-2, Assume that at the end of year 2003 physical count made by Guna trading company
reveals merchandise of $20,000 remains on hand. Assume also again during the following year
(2004) Guna trading company purchases additional worth of $120,000, received credit for
purchase returns and allowance $3,500, takes purchase discount of $1500 and pays
transportation cost of $7,500. And the physical count at the end of the period shows an inventory
of $35,000. Note the ending inventory of previous period (2003) becomes the beginning
inventory of this period. Determine the cost of goods sold.

Beginning inventory (2004) …………………………………………..........$20000

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Purchases ……………………………………...........$120000

Less purchase returns & allowance………$3500

Purchase discount…………….……………1500…….. (5000)

Add: Freight in…………………………………………..7500

Cost of goods purchased……………………………………………………...122500

Cost of goods available for sale …………………………………………..…..142500

Less ending inventory (December, 2004)………………………………..……..35000

Cost of goods sold……………………………………………………………..$107,500

Summary of Important Relationships on the Income Statement

 Net sales = Gross sales- (Sales Discounts + Sales Returns and allowances)
 Net purchases = Purchases – (Purchase Disc. + Purchase Ret. & allowance)
 Total cost of goods Purchased = Net purchase + Transportation –In
 Cost of goods sold = Beg inventory + Total cost of goods purchase –Ending inventory
 Gross profit = Net sales – Cost of goods sold
 Net Income = Gross Profit – operating (i.e., selling & administrative) expenses.

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