Chapter

6
Merchandising
Activities

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Learning
Learning Objective
Objective

To describe the
operating cycle of a
merchandising
company.

LO1
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Operating
Operating Cycle
Cycle of
of aa Merchandising
Merchandising
Company
Company

1.
s he

Pu ch
Cash

m
le f t

er
rc a n
ab o

ha di
i v on

se se
c e ti
re lec

of
ol
C
3.

Accounts
Inventory
Receivable 2. Sale of merchandise
on account

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Comparing
Comparing Merchandising
Merchandising Activities
Activities with
with
Manufacturing
Manufacturing Activities
Activities

Manufacture
Purchase inventory and
inventory in have a longer
ready-to-sell and more
condition. complex
operating cycle.

Merchandising Manufacturing
Company Company
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Retailers
Retailers and
and Wholesalers
Wholesalers

Wholesalers buy
merchandise from
several different
manufacturers and
then sell this Retailers sell
merchandise to merchandise directly
several retailers. to the public.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Learning
Learning Objective
Objective

To understand the
components of a
merchandising
company’s income
statement.

LO2
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Income
Income Statement
Statement of
of aa
Merchandising
Merchandising Company
Company
Computer City Cost of
Condensed Income Statement goods sold
For the Year Ended December 31, 2007 represents
Revenue from sales $ 900,000 the expense
Less: Cost of goods sold 540,000 of goods
Gross profit $ 360,000 that are
Less: Expenses 270,000
sold to
Net income $ 90,000
customers.
Gross profit is a useful means of measuring
the profitability of sales transactions.
© The McGraw-Hill Companies, Inc., 2008
McGraw-Hill/Irwin
 Accounting
Accounting System
System Requirements
Requirements
for
for Merchandising
Merchandising Companies
Companies

Although general ledger accounts provide

useful information, they do not provide
much of the detailed information needed in
the daily business operations.
General Ledger
Accounts Receivable Who
Date Debit Credit Balance
Who
2007
owes
owes us
us
June 1 10,000 10,000 money?
money?
15 3,000 7,000
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Accounting
Accounting System
System Requirements
Requirements
for
for Merchandising
Merchandising Companies
Companies
Control Account General Ledger
Accounts Receivable
Date Debit Credit Balance
Subsidiary Ledgers 2007
June 1 10,000 10,000
15 3,000 7,000

Subsidiary Ledger
Jake Sparks
Date Debit Credit Balance
2007
June 1 3,000 3,000
15 1,000 2,000
Subsidiary Ledger
Heather Jacobs
Date Debit Credit Balance
2007
June 1 7,000 7,000
15
McGraw-Hill/Irwin 2,000 5,000 © The McGraw-Hill Companies, Inc., 2008
 Two
Two Approaches
Approaches Used
Used in
in Accounting
Accounting for
for
Merchandise
Merchandise Inventories
Inventories

Perpetual Periodic
Inventory Inventory
System System

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Learning
Learning Objective
Objective

To account for
purchases and sales of
merchandise in a
perpetual inventory
system.

LO3
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Perpetual
Perpetual Inventory
Inventory Systems
Systems

The inventory account is continuously

updated to reflect items on hand.

Let’s look
at some
entries!

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

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

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Perpetual
Perpetual Inventory
Inventory Systems
Systems

On September 10, Worley Co. sold 10 laser

lights for $50 per unit on account to ABC
Radios.
10  $30
10 $30 == $300
$300 Retail

Cost
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Perpetual
Perpetual Inventory
Inventory Systems
Systems
On September 15, Worley Co. paid Electronic
City $3,000 for the September 5 purchase.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

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

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Taking
Taking aa Physical
Physical Inventory
Inventory

In order to ensure
the accuracy of
their perpetual
records, most
businesses take a
complete physical
count of the
merchandise on
hand at least once
a year.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Taking
Taking aa Physical
Physical Inventory
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.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Closing
Closing Entries
Entries in
in aa Perpetual
Perpetual
Inventory
Inventory System
System

The closing
 Close Revenue accounts
(including Sales) to Income entries are the
Summary. same!
 Close Expense accounts
(including Cost of Goods
Sold) to Income Summary.

 Close Income Summary

account to Retained
Earnings.

 Close Dividends to Retained

Earnings.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Learning
Learning Objective
Objective

To explain how a
periodic inventory
system operates.

LO4
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Periodic
Periodic Inventory
Inventory System
System

No effort is made to keep up-to-date

records of either inventory or cost of
goods sold.

Let’s look
at some
entries!

