Merchandising Activities

Operating Cycle of a Merchandising Company
Cash

Accounts Receivable

Inventory
2. Sale of merchandise on account

Retailers and Wholesalers

Wholesalers buy merchandise from several different manufacturers and then sell this merchandise to several retailers. Retailers sell merchandise directly to the public.

Income Statement Merchandising Company
Computer City Condensed Income Statement For the Year Ended December 31, 2007 Revenue from sales Less: Cost of goods sold Gross profit Less: Expenses Net income $ $ $ 900,000 540,000 360,000 270,000 90,000
Cost of goods sold represents the expense of goods that are sold to customers.

Gross profit is a useful means of measuring the profitability of sales transactions.

Accounting System Requirements for Merchandising Companies
Although general ledger accounts provide useful information, they do not provide much of the detailed information needed in the daily business operations.
Who owes us money?

General Ledger Accounts Receivable Date 2007 June 1 15 10,000 3,000 10,000 7,000 Debit Credit Balance

Accounting System Requirements for Merchandising Companies
Control Account Subsidiary Ledgers
Date 2007 June 1 15 General Ledger Accounts Receivable Debit Credit Balance 10,000 3,000 10,000 7,000

Date 2007 June 1 15

Subsidiary Ledger Jake Sparks Debit Credit 3,000 1,000 Subsidiary Ledger Heather Jacobs Debit Credit 7,000 2,000

Balance 3,000 2,000

Date 2007 June 1 15

Balance 7,000 5,000

Two Approaches Used in Accounting for Merchandise Inventories

Perpetual Inventory System

Periodic Inventory System

1. Perpetual Inventory Systems
The inventory account is continuously updated to reflect items on hand.

1. Perpetual Inventory Systems
On September 5, Worley Co. purchased 100 laser lights for resale for $30 per unit from Electronic City on account.

GENERAL JOURNAL Date Account Titles and Explanation
Accounts Payable (Electronic City)

Debit
3,000

Credit
3,000

Sept. 5 Inventory

1. Perpetual Inventory Systems
On September 10, Worley Co. sold 10 laser lights for $50 per unit on account to ABC Radios.

Retail
GENERAL JOURNAL Date Account Titles and Explanation
Sales 10 Cost of Goods Sold Inventory 300 300

Debit
500

Credit
500

Sept. 10 Accounts Receivable (ABC Radios)

Cost

1. Perpetual Inventory Systems
On September 15, Worley Co. paid Electronic City $3,000 for the September 5 purchase.

GENERAL JOURNAL
Date Account Titles and Explanation Cash Debit 3,000 3,000 Credit

Sept. 15 Accounts Payable (Electronic City)

1. Perpetual Inventory Systems
On September 22, Worley Co. received $500 from ABC Radios as payment in full for their purchase on September 10.

GENERAL JOURNAL
Date Account Titles and Explanation Accounts Receivable (ABC Radios) Debit 500 500 Credit

Sept. 22 Cash

1.2 Taking a Physical Inventory
To ensure the accuracy of their perpetual records

complete physical count

of the merchandise on hand at least once a year

Taking a Physical Inventory
Reasonable amounts of inventory shrinkage are viewed as a normal cost of doing business. Examples include breakage, spoilage and theft. On December 31, Worley Co. counts its inventory. An inventory shortage of $2,000 is discovered.

GENERAL JOURNAL
Date Account Titles and Explanation Inventory Debit 2,000 2,000 Credit

Dec. 31 Cost of Goods Sold

Closing Entries in a Perpetual Inventory System
 Revenue (including Sales)
 Expense (including Cost of Goods Sold)  Income Summary
Income Summary
Income Summary Retained Earnings

 Dividends
The closing entries are the same!

Retained Earnings

2. Periodic Inventory System
No effort is made to keep up-to-date records of either inventory or cost of goods sold.

2. Periodic Inventory System
On September 5, Worley Co. purchased 100 laser lights for resale for $30 per unit from Electronic City on account.
Notice that no entry is made to Inventory.

GENERAL JOURNAL
Date Account Titles and Explanation Accounts Payable (Electronic City) Debit 3,000 3,000 Credit

Sept. 5 Purchases

2. Periodic Inventory System
On September 10, Worley Co. sold 10 laser lights for $50 per unit on account to ABC Radios.

GENERAL JOURNAL
Date Account Titles and Explanation Sales Debit 500

Retail
Credit 500

Sept. 10 Accounts Receivable (ABC Radios)

2. Periodic Inventory System
On September 15, Worley Co. paid Electronic City $3,000 for the September 5 purchase.

GENERAL JOURNAL
Date Account Titles and Explanation Cash Debit 3,000 3,000 Credit

Sept. 15 Accounts Payable (Electronic City)

2. Periodic Inventory System
On September 22, Worley Co. received $500 from ABC Radios as payment in full for their purchase on September 10.

