ACC 201 Chapter 6 PDF

CHAPTER
6 Accounting for
Merchandising Businesses
Financial
Accounting
14e
human/iStock/360/Getty Images
Warren
Reeve
Duchac
Learning Objectives
• LO1: Distinguish between the activities and financial

statements of service and merchandising businesses.
• LO2: Describe and illustrate the accounting for
merchandise transactions.
• LO3: Describe and illustrate the financial statements of
a merchandising business.
• LO4: Describe the adjusting and closing process for a
merchandising business.
• LO5: Describe and illustrate the use of the ratio of
sales to assets in evaluating a company’s operating
performance.
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Nature of the Merchandising Businesses
• The activities of a service business differ from those of

a merchandising business.
o These differences are reflected in the operating cycles of a
service and merchandising business as well as in their
financial statements.
Operating Cycle
(slide 1 of 2)
• The operating cycle is the process by which a

company spends cash, generates revenues, and
receives cash either at the time the revenues are
generated or later by collecting an accounts
receivable.
• The operating cycle of a service and merchandising
business differs in that a merchandising business must
purchase merchandise for sale to customers.
The Operating Cycle for a
Merchandising Business
Operating Cycle
(slide 2 of 2)
• The time in days to complete an operating cycle

differs significantly among merchandise businesses.
o For example, many grocery items, such as milk, must be sold
within their expiration dates of a week or two.
o In contrast, jewelry stores often carry expensive items that
are often displayed months before being sold to customers.
Financial Statements
(slide 1 of 4)
• The differences between service and merchandising

businesses are also reflected in their financial
statements.
(slide 2 of 4)
• The revenue activities of a service business involve

providing services to customers.
• On the income statement for a service business, the
revenues from services are reported as fees earned.
• The operating expenses incurred in providing the
services are subtracted from the fees earned to arrive
at net income.
(slide 3 of 4)
• In contrast, the revenue activities of a merchandising

business involve the buying and selling of
merchandise.
• A merchandising business first purchases merchandise
to sell to its customers.
• When this merchandise is sold, the revenue is reported
as sales, and its cost is recognized as an expense
called cost of merchandise sold.
o The cost of merchandise sold is subtracted from sales to
arrive at gross profit, which is the profit before deducting
operating expenses.
(slide 4 of 4)
• Merchandise on hand (not sold) at the end of an

accounting period is called merchandise inventory.
• It is reported as a current asset on the balance sheet.
Example Exercise Gross Profit
During the current year, merchandise is sold for

$250,000 cash and for $975,000 on account. The cost
of the merchandise sold is $735,000. What is the
amount of the gross profit?
Purchases Transactions
(slide 1 of 5)
• There are two systems for accounting for merchandise

transactions: perpetual and periodic.
o In a perpetual inventory system, each purchase and sale of
merchandise is recorded in the inventory account and related subsidiary
ledger.
 In this way, the amount of merchandise available for sale and the amount
sold are continuously (perpetually) updated in the inventory records.
o In a periodic inventory system, the inventory does not show the amount
of merchandise available for sale and the amount sold.
 Instead, a listing of inventory on hand, called a physical inventory, is
prepared at the end of the accounting period.
– This physical inventory is used to determine the cost of merchandise on hand at
the end of the period and the cost of merchandise sold during the period.
(slide 2 of 5)
• Under the perpetual inventory system, cash purchases

of merchandise are recorded as follows:
(slide 3 of 5)
• Purchases of merchandise on account are recorded as

follows:
(slide 4 of 5)
• The terms of purchases on account are normally

indicated on the invoice or bill that the seller sends
the buyer.
Invoice
(slide 5 of 5)
• The terms for when payments for merchandise are to

be made are called the credit terms.
o If payment is required on delivery, the terms are cash or net
cash.
o Otherwise, the buyer is allowed an amount of time, known
as the credit period, in which to pay.
 The credit period usually begins with the date of the sale as shown
on the invoice.
Purchases Discounts
(slide 1 of 6)
• To encourage the buyer to pay before the end of the

