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Chapter Five: Accounting for Merchandising Operations

- Merchandising
• purchasing products to resell to customers
• Profit = Revenue - Expenses
• revenues — Sales Revenue or Sales
• expenses — Cost of Goods Sold, Operating Expenses (e.g. Salaries, Advertising, Insurance, Rent and Depreciation)
• Gross Profit = Sales Revenue - Cost of Goods Sold
• the time it takes to go from cash to cash in producing revenues is longer in a merchandising company than in service company

- Income Measurement Process for a Merchandising Company

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- Inventory Systems
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• merchandising company must keep track of its inventory in order to determine what is available for sale (inventory) and what has
been sold (COGS)
• Cost of Goods Available for Sale = Beginning Inventory + Cost of Goods Purchased
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• Cost of Goods Sold — when goods are sold

× reported as an expense on the income statement
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• Ending Inventory — those goods not sold by the end of the accounting period
× reported as a current asset on the balance sheet
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- Periodic Inventory System

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• companies do not keep detailed inventory records of the goods on hand throughout the period
• COGS is determined by a physical inventory count only at the end of the accounting period
× Beginning Inventory + Cost of Goods Purchased during the period - Ending Inventory = Cost of Goods Sold
1. find the Beginning Inventory — the cost of goods on hand at the beginning of the accounting period (the same amount as the
previous period’s Ending Inventory)
2. add the Cost of Goods Purchased during the period — to determine the cost of goods available for sale
3. subtract the Ending Inventory from the Cost of Goods Available for Sale — the cost of goods on hand at the end of the
accounting period as determined from the physical inventory count
• managers of small businesses can control merchandise and manage day to day operations using this system
• a complete physical inventory count is always taken at least once a year

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 - Perpetual Inventory System
• the company keep detailed records of each inventory purchase and sale
• this system continuously shows the quantity and cost of the inventory that should be on hand for every item — constantly knows
how much inventory it has in stock and its value based on its cost price
• uses bar codes, optical scanners, and point-of-sale software — keep a running record of every item that it buys and sells
• when inventory is purchased → the purchase is recorded by increasing (DR) the Merchandise Inventory account
• when inventory is sold → the Cost of Goods Sold (the original purchase cost of the merchandise) is transferred from the
Merchandise Inventory account (an asset) to the Cost of Goods Sold account (an expense)
• the company determines and records the cost of goods sold and the reduction in inventory each time a sale occurs
• gives better control over inventories
• makes it easier to answer questions from customers about merchandise availability
• management can also maintain optimum inventory levels and avoid running out of stock
• a complete physical inventory count is always taken at least once a year

- Recording Purchases of Merchandise

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• the purchase is normally recorded when the merchandise is received

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• when merchandise is purchased for resale:

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Date Particulars P.R. DR CR

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2014

April 1 rs e
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Merchandise Inventory 1 7 8 5 -

Accounts Payable or Cash 1 7 8 5 -

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A. Subsidiary Ledger
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• used to organize and track individual inventory items under a perpetual inventory system
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• a group of accounts that share a common characteristic (e.g. all inventory accounts)
• frees the general ledger from the details of individual balances
• other examples: Accounts Receivable (to track individual customer balances), Accounts Payable (to track individual creditor
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balances), Payrolls (to track individual employee pay records)

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• control account is the general ledger account that summarizes the subsidiary ledger data

B. Sales Taxes
• include the Federal Goods and Services Tax (GST), the Provincial Sales Tax (PST) and in several provinces, the Harmonized Sales
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Tax (HST) — which is a combination of GST and PST

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• collected by merchandising companies on the goods that they sell

• periodically remitted to government
• sales taxes collected are not revenue — treated as a liability until paid (as they are due to the government)

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 C. Freight Costs
• purchase invoice indicates when ownership of the goods is transferred from seller to buyer
• FOB means free on board

FOB Shipping Point FOB Destination

- buyer accepts ownership at place of shipping and pays for - buyer accepts ownership when goods are delivered to
shipping costs buyer’s place of business and seller pays freight costs
- buyer debits Merchandise Inventory for cost of shipping - seller debits to the Freight Out account for cost of shipping
- ownership changes to the buyer when the goods are placed - ownership changes to the buyer when the goods are
on the carrier by the seller — “shipping point” delivered by the carrier to the buyer’s place of business —
- the buyer pays the freight costs and is responsible for “destination”
damages - the seller pays the freight and is responsible for damages

• when the buyer pays for the freight costs — freight is just another part of the cost of purchasing the goods

Date Particulars P.R. DR CR

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2014

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May 4 Merchandise Inventory 1 5 0 -

Cash 1 5 0 -

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D. Purchase Returns and Allowances
• goods purchased may be damaged, defective, of inferior quality, or they may not meet purchaser’s specifications
• goods may be returned (Purchase Returns) or purchase price may be reduced (Purchase Allowances)
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Date Particulars P.R. DR CR