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

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

Notice
Notice that
that no
no entry
entry is
is
made
made to to Inventory.
Inventory.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

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

Retail

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

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

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

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

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Computing
Computing Cost
Cost of
of Goods
Goods Sold
Sold
The
The accounting
accounting records
records of
of Party
Party
Supply
Supply show
show the
the following:
following:
Inventory,
Inventory, Jan.
Jan. 11 $$ 14,000
14,000
Purchases
Purchases (during
(during year)
year) 130,000
130,000

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

Calculate Party Supply’s cost of goods sold

McGraw-Hill/Irwin for the year. © The McGraw-Hill Companies, Inc., 2008
 Computing
Computing Cost
Cost of
of Goods
Goods Sold
Sold

Cost of Goods Sold can be

calculated as follows:

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Creating
Creating aa Cost
Cost of
of Goods
Goods Sold
Sold
Account
Account

Now, Party Supply must

create the Cost of Goods
Sold account.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Creating
Creating aa Cost
Cost of
of Goods
Goods Sold
Sold
Account
Account

Now, Party Supply must

record the ending inventory
amount.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Completing
Completing the
the Closing
Closing Process
Process
Close Revenue accounts
(including Sales) to The closing
Income Summary. entries are the
same!
Close Expense accounts
(including Cost of Goods
Sold) to Income Summary.

 Close Income Summary

account to Retained
Earnings.

Close Dividends to
Retained Earnings.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Learning
Learning Objective
Objective

To discuss the factors

to be considered in
selecting an inventory
system.

LO5
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Selecting
Selecting an
an Inventory
Inventory System
System

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Learning
Learning Objective
Objective

To account for
additional merchandise
transactions related to
purchases and sales.

LO6
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Credit
Credit Terms
Terms and
and Cash
Cash Discounts
Discounts

When manufacturers and wholesalers

sell their products on account, the
credit terms are stated in the invoice.

2/10, n/30
Read as: “Two ten, net thirty”
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Credit
Credit Terms
Terms and
and Cash
Cash Discounts
Discounts

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

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Recording
Recording Purchases
Purchases at
at Net
Net Cost
Cost

Purchases are
recorded at their
net amounts.
Net Purchase
Method Discounts Lost
are recorded
when payment is
made outside
the discount
period.
© The McGraw-Hill Companies, Inc., 2008
McGraw-Hill/Irwin
 Recording
Recording Purchases
Purchases at
at Net
Net Cost
Cost
On July 6, Play Clothes purchased $4,000 of
merchandise on credit with terms of
2/10, n/30 from Kid’s Clothes.
Prepare the journal entry for Play Clothes.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Recording
Recording Purchases
Purchases at
at Net
Net Cost
Cost

On July 6, Play Clothes purchased $4,000 of

merchandise on credit with terms of
2/10, n/30 from Kid’s Clothes.
Prepare the journal entry for Play Clothes.

McGraw-Hill/Irwin $4,000  98%

$4,000 98% == $3,920
$3,920 © The McGraw-Hill Companies, Inc., 2008
 Recording
Recording Purchases
Purchases at
at Net
Net Cost
Cost

On July 15, Play Clothes pays the full amount

due to Kid’s Clothes.
Prepare the journal entry for Play Clothes.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Recording
Recording Purchases
Purchases at
at Net
Net Cost
Cost

On July 15, Play Clothes pays the full amount

due to Kid’s Clothes.
Prepare the journal entry for Play Clothes.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Recording
Recording Purchases
Purchases at
at Net
Net Cost
Cost
Now, assume that Play Clothes waited until
July 20 to pay the amount due in full to
Kid’s Clothes.
Prepare the journal entry for Play Clothes.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Recording
Recording Purchases
Purchases at
at Net
Net Cost
Cost
Now, assume that Play Clothes waited until
July 20 to pay the amount due in full to
Kid’s Clothes.
Prepare the journal entry for Play Clothes.

Nonoperating
NonoperatingExpense
Expense

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Recording
Recording Purchases
Purchases atat Gross
Gross
Invoice
Invoice Price
Price

Purchases are
recorded at their
gross amounts.
Gross Purchase
Method discounts taken
are recorded
when payment is
made inside the
discount period.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Recording
Recording Purchases
Purchases atat Gross
Gross
Invoice
Invoice Price
Price

On July 6, Play Clothes purchased $4,000 of

merchandise on credit with terms of
2/10, n/30 from Kid’s Clothes.
Prepare the journal entry for Play Clothes.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Recording
Recording Purchases
Purchases atat Gross
Gross
Invoice
Invoice Price
Price

On July 6, Play Clothes purchased $4,000 of

merchandise on credit with terms of
2/10, n/30 from Kid’s Clothes.
Prepare the journal entry for Play Clothes.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Recording
Recording Purchases
Purchases atat Gross
Gross
Invoice
Invoice Price
Price
On July 15, Play Clothes pays the full amount
due to Kid’s Clothes.
Prepare the journal entry for Play Clothes.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Recording
Recording Purchases
Purchases atat Gross
Gross
Invoice
Invoice Price
Price
On July 15, Play Clothes pays the full amount
due to Kid’s Clothes.
Prepare the journal entry for Play Clothes.