credit period, the seller may offer a discount.
o For example, a seller may offer a 2% discount if the buyer
pays within 10 days of the invoice date. If the buyer does
not take the discount, the total invoice amount is due within
30 days.
 The terms are expressed as 2/10, n/30 and are read as “2%
discount if paid within 10 days, net amount due within 30 days.”
Credit Terms
Purchases Discounts
(slide 2 of 6)
• Discounts taken by the buyer for early payment of an

invoice are called purchases discounts.
o Purchases discounts taken by a buyer reduce the cost of the
merchandise purchased.
Purchases Discounts
(slide 3 of 6)
• Assume that NetSolutions places an order from Alpha

Technologies on January 5 with terms of 2/10, n/30.
In order to pay the invoice on January 15 (the last
day of the discount period), NetSolutions borrows
$2,940, which is $3,000 less the discount of $60
($3,000 × 2%). If an annual interest rate of 6% and
a 360-day year is assumed, the interest on the loan
of $2,940 for the remaining 20 days of the credit
period is $9.80 ($2,940 × 6% × 20 ÷ 360).
Purchases Discounts
(slide 4 of 6)
• The net savings to NetSolutions of taking the discount

is computed as follows:
• If NetSolutions does not take the discount, it pays an

estimated interest rate of 36% for using the $2,940
for the remaining 20 days of the credit period.
Purchases Discounts
(slide 5 of 6)
• Since buyers normally take all purchases discounts,

Merchandise Inventory is debited for the net purchase
price under the perpetual inventory system.
o That is, the buyer debits Merchandise Inventory for the
amount of the invoice less the discount.
Purchases Discounts
(slide 6 of 6)
• NetSolutions would record the Alpha Technologies

invoice and its payment as follows:
Purchases Returns and Allowances
(slide 1 of 5)
• A buyer may request an allowance for merchandise

that is returned (purchases return) or a price
allowance (purchases allowance) for damaged or
defective merchandise. From a buyer’s perspective,
such returns and allowances are called purchases
returns and allowances.
o In both cases, the buyer normally sends the seller a debit
memorandum, often called a debit memo, to notify the
seller of reasons for the return (purchase return) or to
request a price reduction (purchase allowance).
 A debit memo also informs the seller of the amount the buyer
proposes to debit to the account payable due the seller.
Debit Memo
(slide 2 of 5)
• The buyer may use the debit memo as the basis for
recording the return or allowance or wait for
approval from the seller (creditor).
• In either case, the buyer debits Accounts Payable and
credits Merchandise Inventory.
(slide 3 of 5)
• NetSolutions records the return of the merchandise

indicated in the debit memo on slide 26 as follows:
(slide 4 of 5)
• Before paying an invoice, a buyer may return

merchandise or be granted a price allowance for an
invoice with a purchase discount.
o In this case, the amount of the return is recorded at its
invoice amount less the discount.
(slide 5 of 5)
• Assume the following data concerning a purchase of merchandise by NetSolutions on May 2:

May 2. Purchased $5,000 of merchandise on account from Delta Data Link, terms 2/10, n/30.
4. Returned $1,000 of the merchandise purchased on May 2.
12. Paid for the purchase of May 2 less the return and discount.
• NetSolutions would record these transactions as follows:
Example Exercise Purchases Transactions
Rofles Company purchased merchandise on account

from a supplier for $11,500, terms 2/10, n/30. Rofles
Company returned $2,500 of the merchandise and
received full credit.
a. If Rofles Company pays the invoice within the
discount period, what is the amount of cash
required for the payment?
b. Under a perpetual inventory system, what account
is credited by Rofles Company to record the return?
Sales Transactions
• Revenue from merchandise sales is usually recorded

