Accounting For Merchandising Operations

Chapter 5
Accounting for
Merchandising
Operations
Chapter
5-1
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.
Chapter
5-2
Accounting for Merchandising Operations
Recording Recording Completing the Forms of

Merchandising
Purchases of Sales of Accounting Financial
Operations Cycle
Merchandise Merchandise Statements
Operating Freight costs Sales returns Adjusting Multiple-step

cycles Purchase and entries income
Flow of returns and allowances Closing entries statement
costs— allowances Sales Summary of Single-step
perpetual and Purchase discounts merchandising income
periodic discounts entries statement
inventory Classified
Summary of
systems balance sheet
purchasing
transactions
Chapter
5-3
Merchandising Operations
Merchandising Companies
Buy and Sell Goods
Wholesaler Retailer Consumer
The primary source of revenues is referred to as

sales revenue or sales.
Chapter
5-4 SO 1 Identify the differences between service and merchandising companies.
Merchandising Operations
Income Measurement
Not used in a
Sales Less Illustration 5-1
Service business.
Revenue
Cost of Equals Gross Less

Goods Sold Profit
Operating Equals Net

Cost of goods sold is the total Income
cost of merchandise sold Expenses
(Loss)
during the period.
Chapter
Operating Cycles
Illustration 5-2
The operating
cycle of a
merchandising
company
ordinarily is
longer than that
of a service
company.
Chapter
Flow of Costs
Perpetual System
Features:
1. Purchases increase Merchandise Inventory.
2. Freight costs, Purchase Returns and Allowances and
Purchase Discounts are included in Merchandise Inventory.
3. Cost of Goods Sold is increased and Merchandise Inventory
is decreased for each sale.
4. Physical count done to verify Merchandise Inventory
balance.
The perpetual inventory system provides a continuous record

of Merchandise Inventory and Cost of Goods Sold.
Chapter
Flow of Costs
Periodic System
Features:
1. Purchases of merchandise increase Purchases.
2. Ending Inventory determined by physical count.
3. Calculation of Cost of Goods Sold:
Beginning inventory $ 100,000

Add: Purchases, net 800,000
Goods available for sale 900,000
Less: Ending inventory 125,000
Cost of goods sold $ 775,000
Chapter
Recording Purchases of Merchandise
Made using cash or credit (on account). Illustration 5-5
Normally recorded when

goods are received.
Purchase invoice should
support each credit
purchase.
Chapter
5-9 SO 2 Explain the recording of purchases under a perpetual inventory system.
E5-2 Information related to Steffens Co. is presented

below. Prepare the journal entry to record the
transaction under a perpetual inventory system.
1. On April 5, purchased merchandise from Bryant
Company for $25,000 terms 2/10, net/30, FOB
shipping point.
April 5 Merchandise inventory 25,000

Accounts payable 25,000
Chapter
E5-2 Continued Prepare the journal entry to record the

2. On April 6, paid freight costs of $900 on
merchandise purchased from Bryant.
April 6 Merchandise inventory 900

Cash 900
Chapter
Not all purchases increase Merchandise Inventory.

E5-2 Continued Prepare the journal entry to record the
3. On April 7, purchased equipment on account for
$26,000.
April 7 Equipment 26,000

Chapter
Freight Costs – Terms of Sale Illustration 5-6
Seller places goods Free

On Board the carrier, and
buyer pays freight costs.
Seller places goods Free

On Board to the buyer’s
place of business, and
seller pays freight costs.
Chapter Freight costs incurred by the seller are an operating expense.

5-13
Purchase Returns and Allowances

Purchaser may be dissatisfied because goods are
damaged or defective, of inferior quality, or do not
meet specifications.
Purchase Return Purchase Allowance

Return goods for credit May choose to keep the
if the sale was made on merchandise if the seller
credit, or for a cash will grant an allowance
refund if the purchase (deduction) from the
was for cash. purchase price.
Chapter
Question
In a perpetual inventory system, a return of
defective merchandise by a purchaser is
recorded by crediting:
a. Purchases
b. Purchase Returns
c. Purchase Allowance
d. Merchandise Inventory
Chapter
E5-2 Continued Prepare the journal entry to record

the transaction under a perpetual inventory system.
4. On April 8, returned damaged merchandise to
Bryant Company and was granted a $4,000 credit
for returned merchandise.
April 8 Accounts payable 4,000

