Accounting Principles, 7th Edition

Weygandt • Kieso • Kimmel

Chapter 5

Accounting for
Merchandising
Operations
Prepared by Naomi Karolinski
Monroe Community College
and
Marianne Bradford
Bryant College

John Wiley & Sons, Inc. © 2005

 CHAPTER 5
ACCOUNTING FOR MERCHANDISING
OPERATIONS
After studying this chapter, you should be able to:
1 identify the differences between a service
enterprise and a merchandising company
2 explain the entries for purchases under a
perpetual inventory system
3 explain the entries for sales revenues under a
perpetual inventory system
4 explain the steps in the accounting cycle for a
merchandising company
 CHAPTER 5
ACCOUNTING FOR MERCHANDISING
OPERATIONS

After studying this chapter, you should be able to:

5 distinguish between a multiple-step and a
single-step income statement
6 explain the computation and importance of
gross profit
7 determine the cost of goods sold under a
periodic system
 MERCHANDISING COMPANY

A merchandising company buys and

sells goods to earn a profit.
1) Wholesalers sell to retailers
2) Retailers sell to consumers

Primary source of revenue is Sales

 MEASURING NET INCOME
• Expenses for a merchandiser are divided into
two categories:
1 Cost of goods sold
– The total cost of merchandise sold during the period
2 Operating expenses
– Expenses incurred in the process of earning sales revenue
(Examples: sales salaries and insurance expense)

• Gross profit is equal to Sales Revenue less Cost of

Goods Sold
INCOME MEASUREMENT PROCESS
FOR A MERCHANDISING COMPANY
OPERATING CYCLES FOR A SERVICE
COMPANY AND A MERCHANDISING
COMPANY
 INVENTORY SYSTEMS

Merchandising entities may use either:

1) Perpetual Inventory
Detailed records of the cost of each item are
maintained, and the cost of each item sold is
determined from records when the sale
occurs.
2) Periodic Inventory
Cost of goods sold is determined only at the
end of an accounting period.
PERPETUAL VS. PERIODIC
 COST OF GOODS SOLD
To determine the cost of goods sold
under a periodic inventory system:
1) Determine the cost of goods on hand at
the beginning of the accounting period,
2) Add to it the cost of goods purchased,
and
3) Subtract the cost of goods on hand at
the end of the accounting period.
PURCHASES OF MERCHANDISE
STUDY OBJECTIVE 2

• Merchandise is purchased for resale to customers,

the account
– Merchandise Inventory is debited for the cost
of goods.
• Like sales, 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.
• Each credit purchase should be
supported by a purchase invoice.
PURCHASES OF MERCHANDISE
SALES INVOICE
PURCHASES OF MERCHANDISE

3,800
3,800

For purchases on account,

Merchandise Inventory is debited
and Accounts Payable is credited.
 PURCHASE RETURNS AND
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.
• The purchaser initiates the request for a reduction of
the balance due through the issuance of a debit
memorandum (purchaser’s debit decreases A/P!).
• The debit memorandum is a document issued by a
buyer to inform a seller that the seller’s account has
been debited because of unsatisfactory merchandise.
PURCHASE RETURNS AND
ALLOWANCES

300
300

For purchases returns and allowances,

Accounts Payable is debited and
Merchandise Inventory is credited.
 FREE ON BOARD
A 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 placed free on board the carrier
by seller
2) Buyer pays freight costs

• FOB Destination
1) Goods placed free on board at
buyer’s business
2) Seller pays freight costs
ACCOUNTING FOR FREIGHT
COSTS
• Merchandise Inventory is debited if
buyer pays freight.
• Freight-out (or Delivery Expense) is
debited if seller pays freight.
ACCOUNTING FOR FREIGHT
COSTS

150
150

When the purchaser directly incurs the freight costs, the account
Merchandise Inventory is debited and Cash is credited.
ACCOUNTING FOR FREIGHT
COSTS

150
150

Freight costs incurred by the seller on outgoing

merchandise are debited to Freight-out (or
Delivery Expense) and Cash is credited.
 PURCHASE 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.
• Like a sales discount, a
purchase discount is based on
the invoice cost less returns
and allowances, if any.
PURCHASE DISCOUNTS

3,500
3,430
70

If payment is made within the discount period, Accounts

Payable is debited, Cash is credited, and Merchandise
inventory is credited for the discount taken.
PURCHASE DISCOUNTS

3,500
3,500

If payment is made after the discount

period, Accounts Payable is debited and
Cash is credited for the full amount.
SAVINGS OBTAINED BY TAKING
PURCHASE DISCOUNT
A buyer should usually take all available discounts.
If Beyer Video takes the discount, it pays $70 less in cash.
If it forgoes the discount and invests the $3,500 for 20 days
at 10% interest, it will earn only $19.44 in interest.
The savings obtained by taking the discount is calculated as
follows:
 SALES TRANSACTIONS
STUDY OBJECTIVE 3

• Revenues – (Revenue recognition

principle)
– Earned when the goods are transferred
from seller to buyer

• All sales should be supported by a document

such as a cash register tape or sales
invoice.
RECORDING CASH SALES

2,200
2,200

1,400
1,400

 For cash sales, Cash is debited and Sales is credited.