as Sales.
o Sometimes a business may use the title Sales of
Merchandise.
Cash Sales
(slide 1 of 7)
• Assume that on March 3, NetSolutions sells

merchandise for $1,800. These cash sales are
recorded as follows:
Cash Sales
(slide 2 of 7)
• Using the perpetual inventory system, the cost of

merchandise sold and the decrease in merchandise
inventory are also recorded.
o In this way, the merchandise inventory account indicates the
amount of merchandise on hand (not sold).
Cash Sales
(slide 3 of 7)
• Assume that the cost of merchandise sold on March 3

is $1,200. The entry to record the cost of merchandise
sold and the decrease in the merchandise inventory is
as follows:
Cash Sales
(slide 4 of 7)
• Sales may be made to customers using credit cards

such as MasterCard or VISA.
o Such sales are recorded as cash sales.
 This is because these sales are normally processed by a
clearinghouse that contacts the bank that issued the card.
– The issuing bank then electronically transfers cash directly to the
retailer’s bank account. Thus, the retailer normally receives cash within
a few days of making the credit card sale.
Cash Sales
(slide 5 of 7)
• If customers use MasterCards to pay for their

purchases, the sales would be recorded as shown in
the March 3 entry on slide 33.
Cash Sales
(slide 6 of 7)
• Any processing fees charged by the clearinghouse or

issuing bank are periodically recorded as an
expense.
o This expense is normally reported on the income statement
as an administrative expense.
Cash Sales
(slide 7 of 7)
• Assume that NetSolutions paid credit card processing

fees of $4,150 on March 31. These fees would be
Sales on Account
• NetSolutions sold merchandise on account for

$18,000. The cost of the merchandise sold was
$10,800.
Customer Discounts
(slide 1 of 3)
• A seller may grant customers a variety of discounts,

called customer discounts, to encourage customers to
act in a way benefiting the seller.
o For example, a seller may offer customer discounts to
encourage customers to purchase in volume or order early.
Customer Discounts
(slide 2 of 3)
• A sales discount encourages customers to pay their

invoice early.
o For example, a seller may offer credit terms of 2/10, n/30,
which provides a 2% sales discount if the invoice is paid
within 10 days.
Customer Discounts
(slide 3 of 3)
• Assume that NetSolutions sold $18,000 of

merchandise to Digital Technologies on March 10 with
credit terms 2/10, n/30.
o The March 10 sale would be recorded as follows:
o The payment by Digital Technologies on March 19 is

Customer Returns and Allowances
(slide 1 of 7)
• Merchandise sold may be returned to the seller

(returns). In other cases, the seller may reduce the
initial selling price (allowances).
o This may occur if the merchandise is defective, damaged
during shipment, or does not meet the buyer’s expectations.
• From a seller’s perspective, these are termed
customer returns and allowances, sometimes called
sales returns and allowances.
(slide 2 of 7)
• Assume Schafer Co. had sales of $2,000,000 and related cost

of merchandise sold of $1,400,000 for its first year of
operations ending December 31, 2016. Schafer Co. provides
customers a refund for any returned or damaged merchandise.
At the end of the year, Schafer Co. estimates that customers will
request refunds for 2% of sales and estimates that merchandise
costing $25,000 will be returned. On December 31, 2016, the
following two adjusting journal entries must be recorded:
(slide 3 of 7)
• The preceding two adjusting entries ensure that

current period sales are matched with the related cost
of merchandise sold on the income statement.
• In addition, an asset for estimated returned inventory
and a liability for customer refunds is reported on the
balance sheet.
(slide 4 of 7)
• On January 15, 2017, Baker Company returned

merchandise with a selling price of $3,000 for a cash
refund. The merchandise originally cost Schafer Co.
$2,100. Schafer would record the return and refund
with the following two entries:
(slide 5 of 7)
• In some cases, a customer that is due a refund has an

