CHAPTER3

Accounting for
Merchandising
Operations

5-1
 Nature of Merchandising Business
Merchandising
Service Business Business
Fees earned Sales

BrXXX BrXXX
Operating expenses Cost of Mdse Sold

–XXX –XXX
Net income Gross Profit
For a merchandising business:
1. The primary
BrXXX source of revenue is sales revenue
BrXXX
Operating Expenses
2. Expenses are divided into two categories:
a. Cost of goods sold=expired cost of merchandise sold
–XXX
b. Operating expenses =administrative and selling
Net Income
expenses
5-2 BrXXX
 Merchandising Operations
Merchandising Companies
Buy and Sell Goods E.g. supermarkets, drugstores,
stationery shops, car dealers, electronic shops, spare part
shops, etc.

Wholesaler Retailer Consumer

The primary source of revenues is referred to as

sales revenue or sales.
5-3
 Accounting for Merchandising Businesses

Cost of
Discounts: Sales
Cost=Asset Goods
Trade & Cash Revenue
Sold=Expense

II
I
Purchase of Sale of
Inventory Inventory

Supplier/ Inward Merchandising Outward Customer

Freight Enterprise Freight
Vendor
Purchase Sales
Returns & A. Returns & A.

Inventory Systems
1. Periodic Inventory System
2. Perpetual Inventory System
5-4
 Merchandising Operations

Income Measurement

Not used in a
Service business.

Cost of goods sold is the total

cost of merchandise sold during
the period.

5-5
 Merchandising Operations

Operating
Cycles

The operating cycle

of a merchandising
company ordinarily
is longer than that of
a service
company.

5-6
 Merchandising Operations

Flow of Costs

Past/Previous Current
Purchases Purchase
s
Asset

Asset
Expense
When on
When Sold
Hand
Incom Balanc
e e
Stat. sheet
Expense Asset
5-7
 Merchandising Operations
Perpetual Inventory System
 Maintain detailed records of the cost of each inventory purchase and
sale.
 Records continuously show inventory that should be on hand.
 Company determines cost of goods sold each time a sale occurs.
 Traditionally used for merchandise with high unit values.
 Requires additional clerical work and additional cost to maintain inventory records.
 Calculation of Ending [known
Beginning inventory Inventory:
-per book] xxx
Add: Purchases, net [known-per book] xxx
Goods available for sale xxx
Less: Cost of goods sold [known-per book] xxx
Ending inventory [unknown-solved for] xxx

 Inventory
Provides records
better control over inventories. xxx
Inventory count xxx
Inventory shortage xxx
5-8
 Merchandising Operations
Periodic Inventory System
 Record revenues when sales are made.
 Do not record cost of merchandise sold on the date of sale.
 Physical inventory count conducted once at end of a period
determines:
► Cost of merchandise on hand and
► Cost of merchandise sold during the period.
 Record purchases in Purchases account.
 Purchase returns and allowances, Purchase discounts, and
Freight costs are recorded in separate accounts.
 Calculation of Cost of Goods Sold:
Beginning inventory [known-per book] xxx
Add: Purchases, net [known-per book] xxx
Goods available for sale xxx
Less: Ending inventory [known-physical count]
5-9 xxx
Cost of goods sold [unknown-solved for] xxx
 Merchandising Operations

5-10
 Accounting Purchases of Merchandise

 Made using cash or credit (on account).

Inventory xxx
Cash/ Accounts Payable xxx
 Normally recorded when goods are received.
 Purchase invoice should support each credit purchase.
 Purchasing procedures
• Issuance of purchase requisition
• Issuance of purchase order
• Preparation of receiving report
• Recording purchase
• Settlement of invoices
5-11
 Accounting Purchases of Merchandise

Illustration 1: On May 4 ABC Co. purchased merchandise costing Br.

3,800 for cash from XYZ Co.

May 4 Merchandise Inventory 3800

Cash 3800

Illustration 2: On May 4 ABC Co. purchased merchandise costing Br. 3,800

on account from XYZ Co.

May 4 Merchandise Inventory 3800

Accounts Payable 3800

5-12
 Accounting Purchases of Merchandise

Freight Costs – Terms of Sale: Shipping Terms

Seller places goods Free On

Board 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.

Freight costs incurred by the seller are an operating expense.