Merchandise inventory 4,000
Chapter
Purchase Discounts
Credit terms may permit buyer to claim a cash
discount for prompt payment.
Advantages:
Purchaser saves money.
Seller shortens the operating cycle.
Example: Credit terms of 2/10, n/30, is read “two-ten, net

thirty.” 2% cash discount if payment is made within 10 days.
Chapter
Purchase Discounts Terms
2/10, n/30 1/10 EOM n/10 EOM
2% discount if 1% discount if Net amount due

paid within 10 paid within within the first
days, otherwise first 10 days of 10 days of the
net amount due next month. next month.
within 30 days.
Chapter

5. On April 15, paid the amount due to Bryant Company
in full. Remember the return of $4,000 of
merchandise.
(Discount = $21,000 x 2% = $420)

Cash 20,580
Merchandise Inventory 420
Chapter

5. Variation: What entry would be made if the
company failed to pay within 10 days?

or later Cash 21,000
Chapter
Purchase Discounts
Should discounts be taken when offered?
Discount of 2% on $21,000 $ 420.00
$21,000 invested at 10% for 20 days 115.07
Savings by taking the discount $ 304.93
Passing up the discount offered equates to paying an

interest rate of 2% on the use of $21,000 for 20 days.
Example: 2% for 20 days = Annual rate of 36.5%
(365/20 = 18.25 twenty-day periods x 2% = 36.5%)
Chapter
Summary of Purchasing Transactions
E5-2 Merchandise Inventory

Debit Credit
5th - Purchase $25,000 $4,000 8th - Return

6th – Freight-in 900 420 15th - Discount
Balance $21,480
Chapter
Recording Sales of Merchandise
Made for cash or credit (on account).

Illustration 5-5
Normally recorded when

earned, usually when
goods transfer from
seller to buyer.
Sales invoice should
support each credit
sale.
Chapter SO 3 Explain the recording of sales revenues

under a perpetual inventory system.
5-23
Two Journal Entries to Record a Sale
#1 Cash or Accounts receivable XXX Selling

Sales XXX Price
#2 Cost of goods sold XXX

Cost
Merchandise inventory XXX

5-24
E5-5 Presented are transactions related to Wheeler Company.

1. On December 3,Wheeler Company sold $500,000 of
merchandise to Hashmi Co., terms 2/10, n/30, FOB shipping
point. The cost of the merchandise sold was $350,000.
2. On December 8, Hashmi Co. was granted an allowance of
$27,000 for merchandise purchased on December 3.
3. On December 13,Wheeler Company received the balance
due from Hashmi Co.
Instructions: Prepare the journal entries to record these
transactions on the books of Wheeler Company using a
perpetual inventory system.
5-25
E5-5 Prepare the journal entries for Wheeler Company .

1. On December 3, Wheeler Company sold $500,000 of
merchandise to Hashmi Co., terms 2/10, n/30, FOB
shipping point. Cost of merchandise sold was $350,000.
Dec. 3 Accounts receivable 500,000

Sales 500,000
Cost of goods sold 350,000


5-26
Sales Returns and Allowances

“Flipside” of purchase returns and allowances.
Contra-revenue account (debit).
Sales not reduced (debited) because:
 would obscure importance of sales returns and
allowances as a percentage of sales.
 could distort comparisons between total sales
in different accounting periods.

5-27
E5-5 Continued: Prepare the journal entries for

Wheeler Company.
2. On December 8, Hashmi Co. was granted an
allowance of $27,000 for merchandise purchased
on December 3.
Dec. 8 Sales returns and allowances 27,000

Accounts receivable 27,000

5-28

Wheeler Company.
2. Variation On Dec. 8, Hashmi Co. returned
merchandise for credit of $27,000. The original cost
of the merchandise to Wheeler was $19,800.
Dec. 8 Sales returns and allowances 27,000

Accounts receivable 27,000

5-29
Review Question
The cost of goods sold is determined and
recorded each time a sale occurs in:
a. periodic inventory system only.
b. a perpetual inventory system only.
c. both a periodic and perpetual inventory
system.
d. neither a periodic nor perpetual inventory
system.

5-30
Chapter
5-31
Sales Discount
Offered to customers to promote prompt payment.
“Flipside” of purchase discount.
Contra-revenue account (debit).

