Accounting

Principles
Second Canadian Edition
Weygandt · Kieso · Kimmel ·
Trenholm

Prepared by:
Carole Bowman, Sheridan College
 CHAPTER

ACCOUNTING FOR
MERCHANDISING
OPERATIONS
 MERCHANDISING
MERCHANDISING COMPANY
COMPANY

 A merchandising company is an enterprise

that buys and sells goods to earn a profit.
1. Wholesalers sell to retailers.
2. Retailers sell to consumers.
 A merchandiser’s primary source of
revenue is sales, whereas a service
company’s primary source of revenue is
service revenue.
 OPERATING
OPERATING CYCLES
CYCLES FOR
FOR A
A
SERVICE
SERVICE COMPANY
COMPANY AND
AND AA
MERCHANDISING
MERCHANDISING COMPANY
COMPANY
Service Company

Receive Cash Perform

Cash Services

Accounts
Receivable

Merchandising Company
Receive Buy
Cash Inventory
Cash

Sell Inventory

Accounts Merchandise
Receivable Inventory
 ILLUSTRATION
ILLUSTRATION 5-1
5-1
INCOME
INCOME MEASUREMENT
MEASUREMENT PROCESS
PROCESS
FOR
FOR A
A MERCHANDISING
MERCHANDISING COMPANY
COMPANY
Sales Less
Revenue

Equals

Cost
Costof
of Gross
Gross Less
Goods
GoodsSold
Sold Profit
Profit
Equals

Operating Net
Expenses Income
(Loss)
 INVENTORY
INVENTORY SYSTEMS
SYSTEMS
Merchandising entities may use either (or
both) of the following inventory systems:
1. Perpetual – where detailed records of each
inventory purchase and sale are maintained.
Cost of goods sold is calculated at the time of
each sale.
2. Periodic – detailed records are not
maintained. Cost of goods sold is calculated
only at the end of the accounting period.
This chapter covers the perpetual method.
 RECORDING
RECORDING COST
COST OF
OF
GOODS
GOODS PURCHASED
PURCHASED
 When merchandise is purchased for resale
to customers, the account, Merchandise
Inventory, is debited for the cost of the
goods.
 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.
 PURCHASES
PURCHASES OF
OF
MERCHANDISE
MERCHANDISE

General Journal J1
Date Account Title and Explanation Ref Debit Credit
May 4 Merchandise Inventory 3,800
Accounts Payable 3,800
To record goods purchased on
account, terms n/30.

For purchases on account, Merchandise

Inventory is debited and Accounts Payable is
credited. For cash purchases, Merchandise
Inventory is debited and Cash is credited.
 FREIGHT
FREIGHT COSTS
COSTS
 The sales agreement should indicate whether the seller or
the buyer is to pay the cost of transporting the goods to the
buyer’s place of business.
 FOB Shipping Point
1. Goods delivered to shipping point by seller
2. Buyer pays freight costs from shipping
point to destination
 FOB Destination
1. Goods delivered to destination
by seller
2. Seller pays freight costs
 ACCOUNTING
ACCOUNTING FOR
FOR
FREIGHT
FREIGHT COSTS
COSTS
 Merchandise Inventory is debited by the buyer, if the
buyer pays the freight bill (FOB shipping point).
 Freight Out (or Delivery Expense) is debited by the
seller, if the seller pays the freight bill (FOB
destination).
 ACCOUNTING
ACCOUNTING FOR
FOR
FREIGHT
FREIGHT COSTS
COSTS

General Journal J1
Date Account Title and Explanation Ref Debit Credit
May 4 Merchandise Inventory 150
Cash 150
To record payment of freight.

When the purchaser directly incurs the freight

costs, the account Merchandise Inventory is
debited and Cash is credited.
 PURCHASE
PURCHASE RETURNS
RETURNS AND
AND
ALLOWANCES
ALLOWANCES
 A purchaser may be dissatisfied with
merchandise received because the goods
1. are damaged or defective,
2. are of inferior quality, or
3. are not in accord with the
purchaser’s specifications.
 PURCHASE
PURCHASE RETURNS
RETURNS AND
AND
ALLOWANCES
ALLOWANCES

General Journal J1
Date Account Title and Explanation Ref Debit Credit
May 8 Accounts Payable 300
Merchandise Inventory 300
To record return of goods.