outstanding account receivable balance.
o In this case, the seller may credit the customer’s accounts
receivable rather than pay cash.
 When this is done, the seller normally sends the buyer a credit
memorandum or credit memo indicating its intent to credit the
customer’s account receivable.
(slide 6 of 7)
• Assume that Schafer Company issued the credit memo

on the next slide to Blake & Sons.
Credit Memo
(slide 7 of 7)
• Schafer Co. would record issuance of the credit memo

as follows:
Example Exercise Sales Transactions
Journalize the following merchandise transactions:

a. Sold merchandise on account, $7,500, with terms
2/10, n/30. The cost of the merchandise sold was
$5,625.
b. Received payment less the discount.
Freight
(slide 1 of 7)
• Purchases and sales of merchandise often involve

freight.
• The terms of a sale indicate when ownership (title and
control) of the merchandise passes from the seller to
the buyer.
o This point determines whether the buyer or the seller pays
the freight costs.
Freight
(slide 2 of 7)
• The ownership of the merchandise may pass to the

buyer when the seller delivers the merchandise to the
freight carrier.
o In this case, the terms are said to be FOB (free on board)
shipping point.
 This term means that the buyer pays the freight costs from the
shipping point to the final destination.
– Such costs are part of the buyer’s total cost of purchasing inventory
and are added to the cost of the inventory by debiting Merchandise
Inventory.
Freight
(slide 3 of 7)
• Assume that on June 10, NetSolutions purchased merchandise as follows:

June 10. Purchased merchandise from Magna Data, $900, terms FOB
shipping point.
10. Paid freight of $50 on June 10 purchase from Magna Data.
• NetSolutions would record these two transactions as follows:
Freight
(slide 4 of 7)
• The ownership of the merchandise may pass to the

buyer when the buyer receives the merchandise.
o In this case, the terms are said to be FOB (free on board)
destination.
 This term means that the seller pays the freight costs from the
shipping point to the buyer’s final destination.
– When the seller pays the delivery charges, the seller debits Delivery
Expense or Freight Out.
 Delivery Expense is reported on the seller’s income statement as a
selling expense.
Freight
(slide 5 of 7)
• Assume that NetSolutions sells merchandise as follows:

June 15. Sold merchandise to Kranz Company on account, $700, terms FOB
destination. The cost of the merchandise sold is $480.
15. NetSolutions pays freight of $40 on the sale of June 15.
• NetSolutions records the sale, the cost of the sale, and the freight cost as follows:
Freight
(slide 6 of 7)
• The seller may prepay the freight, even though the

terms are FOB shipping point. The seller will then add
the freight to the invoice.
o The buyer debits Merchandise Inventory for the total
amount of the invoice, including the freight.
o Any discount terms would not apply to the prepaid freight.
Freight
(slide 7 of 7)
• Assume that NetSolutions sells merchandise as follows:

June 20. Sold merchandise to Planter Company on account, $800, terms FOB
shipping point. NetSolutions paid freight of $45, which was added to the
invoice. The cost of the merchandise sold is $360.
• NetSolutions records the sale, the cost of the sale, and the freight as follows:
Freight Terms
Example Exercise Freight Terms
Determine the amount to be paid in full settlement of

each of the two invoices, (a) and (b), assuming that
credit for returns and allowances was received prior to
payment and that all invoices were paid within the
discount period.
Recording Merchandise Inventory Transactions
Dual Nature of Merchandise Transactions
• Each merchandising transaction affects a buyer and a

seller.
Illustration of Merchandise Inventory
Transactions for Seller and Buyer
(slide 1 of 2)
Illustration of Merchandise Inventory
Transactions for Seller and Buyer
(slide 2 of 2)
Example Exercise Transactions for Buyer and Seller
Sievert Co. sold merchandise to Bray Co. on account,

$11,500, terms 2/15, n/30. The cost of the
merchandise sold is $6,900. Journalize the entries for
Sievert Co. and Bray Co. for the sale, purchase, and
payment of amount due.
Chart of Accounts for NetSolutions,
a Merchandising Business
Sales Taxes
(slide 1 of 2)
• Almost all states levy a tax on sales of merchandise.

