Chapter 5

Accounting for Merchandising Operations

Accounting 211 Instructor: Professor John Ahmad

CHAPTER 5
ACCOUNTING FOR MERCHANDISING OPERATIONS

After studying this chapter, we will be able to:

1 identify the differences between a service enterprise and a merchandising company 2 explain the entries for purchases under a perpetual inventory system 3 explain the entries for sales revenues under a perpetual inventory system 4 explain the steps in the accounting cycle for a merchandising company

CHAPTER 5
ACCOUNTING FOR MERCHANDISING OPERATIONS

After studying this chapter, we will be able to: 5 distinguish between a multiple-step and a single-step income statement 6 explain the computation and importance of gross profit 7 determine the cost of goods sold under a periodic system

MERCHANDISING COMPANY
A merchandising company buys
and sells goods to earn a profit.
1) Wholesalers

sell to retailers 2) Retailers sell to consumers

Primary source of revenue is Sales

MEASURING NET INCOME

Expenses for a merchandiser are divided into two categories:
1 2 Cost of goods sold Operating expenses
The total cost of merchandise sold during the period Expenses incurred in the process of earning sales revenue (Examples: sales salaries and insurance expense)

Gross profit is equal to Sales Revenue less Cost of Goods Sold

INCOME MEASUREMENT PROCESS FOR A MERCHANDISING COMPANY

OPERATING CYCLES FOR A SERVICE COMPANY AND A MERCHANDISING COMPANY

INVENTORY SYSTEMS
Merchandising entities may use either: 1) Perpetual Inventory
Detailed records of the cost of each item are maintained, and the cost of each item sold is determined from records when the sale occurs.

2) Periodic Inventory
Cost of goods sold is determined only at the end of an accounting period.

PERPETUAL VS. PERIODIC

COST OF GOODS SOLD

To determine the cost of goods sold under a periodic inventory system: 1) Determine the cost of goods on hand at the beginning of the accounting period, 2) Add to it the cost of goods purchased, AND 3) Subtract the cost of goods on hand at the end of the accounting period.

PURCHASES OF MERCHANDISE
Merchandise is purchased for resale to customers, the account Merchandise Inventory is debited for the cost of goods. Like sales, 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. Each credit purchase should be supported by a purchase invoice.

PURCHASES OF MERCHANDISE
SALES INVOICE

PURCHASES OF MERCHANDISE
GENERAL JOURNAL
Date May 4 Account Titles and Explanation Merchandise Inventory Accounts Payable (To record goods purchased on account, terms 2/10, n/30, from Sellers Electronix) Dr. Cr.

3,800 3,800

For purchases on account, Merchandise Inventory is debited and Accounts Payable is credited.

PURCHASE RETURNS AND ALLOWANCES

A purchaser may be dissatisfied with merchandise received because the goods: 1) are damaged or defective, 2) of inferior quality, or 3) not in accord with the purchasers specifications. The purchaser initiates the request for a reduction of the balance due through the issuance of a debit memorandum (purchasers debit decreases A/P!). The debit memorandum is a document issued by a buyer to inform a seller that the sellers account has been debited because of unsatisfactory merchandise.

PURCHASE RETURNS AND ALLOWANCES

GENERAL JOURNAL
Date May 8 Account Titles and Explanation Accounts Payable Merchandise Inventory (To record return of inoperable goods received from Sellers Electronix, DM No. 126) Dr.
300 300

Cr.

For purchases returns and allowances, Accounts Payable is debited and Merchandise Inventory is credited.

FREE ON BOARD
A sales agreement should indicate whether the seller or the buyer is to pay the cost of transporting the goods to the buyers place of business. FOB Shipping Point

1) Goods placed free on board the carrier by the seller 2) Buyer pays freight costs
FOB Destination

1) Goods placed free on board at the buyers business 2) Seller pays freight costs

ACCOUNTING FOR FREIGHT COSTS

Merchandise Inventory is debited if buyer pays freight. Freight-out (or Delivery Expense) is debited if seller pays freight.

ACCOUNTING FOR FREIGHT COSTS

GENERAL JOURNAL
Date May 6 Account Titles and Explanation Merchandise Inventory Cash (To record payment of freight, terms FOB shipping point) Dr. Cr.

150 150

When the purchaser directly incurs the freight costs, the account Merchandise Inventory is debited and Cash is credited.

