Chapter 5

Accounting for
Merchandising
Operations
Chapter
5-1 Accounting Principles, Ninth Edition
 Study Objectives

1. Identify the differences between service and

merchandising companies.
2. Explain the recording of purchases under a perpetual
inventory system.
3. Explain the recording of sales revenues under a
perpetual inventory system.
4. Explain the steps in the accounting cycle for a
merchandising company.
5. Distinguish between a multiple-step and a single-step
income statement.
6. Explain the computation and importance of gross profit.

Chapter
5-2
 Accounting for Merchandising Operations

Completing
Recording Recording Forms of
Merchandising the
Purchases of Sales of Financial
Operations Accounting
Merchandise Merchandise Statements
Cycle

Operating Freight costs Sales returns Adjusting Multiple-step

cycles Purchase and entries income
Flow of returns and allowances Closing entries statement
costs— allowances Sales Summary of Single-step
perpetual and Purchase discounts merchandising income
periodic discounts entries statement
inventory Classified
Summary of
systems balance sheet
purchasing
transactions

Chapter
5-3
 Merchandising Operations

Merchandising Companies
Buy and Sell Goods

Wholesaler Retailer Consumer

The primary source of revenues is referred to as

sales revenue or sales.
Chapter
5-4 SO 1 Identify the differences between service and merchandising companies.
 Merchandising Operations

Income Measurement
Not used in a
Sales Less
Service business.
Revenue
Illustration 5-1

Cost of Equals Gross Less

Goods Sold Profit

Operating Equals Net

Cost of goods sold is the total Income
cost of merchandise sold Expenses
(Loss)
during the period.

Chapter
5-5 SO 1 Identify the differences between service and merchandising companies.
 Operating Cycles
Illustration 5-2

The operating
cycle of a
merchandising
company
ordinarily is
longer than that
of a service
company.

Chapter
5-6 SO 1 Identify the differences between service and merchandising companies.
 Flow of Costs

Perpetual System
Features:
1. Purchases increase Merchandise Inventory.
2. Freight costs, Purchase Returns and Allowances and
Purchase Discounts are included in Merchandise Inventory.
3. Cost of Goods Sold is increased and Merchandise Inventory
is decreased for each sale.
4. Physical count done to verify Merchandise Inventory
balance.

The perpetual inventory system provides a continuous record

of Merchandise Inventory and Cost of Goods Sold.
Chapter
5-7 SO 1 Identify the differences between service and merchandising companies.
 Flow of Costs

Periodic System
Features:
1. Purchases of merchandise increase Purchases.
2. Ending Inventory determined by physical count.
3. Calculation of Cost of Goods Sold:

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

Chapter
5-8 SO 1 Identify the differences between service and merchandising companies.
 Recording Purchases of Merchandise
Illustration 5-5

Made using cash or

credit (on account).
Normally recorded when
goods are received.
Purchase invoice should
support each credit
purchase.

Chapter
5-9 SO 2 Explain the recording of purchases under a perpetual inventory system.
 Recording Purchases of Merchandise

Under the perpetual inventory system, companies record in the

Merchandise Inventory account the purchase of goods they
intend to sell.

Illustration: At May 4th , (Ahmed) Company Purchases goods

from (Ali) Company by $3800

The entry in Ahmed Books is:

May 4 Merchandise inventory 3,800

Accounts payable 3,800

Chapter
5-10 SO 2 Explain the recording of purchases under a perpetual inventory system.
 Recording Purchases of Merchandise

Freight Costs – Terms of Sale

Illustration 5-6

Seller places goods Free

On Board to the carrier,
and buyer pays freight
costs.

Seller places goods Free

On Board to the buyer’s
place of business, and
seller pays freight costs.

Chapter Freight costs incurred by the seller are an operating expense.

5-11
 Recording Purchases of Merchandise

Illustration: Assume upon delivery of the goods on May 6,

Ahmed Company pays to Freight Company $150 for freight
charges (Terms of sales are FOB shipping point).
the entry on Ahmed’s books is:
May 6 Merchandise inventory 150
Cash 150

Assume the freight terms on the invoice in Illustration 5-5

had required PW Audio Supply to pay the freight charges, the
entry by PW Audio Supply would have been:

May 6 Freight-out (or Delivery Expense) 150

Cash 150
Chapter
5-12 SO 2 Explain the recording of purchases under a perpetual inventory system.
 Recording Purchases of Merchandise

Assume the freight terms on the invoice had required Ali

Company to pay the freight charges.

On the Ahmed’s book:

NO entry

Chapter
5-13 SO 2 Explain the recording of purchases under a perpetual inventory system.
 Recording Purchases of Merchandise

Purchase Returns and Allowances

Purchaser may be dissatisfied because goods are
damaged or defective, of inferior quality, or do not
meet specifications.

Purchase Return Purchase Allowance

Return goods for credit May choose to keep the
if the sale was made on merchandise if the seller
credit, or for a cash will grant an allowance
refund if the purchase (deduction) from the
was for cash. purchase price.