Reduces
ReducesCost
Costof
Goods
of $4,000  98%
$4,000 98% == $3,920
$3,920
GoodsSold
Sold

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Recording
Recording Purchases
Purchases atat Gross
Gross
Invoice
Invoice Price
Price
Now, assume that Play Clothes waited until
July 20 to pay the full amount due to Kid’s
Clothes.
Prepare the journal entry for Play Clothes.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Recording
Recording Purchases
Purchases atat Gross
Gross
Invoice
Invoice Price
Price
Now, assume that Play Clothes waited until
July 20 to pay the full amount due to Kid’s
Clothes.
Prepare the journal entry for Play Clothes.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Returns
Returns of
of Unsatisfactory
Unsatisfactory
Merchandise
Merchandise
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.
Prepare the journal entry for Play Clothes.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Returns
Returns of
of Unsatisfactory
Unsatisfactory
Merchandise
Merchandise
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.
Prepare the journal entry for Play Clothes.

McGraw-Hill/Irwin $500  98%

$500 98% == $490
$490 © The McGraw-Hill Companies, Inc., 2008
 Transportation
Transportation Costs
Costs on
on Purchases
Purchases

Transportation
Transportation costs
costs related
related to
to the
the
acquisition
acquisition ofof assets
assets are
are part
part of
of the
the
cost
cost of
of the
the asset
asset being
being acquired.
acquired.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Now, let’s talk
about sales!

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

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

Credit terms and merchandise returns

affect the amount of revenue earned by
the seller.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Sales
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.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Sales
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.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Sales
Sales Returns
Returns and
and Allowances
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.
Contra-revenue
Contra-revenue

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Sales
Sales Returns
Returns and
and Allowances
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.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Sales
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.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Sales
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.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

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

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

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

Contra-revenue
Contra-revenue $4,000  98%
$4,000 98% == $3,920
$3,920

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Sales
Sales Discounts
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.
Prepare the journal entry for Kid’s Clothes.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Sales
Sales Discounts
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.
Prepare the journal entry for Kid’s Clothes.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Delivery
Delivery Expenses
Expenses

Delivery
Delivery costs
costs incurred
incurred by
by sellers
sellers are
are
debited
debited to
to Delivery
Delivery Expense,
Expense, anan
operating
operating expense.
expense.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Accounting
Accounting for
for Sales
Sales Taxes
Taxes

Businesses collect sales tax at the point of sale.

Then, they remit the tax to the appropriate
governmental agency at times specified by law.

$1,000 sale  7%
$1,000 sale 7% tax
tax == $70
$70 sales
sales tax
tax

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Learning
Learning Objective
Objective

To define special
journals and explain
their usefulness.

LO7
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Modifying
Modifying an
an Accounting
Accounting System
System

Most businesses use special journals

rather than a general journal to record
routine transactions that occur
frequently.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Learning
Learning Objective
Objective

To measure the
performance of a
merchandising
business.

LO8
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Financial
Financial Analysis
Analysis

Gross
Net Sales Profit
Margins

••Trends
Trendsover
overtime
time ••Gross profit  Net
Grossprofit Netsales
sales
••Comparable
Comparablestore
storesales
sales ••Overall
Overall gross
grossprofit
profit
margin
margin
••Sales
Salesper
persquare
squarefoot
footof
of
••Gross
Grossprofit
profitmargins
marginsby by
selling
sellingspace
space department
departmentand and
McGraw-Hill/Irwin
products
products
© The McGraw-Hill Companies, Inc., 2008
 Ethics,
Ethics, Fraud,
Fraud, and
and
Corporate
Corporate Governance
Governance

Sales discounts and allowances are contra-revenue

accounts. Sales discounts and allowances reduce
gross sales. As such, net income will be incorrect if
discounts and allowances are not properly recorded.

The pressure brought to bear on subordinates to

implement fraudulent schemes developed by top
management can often be intense. Top
management can threaten employees with
termination if they fail to participate in the fraud.
Unfortunately, employees who acquiesce to such
pressure face tremendous legal risks.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 End
End of
of Chapter
Chapter 66

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008