5-13
 Accounting Purchases of Merchandise

Illustration 3: Assume that ABC Co. purchased the merchandise on

May 4 with freight terms of FOB Shipping point and paid Br. 150 freight
charges upon delivery of the goods on May 6, the entry on ABC’s books
is:
May 6 Merchandise Inventory 150
Cash 150

Illustration 4: Assume that the freight terms on the purchase by ABC

Co. (buyer) had been FOB Destination and required XYZ Co. (seller) to
pay the freight charges. The entry on ABC’s books is:
No entry

5-14
 Illustration 4: Assume that the freight terms on the purchase by ABC
Co. (buyer) had been FOB Destination and required XYZ Co. (seller) to
pay the freight charges. However, the freight of Br 150 was paid by
ABC. The entry on ABC’s books is:

Accounts receivable 150

cash 150

5-15
 Accounting 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 Allowance
Purchase Return
May choose to keep the
Return goods for credit if the sale merchandise if the seller will
was made on credit, or for a cash grant an allowance (deduction)
refund if the purchase was for cash. from the purchase price.

• A purchases return involves actually returning merchandise that is

damaged or does not meet the specifications of the order.
• When the defective or incorrect merchandise is kept by the buyer
and the vendor makes a price adjustment, this is a purchases
allowance.
5-16
 Accounting Purchases of Merchandise
Purchase Discounts
Credit terms may permit buyer to claim a cash discount for prompt
payment.
Advantages: Example: Credit terms may
 Purchaser saves money. read 2/10, n/30.
 Seller shortens the operating cycle.
 Example: Alpha Technologies issues an invoice for $3,000 to
Net Solutions dated March 12, with terms 2/10, n/30.

Determine last day to pay invoice and receive discount:

Invoice period 30
Days in March 31
Date of invoice 12
Remaining days 19
April 11
5-17
 Accounting Purchases of Merchandise
• Credit terms specify the amount of the cash discount and time
period in which it is offered. They also indicate the time period in
which the purchaser is expected to pay the full invoice price.

• Credit terms are 2/10, n/30, which is read “two-ten, net thirty.”
This means that the buyer may take a 2% cash discount on the
invoice price less (“net of”) any returns or allowances:

1. If payment is made within 10 days of the invoice date (the

discount period).
2. Otherwise, the invoice price, less any returns or allowances, is
due 30 days from the invoice date.

5-18
 Accounting Purchases of Merchandise
Alternatively, the discount period may extend to a specified
number of days following the month in which the sale occurs.

Example: 1/10 EOM (end of month) means that a 1% discount is

available if the invoice is paid within the first 10 days of the next
month.

When the seller elects not to offer a cash discount for prompt
payment, credit terms will specify only the maximum time period
for paying the balance due.

Example: The invoice may state the time period as n/30, n/60, or
n/10 EOM. This means, respectively, that the buyer must pay the
net amount (due) in 30 days, 60 days, or within the first 10 days of
the next month.
5-19
 Accounting Purchases of Merchandise
Illustration 5: Assume that on May 8 ABC returned to XYZ goods
costing $300.
May 8 Accounts payable/Cash 300
Inventory 300
Invoice paid within Discount Period
Illustration 6: Assume ABC 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.
May 14 Accounts Payable 3500
Inventory 70
Cash 3430

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

5-20
 Accounting Purchases of Merchandise

Invoice paid after Discount Period

Illustration: If ABC 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 3500
Cash 3500

Summary of Purchasing Transactions:

Net purchases=Gross purchases- (Purchase returns & allowances +
Purchase discounts)

5-21
 Accounting Purchases of Merchandise

Summary of Purchasing Transactions

Inventory
Debit Credit

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

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

Balance $3,580

5-22
 Accounting Sales of Merchandise
 Made using cash or credit (on account).
 Normally recorded when
earned, usually when goods
transfer from seller to buyer.
 Sales invoice should support
each credit sale.
 Selling procedures:
• Approving purchase orders
• Inventory dispatch order
• Issuance of sales invoice
• Recording sales
• Collection of invoices

5-23
 Accounting Sales of Merchandise

Journal Entries to Record a Sale

#1 Cash or Accounts receivable XXX Selling

Sales revenue XXX Price

#2 Cost of goods sold XXX

Cost
Inventory XXX

5-24
 Accounting Sales of Merchandise

Illustration 1: Assume XYZ Audio Supply records its May 4

sale of $3,800 to ABC on account as follows. Assume the
merchandise cost XYZ Audio Supply $2,400.

May 4 Accounts receivable 3,800

Sales revenue 3,800

4 Cost of goods sold 2,400

Inventory 2,400

5-25
 Accounting 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.

5-26
 Accounting Sales of Merchandise

Illustration 2: Prepare the entry XYZ Audio Supply 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 Inventory 140
Cost of goods sold 140

5-27
 Accounting Sales of Merchandise

Illustration 3: Assume the returned goods were defective

and had a scrap value of $50, XYZ Audio would make the
following entries:

May 8 Sales returns and allowances 300

Accounts receivable 300

8 Inventory 50
Cost of goods sold 50

5-28
 Accounting Sales of Merchandise

Sales Discount
 Offered to customers to promote prompt payment.
 “Flipside” of purchase discount.
 Contra-revenue account (debit).