ACCOUNTING FOR FREIGHT COSTS

E E
Date May 4 Account itles and Explanation Freight-out (Delivery Expense) Cash ( o record payment of freight on goods sold FOB destination) Dr. Cr.

150 150

Freight costs incurred by the seller on outgoing merchandise are debited to Freight-out (or Delivery Expense) and Cash is credited.

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. Like a sales discount, a purchase discount is based on the invoice cost less returns and allowances, if any.

PURCHASE DISCOUNTS
ENERA
ate May 14

OURNA
Dr. Cr.

Account itles and Explanation Accounts Payable Cash Merchandise Inventory ( o record payment within discount period)

3,500 3,430 70

If payment is made within the discount period, Accounts Payable is debited, Cash is credited, and Merchandise inventory is credited for the discount taken.

PURCHASE DISCOUNTS
ENERA
Date June 3

OURNA
Debit Credit

Account itles and Explanation Accounts Payable Cash ( o record payment with no discount ta en)

3,500 3,500

If payment is made after the discount period, Accounts Payable is debited and Cash is credited for the full amount.

SAVINGS OBTAINED BY TAKING PURCHASE DISCOUNT

A buyer should usually take all available discounts. If Beyer Video takes the discount, it pays $70 less in cash. If it forgoes the discount and invests the $3,500 for 20 days at 10% interest, it will earn only $19.06 in interest. The savings obtained by taking the discount is calculated as follows:
Discount of 2% on $3,500 Interest received on $3,430 (for 20days at 10%) Savings by taking the discount $ 70.00 ( 19.06) $ 50.94

SALES TRANSACTIONS
Revenues (Revenue recognition principle)
Earned when the goods are transferred from seller to buyer
All sales should be supported by a document such as a cash register tape or sales invoice.

RECORDING CASH SALES

GENERAL JOURNAL
Date May 4 Account itles and Explanation Cash Sales ( o record daily cash sales) Cost of Goods Sold Merchandise Inventory ( o record cost of merchandise sold for cash) Dr. Cr.

2,200 2,200 1,400 1,400

 For cash sales, Cash is debited and Sales is credited.  For the cost of goods sold for cash, Cost of Goods Sold is debited and Merchandise Inventory is credited.

RECORDING CREDIT SALES

GENERAL JOURNAL
Date May 4 Account Titles and Explanation Accounts Receivable Sales (To record credit sales to Beyer Video per invoice #731) Cost of Goods Sold Merchandise Inventory (To record cost of merchandise sold on invoice #731 to Beyer Video) Dr. Cr.

3,800 3,800

2,400 2,400

 For credit sales, Accounts Receivable is debited and Sales is credited.  For the cost of goods sold on account, Cost of Goods Sold is debited and Merchandise Inventory is credited.

SALES RETURNS AND ALLOWANCES

Sales Returns
Customers dissatisfied with merchandise and are allowed to return the goods to the seller for credit or a refund.

Sales Allowances
Result when customers are dissatisfied and the seller allows a deduction from the selling price.

SALES RETURNS AND ALLOWANCES

Credit memorandum
the seller prepares a form to inform the customer that a credit has been made to the customers account receivable

Sales Returns and Allowances

Contra revenue account to the Sales account

The normal balance of Sales Returns and Allowances is a debit

RECORDING SALES RETURNS AND ALLOWANCES

GENERAL JOURNAL
D t May 8 A u t itl and Explanati n al R turns and All wances Accounts Recei able ( o record return of inoperable goods deli ered to Beyer ideo, per credit memorandum) Merchandise Inventory ost of Goods old ( o record cost of goods returned per credit memorandum) Dr. r.

300 300

140 140

The sellers entry to record a credit memorandum involves a debit to the Sales Returns and Allowances account and a credit to Accounts Receivable. The entry to record the cost of the returned goods involves a debit to Merchandise Inventory and a credit to Cost Goods Sold.

SALES DISCOUNTS
Sales discount
Offer of a cash discount to a customer for the prompt payment of a balance due Is a contra revenue account with a normal debit balance Example: A credit sale has the terms 3/10, n/30, a 3% discount is allowed if payment is made within 10 days. After 10 days there is no discount, and the balance is due in 30 days.