For purchases returns and allowances that were

originally made on account, Accounts Payable is
debited and Merchandise Inventory is credited.
For cash returns and allowances, Cash is debited
and Merchandise Inventory is credited.
 QUANTITY
QUANTITY DISCOUNTS
DISCOUNTS

• Volume purchase terms may permit the

buyer to claim a quantity discount.
• The merchandise inventory is simply
recorded at the discounted cost.
 PURCHASE
PURCHASE DISCOUNTS
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.
 A purchase discount is based on
the invoice cost less any returns
and allowances granted.
 SALES
SALES TRANSACTIONS
TRANSACTIONS

 Revenues are reported when earned in

accordance with the revenue recognition
principle. In a merchandising company.
revenues are earned when the goods are
transferred from seller to buyer.
 SALES
SALES TRANSACTIONS
TRANSACTIONS
General Journal J1
Date Account Title and Explanation Ref Debit Credit
May 4 Accounts Receivable 3,800
Sales 3,800
To record credit sale.

May 4 Cost of Goods Sold 2,400

Merchandise Inventory 2,400
To record cost of merchandise
sold.

1. The first entry records the sale of goods to a

customer at the retail (selling) price.
2. The second entry releases the goods from inventory
at cost and charges the goods to cost of goods sold.
 SALES TAXES

• Sales tax is expressed as a percentage of the sales

price on selected goods sold to customers by a
retailer. They are collected on most revenues, and
paid on many costs.
• Sales taxes may include the federal goods and
services tax (GST) and the provincial sales tax
(PST), if any. These two taxes have been combined
into one harmonized sales tax (HST) in some
Atlantic Provinces.
 SALES TAXES ON REVENUES

• The retailer collects the tax from the

customer when the sale occurs, and
periodically (usually monthly) remits the
collections to the Receiver General.
• Sales taxes are not revenue but are a current
liability until remitted.
 SALES
SALES RETURNS
RETURNS AND
AND
ALLOWANCES
ALLOWANCES
 Sales Returns occur when customers are
dissatisfied with merchandise and are
allowed to return the goods to the seller for
credit or a refund.
 Sales Allowances occur when
customers are dissatisfied, and the
seller allows a deduction from
the selling price.
 SALES
SALES RETURNS
RETURNS AND
AND
ALLOWANCES
ALLOWANCES
 The normal balance of Sales Returns and
Allowances is a debit.
 Sales Returns and Allowances is a contra
revenue account to the Sales account.
 RECORDING
RECORDING SALES
SALES RETURNS
RETURNS
AND
AND ALLOWANCES
ALLOWANCES
General Journal J1
Date Account Title and Explanation Ref Debit Credit
May 8 Sales Returns and Allowances 300
Accounts Receivable 300
To record returned goods.

May 8 Merchandise Inventory 140

Cost of Goods Sold 140
To record cost of goods
returned.

1. The first entry reduces the balance owed by the

customer and records the goods returned at retail price.
2. The second entry records the physical return of goods to
inventory at cost and removes the goods from the cost
of goods sold account.
 QUANTITY
QUANTITY DISCOUNTS
DISCOUNTS

• A quantity discount is the offer of a cash

discount to a customer in return for a volume
sale.
• Quantity discounts result in a sales price
reduction. They are not separately journalized.
Instead the sale is recorded at the reduced
price.
 SALES
SALES DISCOUNTS
DISCOUNTS

 A sales discount is the offer of a cash discount

to a customer in exchange for the prompt
payment of a balance due.
 Similar to Sales Returns and Allowances,
Sales Discounts is also a contra revenue
account with a normal debit balance.
 COMPLETING THE
ACCOUNTING CYCLE
 A merchandising company requires the same
types of adjusting entries as a service company,
with one additional adjustment for inventory to
ensure the recorded inventory amount agrees
with the actual quantity on hand.
 A physical count is an important control feature
since a perpetual system indicates what should
be there but a count will determine what is
actually there.
 COMPLETING THE
ACCOUNTING CYCLE

 A merchandising company also requires the

same types of closing entries as a service
company.
 The additional accounts that need to be closed
out in a merchandising account include Sales,
Sales Returns and Allowances, Cost of Goods
Sold, and Freight Out.
 Merchandise Inventory is an asset account and
is not closed at the end of the period.
 ILLUSTRATION
ILLUSTRATION 5-9
5-9
STATEMENT
STATEMENT PRESENTATION
PRESENTATION OF
OF
SALES
SALES REVENUE
REVENUE SECTION
SECTION
As contra revenue accounts, sales returns and
allowances (and sales discounts, if any) are
deducted from sales in the income statement to
arrive at Net Sales.