5-29
 Accounting Sales of Merchandise

Invoice for
$3,500
Terms:
2/10, n/30

If invoice is If invoice is
paid within 10 NOT paid
days of invoice within 10 days
date of invoice date

$3,430 paid ($3,500

less 2% as a cash $3,500 PAID
5-30 discount)
 Accounting Sales of Merchandise

Illustration 4: Assume ABC 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 XYZ Audio Supply makes to
record the receipt on May 14.

May 14 Cash 3,430 *

Sales discounts 70
Accounts receivable 3,500

* [($3,800 – $300) X 2%]

5-31
 Accounting Sales of Merchandise
Illustration 5: Assume that ABC Co. purchased the merchandise on
May 4 with freight terms of FOB Shipping point and paid Br. 150 freight
charges upon delivery of the goods on May 6, the entry on XYZ’s books
is: No Entry

Illustration 6: Assume that the freight terms on the purchase by ABC

Co. (buyer) had been FOB Destination and required XYZ Co. (seller) to
pay the freight charges. The entry on XYZ’s books is:
May 6 Transportation out 150
Cash 150

Summary of Sales Transactions:

Net sales = Gross sales – (Sales returns & allowances + Sales
discounts)
5-32
 Accounting Sales of Merchandise
Sales Taxes
Aug. 12 Accounts Receivable—ABC Co. 106 00
Sales 100 00
Sales Taxes Payable 6 00
Invoice No. 339

Sept.15 Sales Tax Payable 2 900 00

Cash 2 900 00
Payment for sales taxes
collected during August.

5-33
 Completing the Accounting Cycle

Adjusting Entries
 Generally the same as a service company.
 One additional adjustment to make the records agree with
the actual inventory on hand.
 Involves adjusting Inventory and Cost of Goods Sold.

5-34
 Completing the Accounting Cycle

Merchandise Inventory Shrinkage

Illustration: Suppose that PW Audio Supply has an unadjusted

balance of $40,500 in Merchandise Inventory. Through a physical
count, PW Audio determines that its actual merchandise inventory
at year-end is $40,000. The company would make an adjusting
entry as follows.

Cost of goods sold 500

Inventory
500
5-35
 Forms of Financial Statements

Multiple-Step Income Statement

 Shows several steps in determining net income.
 Two steps relate to principal operating activities.
 Distinguishes between operating and non-operating
activities.

5-36
 Forms of Financial Statements

Income
Statement
Presentation
of Sales

5-37
 Forms of Financial Statements

Gross Profit

Key Items:
 Net sales
 Gross profit
 Gross profit
rate

5-38
 Forms of Financial Statements

Operating
Expenses

Key Items:
 Net sales
 Gross profit
 Operating
expenses

5-39
 Forms of
Financial
Statements

Key Items:
 Net sales
 Gross profit
 Operating
expenses
 Non-
operating
activities
 Net income

5-40
 Forms of
Financial
Statements

Key Items:
 Net sales
 Gross profit
 Operating
expenses
 Non-
operating
activities
 Net income

5-41
 Periodic Inventory System

Determining Cost of Goods Sold

5-42
 Forms of Financial Statements

Classified Balance Sheet

5-43
 Periodic Inventory System

Comparison of Entries—Perpetual Vs. Periodic

5-44
 Periodic Inventory System

Comparison of Entries—Perpetual Vs. Periodic

5-45
 Worksheet For Merchandising Enterprise

5-46
The unadjusted trial balance of Alpha Trading Private Limited Company on December
31, 2002 is presented below.
Alpha Trading Plc
Unadjusted Trial Balance
December 31, 2002
Debit Credit
Cash Br 2,300
Accounts Receivable 12,500
Prepaid Insurance 5,600
Merchandise Inventory 23,700
Supplies 5,700
Equipment 17,300
Accumulated Depreciation-Equipment Br3,500
Accounts Payable 3,500
Notes Payable 19,600
Sales Tax Payable 3,400
Larson, Capital 25,600
Larson, Drawing 3,000
Sales 110,200
Sales Returns and Allowance 3,100
Sales Discount 2,300
Purchases 67,800
Purchase Returns and Allowance 1,200
Purchase Discount 1,300
Freight-In 3,900
Salary Expense 11,400
Miscellaneous Expense 9,700
Total Br168,300 Br168,300
5-47
Additional Information:
a. The ending merchandise inventory amount is Br18,500.
b. Accrued salary expense on December 31, 2002 amounts Br3,500.
c. The prepaid insurance reported on the trial balance is an amount paid
on January 1, 2002. This amount applies for four years starting from
the date of payment.
d. Supplies on hand amounts Br3,100 as of December 31, 2002.
e. The depreciation expense for 2002 is Br500.