• The liability for the sales tax is incurred when the sale
is made.
o At the time of a cash sale, the seller collects the sales tax.
o When a sale is made on account, the seller charges the tax
to the buyer by debiting Accounts Receivable.
o The seller credits the sales account for the amount of the
sale and credits the tax to Sales Tax Payable.
Sales Taxes
(slide 2 of 2)
• The seller would record a sale of $100 on account, subject to a

tax of 6%, as follows:
• On a regular basis, the seller pays to the taxing authority

(state) the amount of the sales tax collected. The seller records
such a payment as follows:
Trade Discounts
(slide 1 of 2)
• Wholesalers are companies that sell merchandise to

other businesses rather than to the public.
• Many publish sales catalogs.
• Rather than updating their catalogs, wholesalers may
publish price updates.
o These updates may include large discounts from the catalog
list prices.
• In addition, wholesalers often offer special discounts
to government agencies or businesses that order large
quantities.
o Such discounts are called trade discounts.
Trade Discounts
(slide 2 of 2)
• Sellers and buyers do not normally record the list

prices of merchandise and trade discounts in their
accounts.
o For example, assume that an item has a list price of $1,000
and a 40% trade discount. The seller and buyer records the
sale of the item at $600 [$1,000 less the trade discount of
$400 ($1,000 × 40%)]. Likewise, the buyer records the
purchase the purchase at $600.
Financial Statements for a
Merchandising Business
• Although merchandising transactions affect the

balance sheet in reporting inventory, they primarily
affect the income statement.
• An income statement for a merchandising business is
normally prepared using either a multiple-step or
single-step format.
Multiple-Step Income Statement
• The multiple-step income statement contains several

sections, subsections, and subtotals, including the
following:
o Sales
o Cost of Merchandise Sold
o Gross Profit
o Income from Operations
o Other Income and Expense
Multiple-Step Income Statement—Sales
• The total amount of sales to customers for cash and on

account is reported in this section.
Multiple-Step Income Statement—
Cost of Merchandise Sold
• The amount of cost of merchandise sold to customers is

reported in this section.
• Cost of merchandise sold may also be reported as
cost of goods sold or cost of sales.
Multiple-Step Income Statement—Gross Profit
• The excess of sales over cost of merchandise sold is

gross profit.
Income from Operations
• Income from operations, or operating income, is determined
by subtracting operating expenses from gross profit.
o Operating expenses are normally classified as either selling expenses
or administrative expenses.
 Selling expenses are incurred directly in the selling of merchandise.
– Examples of selling expenses include the following:
 Sales salaries
 Store supplies used
 Depreciation of store equipment
 Delivery expense
 Advertising
 Administrative expenses, sometimes called general expenses, are
incurred in the administration or general operations of the business.
– Examples of administrative expenses include the following:
 Office salaries
 Depreciation of office equipment
 Office supplies used
Other Income and Expense
(slide 1 of 2)
• Other income and expense items are not related to

the primary operations of the business.
o Other income is revenue from sources other than the
primary operating activity of a business.
 Examples of other income include the following:
– Income from interest
– Rent
– Gains resulting from the sale of fixed assets
o Other expense is an expense that cannot be traced directly
to the normal operations of the business.
 Examples of other expenses include the following:
– Interest expense
– Losses from disposing of fixed assets
Other Income and Expense
(slide 2 of 2)
• Other income and other expense are offset against

each other on the income statement.
o If the total of other income exceeds the total of other
expense, the difference is added to income from operations
to determine net income.
o If the total of other expense exceeds the total of other
income, the difference is subtracted from income from
operations to determine net income.
Multiple-Step Income Statement
Single-Step Income Statement
• An alternative form of income statement is the single-