Chapter
5-14 SO 2 Explain the recording of purchases under a perpetual inventory system.
 Recording Purchases of Merchandise

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. Merchandise Inventory

Chapter
5-15 SO 2 Explain the recording of purchases under a perpetual inventory system.
 Recording Purchases of Merchandise

Illustration: Assume that on May 8 Ahmed Company returned

to Ali Company goods costing $300.

The entry On Ahmed’s Book is:

Accounts payable 300

May 8
Merchandise inventory 300

Chapter
5-16 SO 2 Explain the recording of purchases under a perpetual inventory system.
 Recording Purchases of Merchandise

Purchase Discounts
Credit terms may permit buyer to claim a cash
discount for prompt payment.
Advantages:
Purchaser saves money.
Seller shortens the operating cycle.

Example: Credit terms of 2/10, n/30, is read “two-ten, net

thirty.” 2% cash discount if payment is made within 10 days.

Chapter
5-17 SO 2 Explain the recording of purchases under a perpetual inventory system.
 Recording Purchases of Merchandise

Purchase Discounts Terms

2/10, n/30 1/10 EOM n/10 EOM

2% discount if 1% discount if Net amount due

paid within 10 paid within within the first
days, otherwise first 10 days of 10 days of the
net amount due next month. next month.
within 30 days.

Chapter
5-18 SO 2 Explain the recording of purchases under a perpetual inventory system.
 Recording Purchases of Merchandise

Illustration: Assume Ahmed Company 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 Ahmed makes to
record its May 14 payment.

May 14 Accounts payable 3,500

Merchandise Inventory 70
Cash 3,430

(Discount = $3,500 x 2% = $70)

Chapter
5-19 SO 2 Explain the recording of purchases under a perpetual inventory system.
 Recording Purchases of Merchandise

Illustration: If Ahmed failed to take the discount, and

instead made full payment of $3,500 on June 3, the journal
entry would be:

June 3 Accounts payable 3,500

Cash 3,500

Chapter
5-20 SO 2 Explain the recording of purchases under a perpetual inventory system.
 Recording Purchases of Merchandise

Purchase Discounts
Should discounts be taken when offered?
Discount of 2% on $3,500 $ 70.00
$3,500 invested at 10% for 20 days 19.18
Savings by taking the discount $ 50.82

Passing up the discount offered equates to paying an

interest rate of 2% on the use of $3,500 for 20 days.
Example: 2% for 20 days = Annual rate of 36.5%
(365/20 = 18.25 twenty-day periods x 2% = 36.5%)

Chapter
5-21 SO 2 Explain the recording of purchases under a perpetual inventory system.
 Recording Purchases of Merchandise

Summary of Purchasing Transactions

Illustration Merchandise Inventory

Debit Credit

4th - Purchase $3,500 $300 8th - Return

6th – Freight-in 150 70 14th - Discount

Balance $3,580

Chapter
5-22 SO 2 Explain the recording of purchases under a perpetual inventory system.
 Recording Sales of Merchandise

Made for cash or credit (on account).

Illustration 5-5

Normally recorded when

earned, usually when
goods transfer from
seller to buyer.
Sales invoice should
support each credit
sale.

Chapter SO 3 Explain the recording of sales revenues

under a perpetual inventory system.
5-23
 Recording Sales of Merchandise

Two Journal Entries to Record a Sale

#1 Cash or Accounts receivable XXX Selling

Sales XXX Price

#2 Cost of goods sold XXX

Cost
Merchandise inventory XXX

Chapter SO 3 Explain the recording of sales revenues

under a perpetual inventory system.
5-24
 Recording Sales of Merchandise

Illustration: Assume Ali Company records its May 4 sale of

$3,800 to Ahmed Company as follows:
Assume the merchandise cost Ali Company by $2,400.

May 4 Accounts receivable 3,800

Sales 3,800

4 Cost of goods sold 2,400

Merchandise inventory 2,400

Chapter SO 3 Explain the recording of sales revenues

under a perpetual inventory system.
5-25
 Recording Sales of Merchandise

Sales Returns and Allowances

“Flipside” of purchase returns and allowances.
Contra-revenue account (debit).
Sales not reduced (debited) because:
 would obscure importance of sales returns and
allowances as a percentage of sales.
 could distort comparisons between total sales
in different accounting periods.

Chapter SO 3 Explain the recording of sales revenues

under a perpetual inventory system.
5-26
 Recording Sales of Merchandise

Illustration: Prepare the entry Ali Company would make to

record the credit for returned goods that had a $300 selling
price (assume a $140 cost). Assume the goods were not
defective.

May 8 Sales returns and allowances 300

Accounts receivable 300

8 Merchandise inventory 140

Cost of goods sold 140

Chapter SO 3 Explain the recording of sales revenues

under a perpetual inventory system.
5-27
 Recording Sales of Merchandise

Illustration: Assume the returned goods were defective and

had a scrap value of $50.
Ali Company would make the following entries:

May 8 Sales returns and allowances 300

Accounts receivable 300

8 Merchandise inventory 50
Cost of goods sold 50

Chapter SO 3 Explain the recording of sales revenues

under a perpetual inventory system.
5-28
 Recording Sales of Merchandise

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.

Chapter SO 3 Explain the recording of sales revenues

under a perpetual inventory system.
5-29
Chapter
5-30