Required: Prepare the following items for Alpha Trading Private Limited
Company.
f. Ten column worksheet
g. Multiple-step income statement; the capital statement; and report form
balance sheet.
h. Pass the necessary adjusting and closing entries

5-48
a. Worksheet Alpha Trading Plc
Worksheet
For the year ended December 31, 2002
Income Statement
Account Titles Trial balance Adjustments Balance sheet
Debit Credit Debit Credit Debit Credit Debit Credit

Cash 2,300 2300

Accounts Receivable 12,500 12500
Prepaid Insurance 5600 (d)1400 4,200
Merchandise Inventory 23,700 (b)18500 (a)23700 18500
Supplies 5,700 (e)2600 3100
Equipment 17,300 17300
Accumulated Depreciation-Equipment 3500 (f)500 4000
Accounts Payable 3500 3500
Notes Payable 19600 19600
Sales Tax Payable 3400 3400
Lemma, Capital 25600 25600
Lemma, Drawing 3,000 3,000
Sales 110,200 110,200
Sales Returns and Allowance 3100 3100
Sales Discount 2300 2300
Purchases 67,800 67,800
Purchase Returns and Allowance 1200 1200
Purchase Discount 1300 1300
Freight-In 3900 3900
Salary Expense 11400 (c)3500 14900
Miscellaneous Expense 9700 9700
Total 168,300 168,300
Income Summary (a)23700 (b)18500 23700 18500
Salary Payable (c)3500 3500
Insurance expense (d)1400 1400
Supplies expense (e)2600 2600
Depreciation Expense (f)500 500
Total 50200 50200 129900 131200 60900 59600
Net Income 1300 1300
Total 131200 131200 60900 60900

5-49
b. Multiple–Step Income Statement Alpha Trading Plc
Income Statement
For Year Ended December 31, 2002
Revenue from sale:
Sales Br110,200
Less: Sales returns and allowance Br3,100
Sales discount 2,300
Net sales 5,400
Cost of merchandise sold: Br104,800
Merchandise inventory, Br23,700
Purchases Br67,800
Add: Fright-in 3,900 Br71,700
Less: Purchase discount 1,300
Purchase returns and allowance 1,200 2,500
Net purchases 69,200
Merchandise available for sale Br92,900
Less: Merchandise inventory, 18,500
Cost of merchandise sold 74,400
Gross profit Br30,400
Operating expenses:
Salary expense Br14,900
Supplies expense 2,600
Insurance expense 1,400
Depreciation expense-Equip. 500
Miscellaneous expense 9,700
Total operating expenses 29,100
Net income Br1,300

5-50
c. Capital Statement

Alpha Trading Plc

Capital Statement
For Year Ended December 31, 2002
Capital, Lemma Br25,600
Add: Net income Br 1,300
Deduct: Drawing (3,000)
Decrease in capital (1,700)
Capital, Lemma Br23,900

5-51
d. Report form Balance Sheet
Alpha Trading Plc
Balance Sheet
December 31, 2002
Assets
Current assets:
Cash Br2,300
Accounts receivable 12,500
Merchandise inventory 18,500
Supplies 3,100
Prepaid insurance 4,200
Total current assets Br40,600
Plant assets:
Equipment Br17,300
Accumulated depreciation-Equipment 4,000
Total plant assets 13,300
Total assets Br53,900
Liabilities
Accounts payable Br3,500
Notes payable 19,600
Sales tax payable 3,400
Salaries payable 3,500
Total liabilities Br30,000
Capital
Lemma, Capital 23,900
Total liabilities and capital Br53,900

5-52
 e. Adjusting Entries:
a. Income Summary 23,700
Merchandise Inventory 23,700
b. Merchandise Inventory 18,500
Income Summary 18,500
c. Salary Expense 3,500
Salary Payable 3,500
d. Insurance Expense 1,400
Prepaid Insurance 1,400
e. Supplies Expense 2,600
Supplies 2,600
f. Depreciation Expense-Equipment 500
Accumulated Depreciation-Equipment 500
f. Closing Entries:
a. Sales 110,200
Purchases Discount 1,300
Purchase Returns and Allowance 1,200
Income Summary 112,700
b. Income Summary 106,200
Sales Returns and Allowance 3,100
Sales Discount 2,300
Purchases 67,800
Freight-In 3,900
Salary Expense 14,900
Insurance Expense 1,400
Supplies Expense 2,600
Depreciation Expense-Equipment 500
Miscellaneous Expense 9,700
c. Income Summary 1,300
Lemma, Capital
d. Lemma, Capital 3,000
Lemma, Drawing 3,000

5-53