HIGHPOINT ELECTRONIC
Income Statement (Partial)
For the Year Ended December 31, 2002
Sales revenue
Sales $ 480,000
Less: Sales returns and allowances 20,000
Net sales $ 460,000
 ILLUSTRATION
ILLUSTRATION 5-10
5-10
CALCULATION
CALCULATION OF
OF GROSS
GROSS PROFIT
PROFIT
Gross profit is calculated by deducting cost of
goods sold from net sales as follows:

Net
Net sales
sales $$ 460,000
460,000 100%
Cost
Cost of
of goods
goods sold
sold 316,000
316,000 69%
Gross
Gross profit
profit $ 144,000 31%

Gross profit is often expressed as a

percentage of sales.
 ILLUSTRATION
ILLUSTRATION 5-12
5-12
CALCULATION
CALCULATION OF
OF NET
NET INCOME
INCOME

Net income is calculated by deducting operating

expenses from gross profit as follows:

Gross profit $ 144,000

Operating expenses 114,000
Net income $ 30,000

Net income is the “bottom line” of a

company’s income statement.
 HIGHPOINT ELECTRONIC
Income Statement
ILLUSTRATION Sales revenue
For the Year Ended December 31, 2002

5-14 Sales $ 480,000

Less: Sales returns and allowances 20,000
Net sales 460,000
This is the format Cost of goods sold 316,000

of a multi-step Gross profit

Operating expenses
144,000

income statement Selling expenses

Salaries expense $ 45,000
that has both Advertising expense
Amortization expense
16,000
8,000
operating and non- Freight out 7,000
Total selling expenses $ 76,000
operating Administrative expenses

activities. Rent expense

Utilities expense
$ 19,000
17,000
Insurance expense 2,000
Total administrative expenses 38,000
As shown, the non- Total operating expenses
Income from operations
114,000
30,000
operating activities Other revenue and gains
Interest revenue $ 3,000
are reported Gain on sale of equipment 600

immediately after Total non-operating revenue and gain

Other expenses and losses
$ 3,600

the company’s Interest on expense

Casualty loss from vandalism
$ 1,800
200
primary operating Total non-operating expense and loss
Net non-operating revenue
2,000
1,600
activities. Net income $ 31,600
 CLASSIFIED
CLASSIFIED BALANCE
BALANCE SHEET
SHEET
HIGHPOINT ELECTRONIC
Balance Sheet (partial)
December 31, 2002
Assets
Current assets On the balance sheet,
Cash merchandise inventory is $ 9,500
Accounts receivable reported as a current asset 16,100
and appears immediately
Merchandise inventory 40,000
below accounts receivable.
Prepaid insurance This is because current 1,800
Total current assets assets are listed in the 67,400
Capital assets order of their liquidity.
Store equipment $ 80,000
Less: Accumulated amortization 24,000 56,000
Total assets $ 123,400
USING THE INFORMATION IN THE
FINANCIAL STATEMENTS

Inventory is particularly important because:

• It is a large current asset
on the balance sheet
• It becomes a large
expense on the income
statement
• It is vulnerable to theft or
misuse
 USING THE INFORMATION IN THE
FINANCIAL STATEMENTS

 A balancing act is needed to ensure that

a sufficient, but not excessive, quantity of
inventory is on hand.
 Two ratios help evaluate the
management of inventory:
• Inventory turnover
• Days sales in inventory
INVENTORY TURNOVER

Inventory turnover =
Cost of goods sold
Average inventory
DAYS SALES IN INVENTORY

Days sales in inventory =

365 days
Inventory turnover
 COPYRIGHT

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