Accounting Principles

Second Canadian Edition

Weygandt · Kieso · Kimmel · Trenholm

Prepared by:
Carole Bowman, Sheridan College
 CHAPTER

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 Cas Perform

Cash Services
h

Accounts
Receivabl
e
Merchandising Company
Receive Buy
Cash Inventory
Cas
h
Sell Inventory

Accounts Merchandise
Receivabl Inventory
e
 ILLUSTRATION 5-1
INCOME MEASUREMENT PROCESS
FOR A MERCHANDISING COMPANY
Sales Less
Revenu
e
Equal
s
Cost
Costof
of Gross
Gross Less
Goods
GoodsSold
Sold Profit
Profit
Equal
s
Operating Net
Expenses Incom
e
(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

For purchases on account, Merchandise

Inventory is debited and Accounts Payable is
credited. For cash purchases, Merchandise
Inventory is debited and Cash is credited.
 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

When the purchaser directly incurs the freight

costs, the account Merchandise Inventory is
debited and Cash is credited.
 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

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.
 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

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

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.
 ILLUSTRATION 5-10
CALCULATION OF GROSS PROFIT

Gross profit is calculated by deducting cost of

goods sold from net sales as follows:

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:

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 non-
operating
activities.

As shown, the non-

operating activities
are reported
immediately after
the company’s
primary operating
activities.
CLASSIFIED BALANCE SHEET

On the balance sheet,

merchandise inventory is
reported as a current asset
and appears immediately
below accounts receivable.
This is because current
assets are listed in the
order of their liquidity.
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
 COPYRIGHT

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