 For the cost of goods sold for cash, Cost of Goods
Sold is debited and Merchandise Inventory is
credited.
 RECORDING CREDIT SALES

3,800
3,800

2,400
2,400

 For credit sales, Accounts Receivable is debited and Sales is credited.

 For the cost of goods sold on account, Cost of Goods Sold is debited
and Merchandise Inventory is credited.
 SALES RETURNS AND
ALLOWANCES
• Sales Returns
– Customers dissatisfied with merchandise
and are allowed to return the goods to the
seller for credit or a refund.
• Sales Allowances
– Result when customers are dissatisfied and
the seller allows a deduction from
the selling price.
 SALES RETURNS AND
ALLOWANCES
• Credit memorandum
– the seller prepares a form to inform the
customer that a credit has been made to the
customer’s account receivable
• Sales Returns and Allowances
– Contra revenue account to the Sales
account
• The normal balance of Sales Returns and
Allowances is a debit
 RECORDING SALES RETURNS
AND ALLOWANCES

300
300

140
140

The seller’s entry to record a credit memorandum involves a debit to

the Sales Returns and Allowances account and a credit to Accounts
Receivable. The entry to record the cost of the returned goods involves
a debit to Merchandise Inventory and a credit to Cost Goods Sold.
 SALES DISCOUNTS

• Sales discount
– Offer of a cash discount to a customer for the
prompt payment of a balance due
– Is a contra revenue account with a normal debit
balance
• Example: Credit sale has the terms 3/10, n/30, a 3%
discount is allowed if payment is made within 10
days. After 10 days there is no discount, and the
balance is due in 30 days.
 CREDIT TERMS

Credit terms specify the amount and time

period for the cash discount
– Indicates the length of time in which the purchaser is
expected to pay the full invoice price

2/10, n/30 A 2% discount may be taken if payment is made

within 10 days of the invoice date.

1/10 EOM A 1% discount is available if payment is made

by the 10th of the next month.
 RECORDING
SALES DISCOUNTS

3,430
70
3,500

When cash discounts are taken by

customers, the seller debits Sales Discounts.
 CLOSING ENTRIES
STUDY OBJECTIVE 4

 Adjusting entries are journalized from the adjustment

columns of the work sheet.
 All accounts that affect the determination of net income are
closed to Income Summary.
 Data for the preparation of closing entries may be obtained
from the income statement columns of the work sheet.

480,000
480,000
 CLOSING ENTRIES

Cost of Goods Sold is a new account that must be closed to

Income Summary.
 CLOSING ENTRIES

 After the closing entries are posted, all temporary accounts

have zero balances
 It addition, R. A. Lamb, Capital has a credit balance of
$98,000 ($83,000 + $30,000 - $15,000).
Under a perpetual inventory system,
acquisition of merchandise for resale is
debited to the

a. purchases account
b. supplies account
c. merchandise inventory account
d. cost of goods sold account

Chapter5
Under a perpetual inventory system,
acquisition of merchandise for resale is
debited to the

a. purchases account
b. supplies account
c. merchandise inventory account
d. cost of goods sold account

Chapter5
 MULTIPLE-STEP INCOME
STATEMENT
STUDY OBJECTIVE 5

• Includes sales revenue, cost of goods

sold, and gross profit sections
• Additional nonoperating sections may
be added for:
1) revenues and expenses resulting
from secondary or auxiliary operations
2) gains and losses unrelated to
operations
 MULTIPLE-STEP
INCOME STATEMENT
Operating expenses may be subdivided
into:
a) Selling expenses
b) Administrative expenses
Nonoperating sections are reported after
income from operations and are classified as:
a) Other revenues and gains
b) Other expenses and losses
SINGLE-STEP INCOME
STATEMENT

All data are classified under

two categories: 1
Revenues
2 Expenses
Only one step is required in
determining net income or net
loss.
COMPUTATION OF GROSS
PROFIT
STUDY OBJECTIVE 6

Gross profit is determined as follows:

Net sales $ 460,000

Cost of goods sold 316,000
Gross profit $ 144,000
OPERATING EXPENSES IN
COMPUTING NET INCOME

Net income is determined as follows:

Gross profit $ 144,000

Operating expenses 114,000
Net income $ 30,000
Gross profit for a merchandiser is net sales
minus

a. operating expenses
b. cost of goods sold
c. sales discounts
d. cost of goods available for sale

Chapter5
Gross profit for a merchandiser is net sales
minus

a. operating expenses
b. cost of goods sold
c. sales discounts
d. cost of goods available for sale

Chapter5
 PERIODIC INVENTORY
SYSTEMS
Appendix 5A

• Revenues from the sale of merchandise are

recorded when sales are made in the same way as
in a perpetual system
• No attempt is made on the date of sale to record
the cost of merchandise sold
• Physical inventories are taken at end of period to
determine:
– The cost of merchandise on hand
– The cost of the goods sold during the period
Determining Cost of Goods Sold
Periodic
STUDY OBJECTIVE 7
 RECORDING MERCHANDISE
TRANSACTIONS UNDER A
PERIODIC INVENTORY SYSTEM
• Purchases
– Merchandise purchased for resale to
customers
– May be made for cash or on account
(credit)
– Normally recorded by the purchaser when
the goods are received from the seller
– Credit purchase should be
supported by a purchase invoice
 RECORDING PURCHASES
OF MERCHANDISE
General Journal
Date Account Titles Debit Credit
May 4 Purchases 3,800
Accounts Payable 3,800