GENERAL JOURNAL
Date Account Titles and Explanation Accounts Receivable (ABC Radios) Debit 500 500 Credit

Sept. 22 Cash

2.1 Computing Cost of Goods Sold
The accounting records of Worley Co. show the following: Inventory, Jan. 1 $ 14,000 Purchases (during year) 130,000

At December 31, Party Supply counted the merchandise on hand at $12,000.

Cost of Goods Sold for the year…?

2.1 Computing Cost of Goods Sold
Inventory (beginning of the year) Add: Purchases Cost of goods available for sale Less: Inventory (end of year) Cost of goods sold $ 14,000 130,000 144,000 12,000 $ 132,000

2.2 Creating a Cost of Goods Sold Account

Now, Worley Co. must create the Cost of Goods Sold account.

GENERAL JOURNAL
Date Account Titles and Explanation Inventory (beginning of year) Purchases Debit 144,000 14,000 130,000 Credit

Dec. 31 Cost of Goods Sold

2.2 Creating a Cost of Goods Sold Account

Now, Worley Co. must record the ending inventory amount.

GENERAL JOURNAL
Date Account Titles and Explanation Cost of Goods Sold Debit 12,000 12,000 Credit

Dec. 31 Inventory (end of year)

Closing Entries in a Perpetual Inventory System
 Revenue (including Sales)
 Expense (including Cost of Goods Sold)  Income Summary
Income Summary
Income Summary Retained Earnings

 Dividends
The closing entries are the same!

Retained Earnings

Selecting an Inventory System
Factors Suggesting a Perpetual Inventory System
Large company with professional management. Management and employees wanting information about items in inventory and the quantities of specific products that are selling. Items in inventory with a high perunit cost. Low volume of sales transactions or a computerized accounting system. Merchandise stored at multiple locations or in warehouses separate from sales sites.

Factors Suggesting a Periodic Inventory System
Small company, run by owner. Accounting records of inventories and specific product sales not needed in daily operations; such information developed primarily for use in annual income tax returns. Inventory with many different kinds of low-cost items. High volume of sales transactions and a manual accounting system. All merchandise stored at the sales site (for example, in the store).

Credit Terms and Cash Discounts
When manufacturers and wholesalers sell their products on account, the credit terms are stated in the invoice.

2/10, n/30
Percentage of Discount # of Days Discount Is Available Otherwise, the Full Amount Is Due # of Days when Full Amount Is Due

Recording Purchases

Net Method

Gross Method

1.Recording Purchases at Net Cost
Purchases are recorded at their net amounts.

Net Method

Purchase Discounts Lost are recorded when payment is made outside the discount period.

1.Recording Purchases at Net Cost
On July 6, Play Clothes purchased $4,000 of merchandise on credit with terms of 2/10, n/30 from Kid’s Clothes.

GENERAL JOURNAL
Date Account Titles and Explanation Accounts Payable (Kid's Clothes) Debit 3,920 Credit 3,920

July 6 Inventory

$4,000  98% = $3,920

1.Recording Purchases at Net Cost
On July 15, Play Clothes pays the full amount due to Kid’s Clothes (take advantage of discount)

GENERAL JOURNAL
Date Account Titles and Explanation Cash Debit 3,920 3,920 Credit

July 15 Accounts Payable (Kid's Clothes)

1. Recording Purchases at Net Cost
Now, assume that Play Clothes waited until July 20 to pay the amount due in full to Kid’s Clothes. (Forgo the discount offered) The journal entry for Play Clothes:

Non-operating Expense

GENERAL JOURNAL
Date Account Titles and Explanation Purchase Discounts Lost Cash Debit 3,920 80 4,000 Credit

July 20 Accounts Payable (Kid's Clothes)

2. Recording Purchases at Gross Invoice Price
Purchases are recorded at their gross amounts.

Gross Method

Purchase discounts taken are recorded when payment is made inside the discount period.

2.Recording Purchases at Gross Invoice Price
On July 6, Play Clothes purchased $4,000 of merchandise on credit with terms of 2/10, n/30 from Kid’s Clothes. The journal entry for Play Clothes :

GENERAL JOURNAL
Date July Account Titles and Explanation Accounts Payable (Kid's Clothes) Debit 4,000 4,000 Credit

6 Inventory

2. Recording Purchases at Gross Invoice Price
On July 15, Play Clothes pays the full amount due to Kid’s Clothes (take discount) The journal entry for Play Clothes :
Reduces Cost of Goods Sold

$4,000  98% = $3,920

GENERAL JOURNAL
Date Account Titles and Explanation Cash Purchase Discounts Taken Debit 4,000 3,920 80 Credit

July 15 Accounts Payable (Kid's Clothes)

2. Recording Purchases at Gross Invoice Price
Now, assume that Play Clothes waited until July 20 to pay the full amount due to Kid’s Clothes. (Forgo discount) The journal entry for Play Clothes :

GENERAL JOURNAL
Date Account Titles and Explanation Cash Debit 4,000 4,000 Credit

July 20 Accounts Payable (Kid's Clothes)

3. Returns of Unsatisfactory Merchandise (Net Cost)
On August 5, Play Clothes returned $500 of unsatisfactory merchandise purchased from Kid’s Clothes on credit terms of 2/10, n/30. The purchase was originally recorded at net cost.

