CHAPTER 5

Accounting for Merchandising Inventory

STUDY OBJECTIVES
1. IDENTIFY THE DIFFERENCES BETWEEN SERVICE AND MERCHANDISING COMPANIES. 2. EXPLAIN THE RECORDING OF PURCHASES UNDER A PERPETUAL INVENTORY SYSTEM. 3. EXPLAIN THE RECORDING OF SALES REVENUES UNDER A PERPETUAL INVENTORY SYSTEM. 4. EXPLAIN THE STEPS IN THE ACCOUNTING CYCLE FOR A MERCHANDISING COMPANY. 5. DISTINGUISH BETWEEN A MULTIPLE-STEP AND A SINGLE-STEP INCOME STATEMENT. 6. EXPLAIN THE COMPUTATION AND IMPORTANCE OF GROSS PROFIT. 7. DETERMINE COST OF GOODS SOLD UNDER A PERIODIC SYSTEM. *8. EXPLAIN THE RECORDING OF PURCHASES AND SALES OF INVENTORY UNDER A PERIODIC INVENTORY SYSTEM.
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*9. PREPARE A WORKSHEET FOR A MERCHANDISING COMPANY.

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In a periodic inventory system. Operating expenses are expenses incurred in the process of earning sales revenue. and those that sell to retailers are known as wholesalers. Merchandisers that purchase and sell directly to consumers are retailers. The primary source of revenue for a merchandiser is sales revenue. (S. 2. Delivery Expense or Freight-out is debited and cash is credited. Cash is credited. For example. A merchandiser may use either a perpetual or a periodic inventory system in determining cost of goods sold. When the seller pays the freight. for a credit purchase. After gross profit is calculated.000 and cost of goods sold is $3. if sales are $5. detailed records of the cost of each inventory item are maintained and the cost of each item sold is determined from the records when the sale occurs. 10. Accounts Payable is credited. Merchandise Inventory is debited and Cash is credited. Expenses are divided into two categories: (1) cost of goods sold and (2) operating expenses. 3. and the seller pays the freight. 5.CHAPTER REVIEW Measuring Net Income 1. FOB shipping point means that goods are placed free on board the carrier by the seller. a. 9. operating expenses are deducted to determine net income (or loss).O. (S. 1) A merchandiser is an enterprise that buys and sells goods to earn revenue. Purchase Transactions 8. gross profit is $2. detailed inventory records are not maintained and the cost of goods sold is determined only at the end of an accounting period. FOB destination means that goods are placed free on board at the buyer’s place of business. 5-3 .O. purchases of merchandise for sale are recorded in the Merchandise Inventory account.000. and the buyer must pay the freight costs. The operating cycle of a merchandiser is as follows: Receive Cash Cash Buy Inventory Accounts Receivable Sell Inventory Merchandise Inventory Inventory Systems 7. Sales less cost of goods sold is called the gross profit (or gross margin) on sales.000. When the purchaser pays the freight. 4. This account is classified as an operating expense by the seller. For a cash purchase. b. 2) Under the perpetual inventory system. Operating Cycles 6. In a perpetual inventory system.