step income statement.
• The single-step form deducts the total of all expenses
in one step from the total of all revenues.
• The single-step form emphasizes total revenues and
total expenses in determining net income.
• A criticism of the single-step form is that gross profit
and income from operations are not reported.
Single-Step Income Statement
Statement of Owner’s Equity
for Merchandising Business
Balance Sheet
• The balance sheet may be presented with assets on

the left-hand side and the liabilities and owner’s
equity on the right-hand side.
o This form of the balance sheet is called the account form.
• The balance sheet may also be presented in a
downward sequence in three sections.
o This form of the balance sheet is called the report form.
Report Form of Balance Sheet
Adjusting Entry for Inventory Shrinkage
(slide 1 of 2)
• Under the perpetual inventory system, the merchandise

inventory account is continually updated for purchase and sales
transactions.
• As a result, the balance of the merchandise inventory account is
the amount of merchandise available for sale at that point in
time.
• However, retailers normally experience some loss of inventory
due to shoplifting, employee theft, or errors.
• Thus, the physical inventory on hand at the end of the
accounting period is usually less than the balance of
Merchandise Inventory.
o This difference is called inventory shrinkage or inventory shortage.
Adjusting Entry for Inventory Shrinkage
(slide 2 of 2)
• NetSolutions’ inventory records indicate the following on December 31,

2017:
• At the end of the accounting period, inventory shrinkage is recorded by the

following adjusting entry:
o After the preceding entry is recorded, the balance of Merchandise Inventory

agrees with the physical inventory on hand at the end of the period.
Example Exercise Inventory Shrinkage
Pulmonary Company’s perpetual inventory records

indicate that $382,800 of merchandise should be on
hand on March 31, 2016. The physical inventory
indicates that $371,250 of merchandise is actually on
hand. Journalize the adjusting entry for the inventory
shrinkage for Pulmonary Company for the year ended
March 31, 2016. Assume that the inventory shrinkage is
a normal amount.
Closing Entries
(slide 1 of 4)
• The four closing entries for a merchandising business are as

follows:
1. Debit each temporary account with a credit balance, such as Sales, for
its balance and credit Income Summary.
2. Credit each temporary account with a debit balance, such as the various
expenses, and debit Income Summary. Since Cost of Merchandise Sold is
a temporary account with a debit balance, it is credited for its balance.
3. Debit Income Summary for the amount of its balance (net income) and
credit the owner’s capital account. The accounts debited and credited
are reversed if there is a net loss.
4. Debit the owner’s capital account for the balance of the drawing
account and credit the drawing account.
Closing Entries
(slide 2 of 4)
• The four closing entries for NetSolutions follow:
Closing Entries
(slide 3 of 4)
• NetSolutions’ income summary account after the

closing entries have been posted is as follows:
• After the closing entries are posted to the accounts, a

post-closing trial balance is prepared.
Closing Entries
(slide 4 of 4)
• After the closing entries are posted to the accounts, a

post-closing trial balance is prepared.
o The only accounts that should appear on the post-closing
trial balance are the asset, contra asset, liability, and
owner’s capital accounts with balances.
 These are the same accounts that appear on the end-of-period
balance sheet.
o If the two totals of the trial balance columns are not equal,
an error has occurred that must be found and corrected.
Financial Analysis and Interpretation:
Ratio of Sales to Assets
(slide 1 of 2)
• The ratio of sales to assets measures how effectively

a business is using its assets to generate sales.
• A high ratio indicates an effective use of sales.
• The ratio of sales to assets is computed as follows:
Sales
Ratio of Sales to Assets =
Average Total Assets
Financial Analysis and Interpretation:
Ratio of Sales to Assets
(slide 2 of 2)
• The following data (in millions) were taken from the

annual reports of Dollar Tree, Inc.:
• The ratio of sales to assets for each year are as

follows:
Example Exercise Ratio of Sales to Assets
Financial statement data for the years ending December 31,