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2014

April 1 Cash or Accounts Payable 2 6 8 4 -

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Merchandise Inventory (for amount of return or adjustment) 2 6 8 4 -

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E. Quantity and Purchase Discount

• Quantity Discount — reduction in price due to the quantity being purchased
• Purchase Discount — reduction in price due to early payment of amount due
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• e.g. if pay early and get a purchase discount:

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Date Particulars P.R. DR CR

2014

April 1 Accounts Payable 2 6 8 4 -

Merchandise Inventory (for amount of discount) 1 6 6 6 -

Cash (for net amount paid) 1 0 1 8 -

- Recording Sales Merchandise

• revenue is recorded when goods are transferred from seller to buyer

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 • two entries needed to record the sale:

Date Particulars P.R. DR CR

2014 To record sale of merchandise

April 1 Cash or Accounts Receivable 2 6 8 4 -

Sales 2 6 8 4 -

To record cost of goods sold

1 Cost of Goods Sold 1 0 9 0 -

Merchandise Inventory 1 0 9 0 -

A. Sales Taxes

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• collected on the sale of a good or service

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• not recorded as revenue — instead are a liability until they are paid to government

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B. Freight Costs

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• if the term is FOB destination — the seller is responsible for getting the goods to their intended destination

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• if the term is FOB shipping point — the seller makes no journal entry since this is the buyer’s cost
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• freight costs paid by the seller on merchandise sold are an operating expense

Date Particulars P.R. DR CR

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2014
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May 4 Freight Out 1 5 0 -

Cash 1 5 0 -
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C. Sales Returns and Allowances

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• when customers (purchasers) return goods, or are given price reductions — the seller will either return cash to the buyer, or reduce
the buyer’s account receivable if the goods were originally purchased on credit

Date Particulars P.R. DR CR

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2014 To record goods returns returned by customers

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May 9 Sales Returns and Allowances 3 0 0 -

Accounts Receivable 3 0 0 -

If the merchandise is not damaged and can be sold again

May 9 Merchandise Inventory 1 4 0 -

Cost of Goods Sold 1 4 0 -

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 - Sales Discounts
• discount offered for early payment of bill
• discount amount taken is credited to Sales Discounts (a contra revenue account)
• original amount in Sales is not charged
• if the discount is not taken, buyer pays the full amount

Date Particulars P.R. DR CR

2014 To record sales discounts

April 1 Cash 1 0 9 0 -

Sales Discounts 8 0 -

Accounts Receivable 1 1 7 0 -

- Complete the Accounting Cycle —- Adjusting Entries

• same types of adjusting entries as a service company — but one additional adjustment for inventory

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× to ensure the recorded inventory amount shows the same amount of goods as the actual quantity on hand
• even though the Merchandise Inventory account gives a record of the inventory on hand — it only indicates what should be

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there, not necessarily what actually is there

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Date Particulars P.R. DR CR
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2014 Adjusting Entry

April 1 Cost of Goods Sold 1 0 9 0 -

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Merchandise Inventory 1 0 9 0 -
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- Complete the Accounting Cycle —- Closing Entries

• additional accounts to be closed: Sales, Sales Returns and Allowances, Sales Discounts, Cost of Goods Sold, Freight Out

Date Particulars P.R. DR CR

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2014 Closing Entries

May 31 Sales

Interest Revenue
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Rent Revenue
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Income Summary

31 Income Summary

Sales Returns and Allowances

Sales Discounts

Cost of Goods Sold

Salaries Expense

Rent Expense

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 Utilities Expense

Advertising Expense

Depreciation Expense

Freight Out

Insurance Expense

Interest Expense

31 Income Summary

R. Lamb, Capital

31 R. Lamb, Capital

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R. Lamb, Drawings

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- Single-Step Income Statement

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 - Multiple-Step Income Statement
• five main steps
1. Net Sales = Sales - Sale Returns - Sales Allowances - Sales Discounts
2. Gross Profit = Net Sales - Cost of Goods Sold
3. Profit from Operations = Gross Profit - Operating Expenses
4. Non-Operating Activities = Activities not related to operations
5. Profit = Profit from Operations + Non-Operating Activities

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- Classified Balance Sheet

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- Using the Information in the Financial Statements

- measures profit or operating success for a specific time period

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Profitability Ratios
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- gross profit expressed as a percentage

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Gross Profit Margin - measures the effectiveness of a company’s purchasing and pricing policies
- Gross Profit Margin = Gross Profit ÷ Net Sales
- the percentage of sales that results in profit
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Profit Margin - measures the ability of a company to cover all expenses and provide a return to owners
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- Profit Margin = Profit ÷ Net Sales

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