.. 5-4 18....... this is called a purchase discount...O...... Typically sales revenues are earned when the goods are transferred from the seller to the buyer. Cost of Goods Sold.... sales invoices provide support for credit sales.......... or not in accord with the purchaser’s specifications.......... XXXX XXXX A cash sale is recorded by a debit to Cash and a credit to Sales............... then a 3% discount is taken on the invoice price (less any returns or allowances) if payment is made within 10 days.. A sales allowance results when a customer is dissatisfied with merchandise and the seller is willing to grant an allowance (deduction) from the selling price............... Cash register tapes provide evidence of cash sales. then there is no purchase discount. A purchaser may be dissatisfied with the merchandise received because the goods may be damaged or defective............... If a purchase discount has terms 3/10............ n/30...................... The purchaser may return the merchandise................................................................ When an invoice is paid within the discount period.... sales revenues are recorded when earned..... Merchandise Inventory ........ (S...................11. Sales ...... the following entry is recorded: Cash ........................ the amount of the discount is credited to Merchandise Inventory.... When merchandise is returned..... Accounts Receivable .................................... XXXX XXXX XXXX XXXX 15............ If payment is not made within 10 days.............................. and the net amount of the bill is due within 30 days......... XXXX XXXX XXXX ................. All sales transactions should be supported by a business document............. To give the customer a sales return or allowance.......... Merchandise Inventory is credited.................. After the cash payment is received by the seller. of inferior quality.......... the seller normally makes the following entry if the sale was a credit sale (the second entry is made only if the goods are returned): Sales Returns and Allowances .......... and a debit to Cost of Goods Sold and a credit to Merchandise Inventory............ When an invoice is not paid within the discount period......... 13........... When the credit terms of a purchase on account permits the purchaser to claim a cash discount for the prompt payment of a balance due..... then the usual entry is made with a debit to Accounts Payable and a credit to Cash........ Accounts Receivable................. Sales Transactions 14........... 12................ A sale on credit is recorded as follows: Accounts Receivable ........... Merchandise Inventory ......... Sales Returns and Allowances 17.... or choose to keep the merchandise if the supplier is willing to grant an allowance (deduction) from the purchase price............ 16..................... A sales return results when a customer is dissatisfied with merchandise and is allowed to return the goods to the seller for credit or for a cash refund............ 3) In accordance with the revenue recognition principle..

... Sales Discounts is a contra-revenue account and the normal balance of this account is a debit. like a service company.O. then a 2% discount is taken on the invoice price (less any returns or allowances) if payment is made within 10 days. Revenues and expenses that result from secondary or auxiliary operations. 27. 21....... In addition. is due within 30 days. Both Sales Returns and Allowances and Sales Discounts are subtracted from Sales in the income statement to arrive at net sales.Cost of Goods Sold ... Gains and losses that are unrelated to the company’s operations. Operating expenses are the third component in measuring net income for a merchandising company.O. and the net amount of the bill... XXXX For a sales return or allowance on a cash sale. Gross Profit and Operating Expenses 25. The gross profit rate is expressed as a percentage by dividing the amount of gross profit by net sales. In addition.. 5) A multiple-step income statement shows several steps in determining net income: (1) cost of goods sold is subtracted from net sales for determining gross profit and (2) operating expenses are deducted from gross profit to determine net income. Sales Discounts 20.. Adjusting Entries and Closing Entries 23... 4) Each of the required steps in the accounting cycle applies to a merchandising company..... 26.. If a credit sale has terms 2/10... (S..O.. The second entry is the same as above. (S..... 5-5 . Single-Step Income Statement 24.. (S. 6) Gross profit is net sales less cost of goods sold. A sales discount is the offer of a cash discount to a customer for the prompt payment of a balance due. 19... then there is no sales discount... and (b) administrative expenses. A merchandising company generally has the same types of adjusting entries as a service company but a merchandiser using a perpetual inventory system will require an additional adjustment to reflect the difference between a physical count of the inventory and the accounting records.... If payment is not made within 10 days...... there may be nonoperating sections for: a. and b. a cash refund is made and Cash is credited instead of Accounts Receivable. Nonoperating sections are reported in the income statement after income from operations and are classified as (a) Other revenues and gains and (b) Other expenses and losses....... without discount. The Accounting Cycle 22... Sales Returns and Allowances is a contra-revenue account and the normal balance of the account is a debit. Multiple-Step vs.... n/30.. a merchandising company makes closing entries to and from Income Summary. A multiple-step income statement may also subdivide operating expenses into two functional groupings: (a) selling expenses.

28. and only one step is required in determining net income or net loss. 5-6 . The income statement is referred to as a single-step income statement when all data are classified under two categories: (a) Revenues and (b) Expenses.