5-32

Wheeler Company.
3. On December 13, Wheeler Company received the
balance due from Hashmi Co.
Dec. 13 Cash 463,540 *

Sales discounts 9,460 **
Accounts receivable 473,000 ***
* ($473,000 – $9,460)
** [($500,000 – $27,000) X 2%]
*** ($500,000 – $27,000)
5-33
E5-5 Continued: Prepare the sales revenue section of

the income statement for Wheeler Company.
Wheeler Company
Income Statement (Partial)
For the Month Ended Dec. 31,
Sales revenue
Sales $ 500,000
Less: Sales returns and allowances (27,000)
Sales discounts (9,460)
Net sales 463,540

5-34
Discussion Question
Q5-9 Joan Roland believes revenues from
credit sales may be earned before they
are collected in cash. Do you agree?
Explain.
See notes page for discussion

5-35
Completing the Accounting Cycle
Adjusting Entries
Generally the same as a service company.
One additional adjustment to make the records
agree with the actual inventory on hand.
Involves adjusting Merchandise Inventory and
Cost of Goods Sold.
Chapter
5-36 SO 4 Explain the steps in the accounting cycle for a merchandising company.
Closing Entries
Close all accounts that affect net income.
E5-8 Presented is information related to Rogers Co. for the month

of January 2010.
Ending inventory per books $ 21,600 Rent expense $ 20,000
Ending inventory per count 21,000 Salary expense 61,000
Cost of goods sold 218,000 Sales discount 10,000
Freight-out 7,000 Sales returns 13,000
Insurance expense 12,000 Sales 350,000
Required: (a) Prepare the necessary adjusting entry for inventory.
(b) Prepare the necessary closing entries.
Chapter
E5-8 (a) Prepare the necessary adjusting entry for

inventory.
Cost of goods sold 600

Merchandise inventory 600
Ending inventory per books $ 21,600

Ending inventory per count 21,000
Overstatement of inventory $ 600
Chapter
E5-8 (b) Prepare the necessary closing entries.

Sales 350,000
Income summary 350,000
Freight-out 7,000
Insurance expense 12,000
Rent expense 20,000
Salary expense 61,000
Sales discounts 10,000
Sales returns 13,000
Rogers, Capital 8,400
Chapter
Forms of Financial Statements
Multiple-Step Income Statement

Shows several steps in determining net income.
Two steps relate to principal operating
activities.
Distinguishes between operating and non-
operating activities.
Chapter
5-40 SO 5 Distinguish between a multiple-step and a single-step income statement.
Calculation of Gross Profit
Illustration 5-13
Key Items:
Net sales
Gross profit
Gross profit
rate
Illustration 5-10
Chapter
5-41 SO 6 Explain the computation and importance of gross profit.
Illustration 5-13
Forms of
Financial
Statements
Multiple-
Step
Key Items:
Net sales
Gross profit
Operating
expenses
Chapter
Illustration 5-13
Forms of
Financial
Statements
Key Items:
Net sales
Gross profit
Operating
expenses
Nonoperating
activities
Net income
Chapter
Review Question
The multiple-step income statement for a
merchandiser shows each of the following
features except:
a. gross profit.
b. cost of goods sold.
c. a sales revenue section.
d. investing activities section.
Chapter
Single-Step Income Statement

Subtract total expenses from total revenues
Two reasons for using the single-step format:
1) Company does not realize any type of profit
until total revenues exceed total expenses.
2) Format is simpler and easier to read.
Chapter
Illustration 5-14
Single-
Step
Chapter
Classified Balance Sheet Illustration 5-15
Chapter
Periodic Inventory System
Periodic System
Separate accounts used to record purchases,
freight costs, returns, and discounts.
Company does not maintain a running account
of changes in inventory.
Ending inventory determined by physical count.
Chapter SO 7 Explain the recording of purchases and sales of

inventory under a periodic inventory system.
5-48
Periodic Inventory System
Calculation of Cost of Goods Sold Illustration 5A-1
$316,000

5-49
Recording Purchases under Periodic System
*E5-19 Information related to Chevalier Co. is

presented below. Prepare the journal entry to record the
transaction under a periodic inventory system.
1. On April 5, purchased merchandise from Paris
Company for $22,000 terms 2/10, net/30, FOB
shipping point.
April 5 Purchases 22,000


5-50
*E5-19 Continued Prepare the journal entry to record

the transaction under a periodic inventory system.
2. On April 6, paid freight costs of $600 on
merchandise purchased from Paris.
April 6 Freight-in (Transportation-in) 600