GENERAL JOURNAL
Date Account Titles and Explanation Inventory Debit 490 490 Credit

Aug. 5 Accounts Payable (Kid's Clothes)

$500  98% = $490

4. Transportation Costs on Purchases
Transportation costs related to the acquisition of assets are part of the cost of the asset being acquired.

5. Transactions Relating to Sales
Computer City Partial Income Statement For the Year Ended December 31, 2007 Revenue Sales Less: Sales returns and allowances Sales discounts Net sales $ 912,000 $ 8,000 4,000 12,000 $ 900,000

Credit terms and merchandise returns affect the amount of revenue earned by the seller.

5. Sales
On August 2, Kid’s Clothes sold $2,000 of merchandise to Play Clothes on credit terms 2/10, n/30. Kid’s Clothes originally paid $1,000 for the merchandise. Because Kid’s Clothes uses a perpetual inventory system, they must make two entries.

GENERAL JOURNAL
Date Account Titles and Explanation Sales Debit 2,000 2,000 Credit

Aug. 2 Accounts Receivable (Play Clothes)

5. Sales
On August 2, Kid’s Clothes sold $2,000 of merchandise to Play Clothes on credit terms 2/10, n/30. Kid’s Clothes originally paid $1,000 for the merchandise. Because Kid’s Clothes uses a perpetual inventory system, they must make two entries.

GENERAL JOURNAL
Date Account Titles and Explanation Inventory Debit 1,000 1,000 Credit

Aug. 2 Cost of Goods Sold

5. Sales Returns and Allowances
On August 5, Play Clothes returned $500 of unsatisfactory merchandise to Kid’s Clothes from the August 2 sale. Kid’s Clothes cost for this merchandise was $250. Because Kid’s Clothes uses a perpetual inventory system, they must make two entries.

GENERAL JOURNAL
Date Account Titles and Explanation Accounts Receivable (Play Clothes)

Contra-revenue
Debit 500 500 Credit

Aug. 5 Sales Returns and Allowances

5. Sales Returns and Allowances
On August 5, Play Clothes returned $500 of unsatisfactory merchandise to Kid’s Clothes from the August 2 sale. Kid’s Clothes cost for this merchandise was $250. Because Kid’s Clothes uses a perpetual inventory system, they must make two entries.

GENERAL JOURNAL
Date Account Titles and Explanation Cost of Goods Sold Debit 250 250 Credit

Aug. 5 Inventory

5. Sales
On July 6, Kid’s Clothes sold $4,000 of merchandise to Play Clothes on credit with terms of 2/10, n/30. The merchandise originally cost Kid’s Clothes $2,000. Because Kid’s Clothes uses a perpetual inventory system, they must make two entries.

GENERAL JOURNAL
Date July Account Titles and Explanation Sales Debit 4,000 4,000 Credit

6 Accounts Receivable (Play Clothes)

5. Sales
On July 6, Kid’s Clothes sold $4,000 of merchandise to Play Clothes on credit with terms of 2/10, n/30. The merchandise originally cost Kid’s Clothes $2,000. Because Kid’s Clothes uses a perpetual inventory system, they must make two entries.

GENERAL JOURNAL
Date July Account Titles and Explanation Inventory Debit 2,000 2,000 Credit

6 Cost of Goods Sold

5. Sales Discounts
On July 15, Kid’s Clothes receives the full amount due from Play Clothes from the July 6 sale.

Contra-revenue

$4,000  98% = $3,920

GENERAL JOURNAL
Date Account Titles and Explanation Sales Discounts Accounts Receivable (Play Clothes) Debit 3,920 80 4,000 Credit

July 15 Cash

5. Sales Discounts
Now, assume that it wasn’t until July 20 that Kid’s Clothes received the full amount due from Play Clothes from the July 6 sale.

GENERAL JOURNAL
Date Account Titles and Explanation Accounts Receivable (Play Clothes) Debit 4,000 4,000 Credit

July 20 Cash

6. Delivery Expenses
Delivery costs incurred by sellers are debited to Delivery Expense, an operating expense.

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