(2) Determine the cost of goods purchased. using a periodic inventory system. then the usual entry is made with a debit to Accounts Payable and a credit to Cash. Purchase Returns and Allowances is a temporary account whose normal balance is a credit.O.200 10. purchases of merchandise for sale are recorded in a Purchases account. returns.000 $8.200 4. for a credit purchase. 2008 Cost of goods sold Inventory. the amount of the discount is credited to the account Purchases Discounts. But. (S. a running account of changes in inventory is not maintained. When an invoice is not paid within the discount period. Under the periodic inventory system. Accounts Payable is credited.800 221. Instead.000 Periodic Inventory System *31.000 260. is calculated at the end of the period. is as follows: Tsutsui Company Cost of Goods Sold For the Year Ended December 31. no attempt is made on the date of sale to record the cost of the merchandise sold. *32. To determine the cost of goods sold under a periodic inventory system. In addition. The determination of cost of goods sold for Tsutsui Co. A merchandiser generally has the same type of balance sheet as a service company except merchandise inventory is reported as a current asset. a physical inventory count is taken at the end of the period to determine (1) the cost of the merchandise then on hand and (2) the cost of the goods sold during the period. 7) Under a periodic system separate accounts are used to record freight costs. For a cash purchase. *34. three steps are required: (1) Record purchases of merchandise.000 30. as well as cost of goods sold for the period. (S. 8) In a periodic inventory system revenues from the sale of merchandise are recorded when sales are made in the same way as in a perpetual system.800 232.000 $234. If payment is made within a discount period. Cash is credited. and (3) Determine the cost of goods on hand at the beginning and end of the accounting period. Instead. December 31 Cost of goods sold $28. Determining Cost of Goods Sold Under a Periodic System 30. the balance in ending inventory.O.000 230. and discounts. Cost of Goods Sold *35. January 1 Purchases Less: Purchases returns and allowances Purchase discounts Net Purchases Add: Freight-in Cost of goods purchased Cost of goods available for sale Inventory. *33. A purchase return and allowance is recorded by debiting Accounts Payable or Cash and crediting the account Purchase Returns and Allowances. 5-7 .Classified Balance Sheet 29.600 12.

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(S. The cost of goods on hand at the end of the period is subtracted from the cost of goods available for sale. b. The cost of goods purchased is added to the cost of goods on hand at the beginning of the period to obtain the cost of goods available for sale. Totaling the costs for each item of inventory. Counting the units on hand for each item of inventory. Cost of inventory on hand under the periodic inventory method is obtained from a physical inventory. The income statement for retailers and wholesalers under a periodic inventory system will generally contain more detail listing the above calculations. Applying unit costs to the total units on hand for each item.O. *39. Using a Worksheet *40. In determining cost of goods purchased. The steps in preparing a worksheet for a merchandiser are the same as they are for a service enterprise except the additional merchandising accounts are included. c.Cost of Goods Purchased *36. Cost of goods sold is determined by two steps: a. (a) contra-purchase accounts are subtracted from purchases to produce net purchases. 5-9 . b. a worksheet enables financial statements to be prepared before the adjusting entries are journalized and posted. Taking a physical inventory involves: a. 9) As indicated in Chapter 4. Cost of Goods Sold *38. to determine the total cost of goods on hand. Cost of Inventory *37. and (b) freight-in is then added to net purchases.

or of inferior quality. In a perpetual inventory system. b. 5-10 . such as supplies and equipment. companies keep detailed records of the cost of each inventory purchase and sale. 1. Recording Purchases and Sales of Merchandise. Companies record in the Merchandise Inventory account the purchase of goods they intend to sell. b.LECTURE OUTLINE A. A purchaser may return goods to the seller for credit because the goods are damaged or defective. 1. 3. 2. Operating expenses are expenses incurred in the process of earning sales revenues. Cost of goods sold is the total cost of merchandise sold during the period. TEACHING TIP Use ILLUSTRATION 5-1 to illustrate the purchasing entries for a merchandising company. Merchandising Operations. The return of goods to the seller is known as a purchase return. These records continuously (perpetually) show the inventory that should be on hand for every item. The primary source of revenues for merchandising companies is the sale of merchandise. Under a perpetual inventory system: a. A merchandising company has two categories of expenses: a. B. referred to as sales revenue or sales. as increases to specific asset accounts rather than to Merchandise Inventory. Gross profit is the difference between sales revenue and cost of goods sold. Companies record purchases of assets acquired for use. 2.