CREDIT TERMS
Credit terms specify the amount and time period for the cash discount
Indicates the length of time in which the purchaser is expected to pay the full invoice price

T E R M

E X

L A N A T I O N

2/10, n/30

A 2% discount may be taken if payment is made within 10 days of the invoice date. A 1% discount is available if payment is made by the 10th of the next month.

1/10 EOM

RECORDING SALES DISCOUNTS

GENERAL JOURNAL
Date May 14 Account Titles and Explanation Cash Sales Discounts Accounts Receivable (To record collection within 2/10, n/30 discount period from Beyer Video) Dr. Cr.

3,430 70 3,500

When cash discounts are taken by customers, the seller debits Sales Discounts.

CLOSING ENTRIES
 Adjusting entries are journalized from the adjustment columns of the work sheet.  All accounts that affect the determination of net income are closed to Income Summary.  Data for the preparation of closing entries may be obtained from the income statement columns of the work sheet.

GENER
D t 2005 D 31 t t ( )

URN
Explanat n D t Cr t
480,000 480,000

Sales Income Summar ( o close income statement accounts wit credit balances)

CLOSING ENTRIES
Cost of Goods Sold is a new account that must be closed to Income Summary.

GENERAL
t 5 c. Inco Account Titl

RNAL
bit dit

nd Expl n tion ( )

u l Retu n nd Allow nces les iscounts ost of goods sold to e l ies Expense Rent Expense F eight-out Advertising Expense tilities Expense epreci tion Expense Insurance Expense (To close inco e statement accounts with debit balances)

140,000 12,000 8,000 316,000 45,000 19,000 7,000 16,000 17,000 8,000 2,000

CLOSING ENTRIES
GENERAL JOURNAL
Date 2005 Dec. 31 Account Titles and Explanation (3) Income Summary R. A. Lamb, Capital (To close net income to capital) (4) 31 R. A. Lamb, Capital R. A. Lamb, Drawing (To close drawings to capital) Debit Credit

30,000 30,000

15,000 15,000

 After the closing entries are posted, all temporary accounts have zero balances  It addition, R. A. Lamb, Capital has a credit balance of $9 ,000 ($ ,000 + $ 0,000 - $ 5,000).

Under a perpetual inventory system, acquisition of merchandise for resale is debited to the
purchases account supplies account merchandise Inventory account cost of Goods Sold account

Under a perpetual inventory system, acquisition of merchandise for resale is debited to the
purchases account supplies account merchandise Inventory account cost of Goods Sold account

MULTIPLE-STEP INCOME STATEMENT

Includes sales revenue, cost of goods sold, and gross profit sections Additional nonoperating sections may be added for:
1) revenues and expenses resulting from secondary or auxiliary operations 2) gains and losses unrelated too operations

MULTIPLE-STEP INCOME STATEMENT

Operating expenses may be subdivided into: a) Selling expenses b) Administrative expenses Nonoperating sections are reported after income from operations and are classified as: a) Other revenues and gains b) Other expenses and losses

SINGLE-STEP INCOME STATEMENT

SELLERS ELECTRONIX Income Statement For the Year Ended December 31, 2005
Revenues All data are classified under Net sales two categories: Interest revenue 1 Revenues Gain on sale of equipment 2 Expenses Total revenues Expenses Only one step is required in Cost of goods sold determining net income or net loss. Selling expenses Administrative expenses Interest expense Casualty loss from vandalism Total expenses Net income $ 460,000 3,000 600 463,600 $ 316,000 76,000 38,000 1,800 200 432,000 $ 31,600

COMPUTATION OF GROSS PROFIT

STUDY OBJECTIVE 6

Gross profit is determined as follows: Net sales Cost of goods sold Gross profit $ 460,000 316,000 $ 144,000

OPERATING EXPENSES IN COMPUTING NET INCOME

Net income is determined as follows: Gross profit Operating expenses Net income $ 144,000 114,000 $ 30,000

Gross profit for a merchandiser is net sales minus

operating expenses cost of goods sold sales discounts cost of goods available for sale

Gross profit for a merchandiser is net sales minus

operating expenses cost of goods sold sales discounts cost of goods available for sale

USING A WORK SHEET

Balance Sheet Columns 1 The major difference between the balance sheets of a service company and a merchandising company is inventory 2 For Sellers Electronix, the ending Merchandise Inventory amount of $40,000 is shown in the balancesheet debit column 3 The information to prepare the owners equity statement is also found in these columns

Homework!

Have a great day!