2016 and 2015, for Gilbert Company follow:
a. Determine the ratio of sales to assets for 2016 and 2015.

b. Does the change in the ratio of sales to assets from 2015 to
2016 indicate a favorable or an unfavorable trend?
Appendix: Periodic Inventory System
(slide 1 of 2)
• Small merchandise businesses, such as a local

hardware store, may use a manual accounting system.
• A manual perpetual inventory system is time
consuming and costly to maintain.
• In this case, the periodic inventory system may be
used.
Appendix: Periodic Inventory System
(slide 2 of 2)
• Under the periodic inventory system, purchases are

normally recorded at their invoice amount.
o If the invoice is paid within the discount period, the discount
is recorded in a separate account called Purchases
Discounts.
o Likewise, purchase returns are recorded in a separate
account called Purchase Returns and Allowances.
Chart of Accounts Under the
Periodic Inventory System
Appendix: Recording Merchandise Transactions
Under the Periodic Inventory System
(slide 1 of 2)
• Using the periodic inventory system, purchases of inventory are

not recorded in the merchandise inventory account.
o Instead, purchases, purchases discounts, and purchases returns and
allowances accounts are used.
• In addition, the sales of merchandise are not recorded in the
inventory account.
• Thus, there is no detailed record of the amount of inventory on
hand at any given time.
• At the end of the period, a physical count of merchandise
inventory on hand is taken.
o This physical count is used to determine the cost of merchandise sold.
Under the Periodic Inventory System—Purchases
• Purchases of inventory are recorded in a purchases

account rather than in the merchandise inventory
account.
• Purchases is debited for the invoice amount of a
purchase.
Under the Periodic Inventory System—Purchases Discounts
• Purchases discounts are normally recorded in a

separate purchases discounts account.
• The balance of the purchases discounts account is
reported as a deduction from Purchases for the
period.
• Thus, Purchases Discounts is a contra (or offsetting)
account to Purchases.
Appendix: Recording Merchandise Transactions Under the
Periodic Inventory System—Purchases Returns and Allowances
• A separate purchases returns and allowances account

is used to record returns and allowances.
• Purchases returns and allowances are reported as a
deduction from Purchases for the period.
• Thus, Purchases Returns and Allowances is a contra (or
offsetting) account to Purchases.
Under the Periodic Inventory System—Freight In
• Under the periodic inventory system, freight paid

when purchasing merchandise FOB shipping point is
debited to Freight In, Transportation In, or a similar
account.
Under the Periodic Inventory System
(slide 2 of 2)
Transactions Using the
Periodic Inventory System
Appendix: Adjusting Process Under
the Periodic Inventory System
• The adjusting process is the same under the periodic and perpetual inventory
systems except for the inventory shrinkage adjustment.
• The ending merchandise inventory is determined by a physical count under
both systems.
o Under the perpetual inventory system, the ending inventory physical count is
compared to the balance of Merchandise Inventory.
 The difference is the amount of inventory shrinkage.
 The inventory shrinkage is then recorded as a debit to Cost of Merchandise Sold and
a credit to Merchandise Inventory.
o Under the periodic inventory system, the merchandise inventory account is not
kept up to date for purchases and sales.
 As a result, the inventory shrinkage cannot be directly determined.
 Instead, any inventory shrinkage is included indirectly in the computation of the cost
of merchandise sold.
Determining Cost of Merchandise Sold
Using the Periodic System
Appendix: Closing Entries Under
(slide 1 of 3)
• The closing entries differ in the periodic inventory