and the buyer pays the freight costs. (3) Companies record sales revenues when earned—typically when goods transfer from the seller to the buyer. and Sales Discounts. The cost of goods sold is recognized for each sale by debiting Cost of Goods Sold and crediting Merchandise Inventory. The credit terms of a purchase on account may permit the buyer to claim a cash discount for prompt payment.c. 5-11 (4) (5) (6) . Freight terms are expressed as either FOB shipping point or FOB destination. Sales Returns and Allowances. Companies use a contra account. The buyer calls this cash discount a purchase discount. FOB destination means that the seller places the goods free on board to the buyer's place of business. Companies record sales by debiting Accounts Receivable (or Cash) and crediting Sales for the selling price of the merchandise. Emphasize the accounts used by a merchandising company—Sales. Sales Returns and Allowances is a contra-revenue account to Sales. (2) TEACHING TIP ILLUSTRATION 5-2 provides a short in-class example that can be used to demonstrate the entries for sales revenue transactions. d. Sales may be made on credit or for cash. and the seller pays the freight. to disclose in the accounts and in the income statement the amount of sales returns and allowances. (1) FOB shipping point means that the seller places the goods free on board the common carrier. Freight costs incurred by the seller on outgoing merchandise are an operating expense to the seller and are debited to Freight-out or Delivery Expense. The company debits the Merchandise Inventory account for all purchases of merchandise and freight-in. and credits it for purchase discounts and purchase returns and allowances. instead of debiting Sales.

A company’s unadjusted balance in Merchandise Inventory usually does not agree with the actual amount of inventory on hand. Multiple-step income statement. 1. The temporary accounts with credit balances are closed to Income Summary. The temporary accounts with debit balances are closed to Income Summary. Income Summary is closed to the owner’s capital account. This involves debiting (or crediting) Merchandise Inventory and crediting (or debiting) Cost of Goods Sold. Closing Entries. Forms of Income Statements.(8) Companies record sales returns and allowances by decreasing Cost of Goods Sold and increasing the Merchandise Inventory account. 5-12 . 3. a merchandising company that uses a perpetual system will take a physical count of its goods on hand. Sales Discounts is a contra revenue account to Sales and its normal balance is a debit. At the end of each period. E. Merchandising companies use one of two forms for the income statement: 1. 2. D. 4. A merchandiser using a perpetual system will require one additional adjusting entry to make the records agree with the actual inventory on hand. The company may need to adjust the perpetual inventory records to make the recorded inventory amount agree with the inventory on hand. Like Sales Returns and Allowances. 2. 3. The owner’s drawing account is closed to the owner’s capital account. Adjusting Entries. for control purposes. (7) (9) C. 1. A sales discount occurs when the seller offers a cash discount for prompt payment of the balance due.

and discounts. Examples of nonoperating items are also given. a. cost of goods sold. 3. b. At the end of the period. 1. 5-13 . a company calculates the balance in ending inventory. Under a periodic system. (2) Expenses include cost of goods sold. Record the purchases of merchandise. Determine the cost of goods purchased: Purchases less purchase returns and purchase discounts plus freight-in. Determining Cost of Goods Sold Under a Periodic System. F. and cost of goods sold for the period. Includes sales revenues. Two nonoperating activities sections: Other revenues and gains and other expenses and losses. returns. and other expenses and losses. and operating expenses with the subgrouping of operating expenses into selling and administrative expenses. Single-step income statement. 2. Determining cost of goods sold is different under the periodic system than under the perpetual system. The steps in determining cost of goods sold are: a. 2. 4.a. the company uses separate accounts to record freight costs. operating expenses. TEACHING TIP Use ILLUSTRATION 5-3 to contrast the Multiple-Step and the Single-Step forms of income statements. b. All data are classified under two categories: (1) Revenues include both operating revenues and other revenues and gains.