To illustrate the recording of merchandise

transactions under a periodic system, we will
use the purchase/sale transactions between
Seller and Buyer. For purchases on account,
Purchases is debited and Accounts Payable is
credited for merchandise ordered from Seller.
 PURCHASE RETURNS
AND ALLOWANCES
• A sales return and allowance on the seller’s books is
recorded as a purchase return and allowance on the
books of the purchaser.
• Purchase Returns and Allowances
– contra account to Purchases
– Normal credit balance
• Debit memorandum
– Purchaser initiates the request for a reduction of the
balance due through the issuance of a debit memorandum
– A document issued by a buyer to inform a seller that the
seller’s account has been debited because of
unsatisfactory merchandise
 RECORDING PURCHASE
RETURNS AND
ALLOWANCES
General Journal
Date Account Titles Debit Credit
May 8 Accounts Payable 300
Purchase Returns and Allowances 300

For purchases returns and allowances, Accounts

Payable is debited and Purchase Returns and
Allowances is credited. Because $300 of
merchandise received from Seller is inoperable,
Buyer returns the goods and issues a debit
memo.
ACCOUNTING FOR FREIGHT
COSTS
• Freight-in is debited if buyer pays
freight
• Freight-out (or Delivery Expense) is
debited if seller pays freight
ACCOUNTING FOR FREIGHT
COSTS

General Journal
Date Account Titles Debit Credit
May 9 Freight-in 150
Cash 150

When the purchaser directly incurs the freight

costs, the account Freight-in (or Transportation-in)
is debited and Cash is credited. In this example,
Buyer pays Acme Freight Company $150 for
freight charges on its purchase from Seller.
 PURCHASE 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.
• Like a sales discount, a purchase discount
is based on the invoice cost less returns
and allowances, if any.
 PURCHASE DISCOUNTS

General Journal
Date Account Titles Debit Credit
May 14 Accounts Payable 3,500
Purchase Discounts
70
Cash
3,430
If payment is made within the discount period,
Accounts Payable is debited, Purchase
Discounts is credited for the discount taken,
and Cash is credited. On May 14 Buyer pays
the balance due on account to Seller taking
the 2% cash discount allowed by Seller for
payment within 10 days.
 RECORDING SALES OF
MERCHANDISE

General Journal
Date Account Titles Debit Credit
May 4 Accounts Receivable 3,800
Sales
3,800

For credit sales, Accounts

Receivable is debited and Sales is
credited. In this illustration, the
sale of $3,800 of merchandise to
Buyer on May 4 is recorded by the
Seller.
RECORDING SALES RETURNS
AND ALLOWANCES

General Journal
Date Account Titles Debit Credit
May 8 Sales Returns and Allowances 300
Accounts Receivable 300

The seller’s entry to record a credit memorandum

involves a debit to the Sales Returns and Allowances
account and a credit to Accounts Receivable. Based
on the debit memo received from Buyer on May 8 for
returned goods, Seller records the $300 sales returns
above.
 RECORDING
SALES DISCOUNTS

General Journal
Date Account Titles Debit Credit
May 15 Cash 3,430
Sales Discounts 70
Accounts Receivable 3,500

When cash discounts are taken by customers, the

seller debits Sales Discounts. On May 15, Seller
receives payment of $3,430 on account from
Buyer. Seller honors the 2% discount and records
the payment of Buyer’s accounts receivable.
WORK SHEET FOR A MERCHANDISING
COMPANY
 USING A WORK SHEET
Appendix 5B
Trial Balance Columns
1 Data from the trial balance are obtained from
the ledger balances of Sellers Electronix at
December 31
2 The amount shown for Merchandise
Inventory, $40,500, is the year-end inventory
amount which results from the application
of a perpetual inventory system
 USING A WORK SHEET

Adjustments Columns
1 A merchandising company usually has the
same types of adjustments as a service
company
2 Work sheet adjustments b, c, and d are for
insurance, depreciation, and salaries
Adjusted Trial Balance - The adjusted trial
balance shows the balance of all accounts after
adjustment at the end of the accounting period
 USING A WORK SHEET

Income Statement Columns

1 The accounts and balances that affect the
income statement are transferred from the
adjusted trial balance columns to the
income statement columns for Sellers
Electronix at December 31
2 All of the amounts in the income statement
credit column should be totaled and
compared to the total of the amounts in the
income statement debit column
 USING A WORK SHEET

Balance Sheet Columns

1 The major difference between the balance
sheets of a service company and a
merchandising company is inventory
2 For Sellers Electronix, the ending
Merchandise Inventory amount of $40,000 is
shown in the balance sheet debit column
3 The information to prepare the owner’s equity
statement is also found in these columns