Cash 600

5-51
*E5-19 Continued: Prepare the journal entry to record

4. On April 8, returned damaged merchandise to Paris
Company and was granted a $4,000 allowance.

Purchase returns and allowances 4,000

5-52
*E5-19 Continued: Prepare the journal entry to record

5. On April 15, paid the amount due to Paris Company
in full. Remember the return of $4,000 of
merchandise.
(Discount = $18,000 x 2% = $360)

Cash 17,640
Purchase Discounts 360

5-53
E5-5 (variation): Prepare the journal entry for Wheeler

Company to record a sale of merchandise under a periodic
system.
1. On December 3, Wheeler Company sold $500,000 of

merchandise to Hashmi Co., terms 2/10, n/30, FOB
shipping point. Cost of merchandise sold was $350,000.
Dec. 3 Accounts receivable 500,000

Sales 500,000
No entry is recorded for cost of goods sold at the time of

the sale under a periodic system.
5-54
Worksheet for a Merchandising Company
Illustration 5B-1
Chapter
5-55
Acid-Test and Gross Margin Ratios
Acid-Test Quick Assets

=
Ratio Current Liabilities
Acid-Test Cash + S-T Investments + Receivables

=
Ratio Current Liabilities
A common rule of thumb is the acid-test ratio should have a

value of at least 1.0 to conclude a company is unlikely to
face liquidity problems in the near future.
Chapter
5-56
Gross Margin Ratio
Gross
Net Sales - Cost of Goods Sold
Margin =
Net Sales
Ratio
Year Percent JCPenney
31.0% 2003 30.2%
2002 28.8%
2001 27.7%
30.0% 2000 29.8%
1999 30.7%
Percentage of 29.0%
dollar sales
available to cover 28.0%
expenses and 27.0%
provide a profit.
26.0%
Chapter
2003 2002 2001 2000 1999
5-57 Gross Margin Ratio
End of Chapter 5
Chapter
5-58

Accounting For Merchandising Operations

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Chapter 5

1. Identify the differences between service and

Recording Recording Completing the Forms of

Operating Freight costs Sales returns Adjusting Multiple-step

Wholesaler Retailer Consumer

The primary source of revenues is referred to as

Cost of Equals Gross Less

Operating Equals Net

The perpetual inventory system provides a continuous record

Beginning inventory $ 100,000

Made using cash or credit (on account). Illustration 5-5

Normally recorded when

E5-2 Information related to Steffens Co. is presented

April 5 Merchandise inventory 25,000

E5-2 Continued Prepare the journal entry to record the

April 6 Merchandise inventory 900

Not all purchases increase Merchandise Inventory.

April 7 Equipment 26,000

Freight Costs – Terms of Sale Illustration 5-6

Seller places goods Free

Seller places goods Free

Chapter Freight costs incurred by the seller are an operating expense.

Purchase Returns and Allowances

Purchase Return Purchase Allowance

E5-2 Continued Prepare the journal entry to record

April 8 Accounts payable 4,000

Example: Credit terms of 2/10, n/30, is read “two-ten, net

Purchase Discounts Terms

2/10, n/30 1/10 EOM n/10 EOM

2% discount if 1% discount if Net amount due

E5-2 Continued Prepare the journal entry to record

April 15 Accounts payable 21,000

E5-2 Continued Prepare the journal entry to record

April 16 Accounts payable 21,000

Passing up the discount offered equates to paying an

Summary of Purchasing Transactions

E5-2 Merchandise Inventory

5th - Purchase $25,000 $4,000 8th - Return

Made for cash or credit (on account).

Normally recorded when

Chapter SO 3 Explain the recording of sales revenues

Two Journal Entries to Record a Sale

#1 Cash or Accounts receivable XXX Selling

#2 Cost of goods sold XXX

Chapter SO 3 Explain the recording of sales revenues

E5-5 Presented are transactions related to Wheeler Company.

E5-5 Prepare the journal entries for Wheeler Company .

Dec. 3 Accounts receivable 500,000

Cost of goods sold 350,000

Chapter SO 3 Explain the recording of sales revenues

Sales Returns and Allowances

Chapter SO 3 Explain the recording of sales revenues

E5-5 Continued: Prepare the journal entries for

Dec. 8 Sales returns and allowances 27,000

Chapter SO 3 Explain the recording of sales revenues

E5-5 Continued: Prepare the journal entries for

Dec. 8 Sales returns and allowances 27,000

Merchandise inventory 19,800

Chapter SO 3 Explain the recording of sales revenues