Determine the cost of goods on hand at the beginning and end of the accounting period. *G.c. TEACHING TIP Use ILLUSTRATION 5-5 to compare the journalizing of inventory transactions under the periodic and perpetual inventory systems. 5-14 . The steps in preparing a worksheet for a merchandising company are the same as they are for a service company. Companies record purchases of merchandise in the Purchases account rather than the Merchandise Inventory account. 3. 2. Companies record revenues from the sale of merchandise when sales are made. The Merchandise Inventory account is extended from the adjusted trial balance column to the balance sheet debit column. When a purchaser returns merchandise for credit or receives a discount for prompt payment. TEACHING TIP Use ILLUSTRATION 5-4 to demonstrate the calculation of cost of goods purchased and cost of goods sold. But companies do not attempt on the date of sale to record the cost of the merchandise sold. it is called purchase returns and allowances or purchase discounts. Periodic Inventory System. Using a Worksheet. Purchase Returns and Allowances and Purchase Discounts are contra accounts to Purchases and have normal credit balances. *H. Freight costs are recorded in a Freight-in account which is a temporary account whose normal balance is a debit. 1. 1. just as in a perpetual system. 2. 4.

Sales is placed in the credit column while Sales Returns/Allowances and Sales Discounts are entered in the debit column. 5-15 . Sales Returns and Allowances. and Sales Discounts are extended from the adjusted trial balance column to the income statement columns.3. Sales.

Cost of Goods Sold is extended from the adjusted trial balance column to the income statement debit column. Emphasize that all the unique accounts for a merchandising company appear in the income statement column except for the Merchandise Inventory account.4. TEACHING TIP Use ILLUSTRATION 5-6 to demonstrate the worksheet procedure for a merchandising company. 5-16 .

all income statement column debits represent expenses. merchandise inventory is reported as a current asset immediately below accounts receivable. True False 4. True/False 1. True False 8. Under the perpetual inventory system.20 MINUTE QUIZ Circle the correct answer. Administrative expenses relate to general operating activities such as personnel management. Sales Discounts is a contra revenue account and has a debit balance. gross profit and operating income are shown on the income statement. the purchase of merchandise is recorded with a debit to the Purchases account. In preparing a worksheet for a merchandising firm. In a single-step income statement. Income from operations is determined by subtracting administrative expenses from gross profit. A customer may receive a sales discount for goods that are damaged or defective. True False 2. True False 3. True False 5-17 . True False *10. True False 5. True False 9. True False 7. True False 6. Measuring net income for a merchandising company is conceptually the same as for a service company. The cost of goods sold is determined only at the end of the accounting period under a perpetual inventory system. In the balance sheet.

acquisition of merchandise requires a debit to Purchases. 5-18 . is a contra revenue account. c. c. has a normal debit balance. c. debit to a sales account and credit to an asset account. When a company uses the perpetual method of accounting for inventories the a. b. Net sales. d. 3. appears on the income statement. b. debit to Cash and a credit to Capital X. Merchandise Inventory account does not change until the end of the year. credit to Sales and a debit to Sales Discounts. Cost of goods sold. Office expense. Which of the following would not be considered an operating expense? a. b. credit to a sales account and a debit to an asset account. c. 2. all of the above. d. d. 5. c. The recording of a sale requires a a. 4. sale of inventory requires a credit to Cost of Goods Sold. b. Sales Discounts a. b. Gross profit. d.Multiple Choice 1. d. Freight-out. Income from operations. Which of the following is reported on both a multiple-step and a single-step income statement? a. Rent expense. Merchandise Inventory account is debited when inventory is purchased and Cost of Goods Sold is debited when inventory is sold. Other revenues and gains.

ANSWERS TO QUIZ True/False 1. a. 7. *10. 2. 8. 2. b. 4. 3. a. d. 5. 5. 4. 9. False True False True False Multiple Choice 1. True False False True False 6. 3. d. 5-19 .

ILLUSTRATION 5-1 MERCHANDISE PURCHASE ENTRIES FOR A MERCHANDISING COMPANY (PERPETUAL SYSTEM) 5-20 .

ILLUSTRATION 5-2 REVENUE ENTRIES FOR A MERCHANDISING COMPANY 5-21 .

ILLUSTRATION 5-3 MULTIPLE-STEP VS. SINGLE-STEP INCOME STATEMENT 5-22 .

ILLUSTRATION 5-4 COST OF GOODS SOLD 5-23 .

ILLUSTRATION 5-5 COMPARISON OF JOURNAL ENTRIES UNDER PERPETUAL AND PERIODIC INVENTORY SYSTEMS 5-24 .

ILLUSTRATION 5-6 WORKSHEET FOR A MERCHANDISING COMPANY 5-25 .