system in that there is no cost of merchandise sold
account to close to Income Summary.
• Instead, the purchases, purchases discounts, purchases
returns and allowances, and freight in accounts are
closed to Income Summary.
• In addition, the merchandise inventory account is
adjusted to the end-of-period physical inventory count
during the closing process.
(slide 2 of 3)
• The four closing entries under the periodic inventory system are as follows:
1. Debit each temporary account with a credit balance, such as Sales, for its
balance and credit Income Summary. Since Purchases Discounts and Purchases
Returns and Allowances are temporary accounts with credit balances, they are
debited for their balances. In addition, Merchandise Inventory is debited for its
end-of-period balance based on the end-of-period physical inventory.
2. Credit each temporary account with a debit balance, such as the various
expenses, and debit Income Summary. Since Freight In is a temporary account
with a debit balance, it is credited for its balance. In addition, Merchandise
Inventory is credited for its balance as of the beginning of the period.
3. Debit Income Summary for the amount of its balance (net income) and credit the
owner’s capital account. The accounts debited and credited are reversed if
there is a net loss.
4. Debit the owner’s capital account for the balance of the drawing account and
credit the drawing account.
(slide 3 of 3)
• The four closing entries for NetSolutions under the

periodic inventory system follow:

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CHAPTER

• LO1: Distinguish between the activities and financial

• The activities of a service business differ from those of

• The operating cycle is the process by which a

• The time in days to complete an operating cycle

• The differences between service and merchandising

• The revenue activities of a service business involve

• In contrast, the revenue activities of a merchandising

• Merchandise on hand (not sold) at the end of an

During the current year, merchandise is sold for

• There are two systems for accounting for merchandise

• Under the perpetual inventory system, cash purchases

• Purchases of merchandise on account are recorded as

• The terms of purchases on account are normally

• The terms for when payments for merchandise are to

• To encourage the buyer to pay before the end of the

• Discounts taken by the buyer for early payment of an

• Assume that NetSolutions places an order from Alpha

• The net savings to NetSolutions of taking the discount

• If NetSolutions does not take the discount, it pays an

• Since buyers normally take all purchases discounts,

• NetSolutions would record the Alpha Technologies

• A buyer may request an allowance for merchandise

• NetSolutions records the return of the merchandise

• Before paying an invoice, a buyer may return

• Assume the following data concerning a purchase of merchandise by NetSolutions on May 2:

Rofles Company purchased merchandise on account

• Revenue from merchandise sales is usually recorded

• Assume that on March 3, NetSolutions sells

• Using the perpetual inventory system, the cost of

• Assume that the cost of merchandise sold on March 3

• Sales may be made to customers using credit cards

• If customers use MasterCards to pay for their

• Any processing fees charged by the clearinghouse or

• Assume that NetSolutions paid credit card processing

• NetSolutions sold merchandise on account for

• A seller may grant customers a variety of discounts,

• A sales discount encourages customers to pay their

• Assume that NetSolutions sold $18,000 of

o The payment by Digital Technologies on March 19 is

• Merchandise sold may be returned to the seller

• Assume Schafer Co. had sales of $2,000,000 and related cost

• The preceding two adjusting entries ensure that

• On January 15, 2017, Baker Company returned

• In some cases, a customer that is due a refund has an

• Assume that Schafer Company issued the credit memo

• Schafer Co. would record issuance of the credit memo

Journalize the following merchandise transactions:

• Purchases and sales of merchandise often involve

• The ownership of the merchandise may pass to the

• Assume that on June 10, NetSolutions purchased merchandise as follows:

• The ownership of the merchandise may pass to the

• Assume that NetSolutions sells merchandise as follows:

• The seller may prepay the freight, even though the

• Assume that NetSolutions sells merchandise as follows:

Determine the amount to be paid in full settlement of

• Each merchandising transaction affects a buyer and a

Sievert Co. sold merchandise to Bray Co. on account,

• Almost all states levy a tax on sales of merchandise.

• The seller would record a sale of $100 on account, subject to a

• On a regular basis, the seller pays to the taxing authority

• Wholesalers are companies that sell merchandise to

• Sellers and buyers do not normally record the list