Financial Accounting

IFRS 4th Edition

Weygandt ● Kimmel ● Kieso

Chapter 5
Accounting for Merchandise
Operations
Chapter Outline
Learning Objectives
LO 1 Describe merchandising operations and inventory
systems.
LO 2 Record purchases under a perpetual inventory system.
LO 3 Record sales under a perpetual inventory system.
LO 4 Apply the steps in the accounting cycle to a
merchandising company.
LO 5 Prepare financial statements for a merchandising
company.

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Learning Objective 1
Describe Merchandising Operations
and Inventory Systems

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Merchandising Operations and
Inventory Systems
Merchandising Companies
Buy and Sell Goods
Retailer

Wholesaler Consumer

The primary source of revenues is referred to as sales revenue or sales.

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Merchandising Company
Income Measurement

Cost of goods sold is the total

cost of merchandise sold
during the period.

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Operating
Cycles

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Flow of Costs (1 of 4)

Companies use either a perpetual inventory system or a periodic

inventory system to account for inventory.

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Flow of Costs (2 of 4)
Perpetual System
• Maintain detailed records of the cost of each
inventory purchase and sale
• Records continuously show inventory that should be
on hand for every item
• Company determines cost of goods sold each time a
sale occurs

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Flow of Costs (3 of 4)
Periodic System
• Does not keep detailed records of goods on hand
• Cost of goods sold determined by count
• 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

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Flow of Costs (4 of 4)
Advantages of the Perpetual System
• Traditionally used for merchandise with high unit
values
• Shows quantity and cost of inventory that should be
on hand at any time
• Provides better control over inventories than a
periodic system

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Do It! 1: Merchandising Operations
and Inventory Systems
Indicate whether the following statements are true or false. If false,
indicate how to correct the statement.
1. The primary source of revenue for a merchandising
company results from performing services for
customers.
2. The operating cycle of a service company is usually
shorter than that of a merchandising company.
3. Sales revenue less cost of goods sold equals gross
profit.
4. Ending inventory plus the cost of goods purchased
equals cost of goods available for sale.

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Learning Objective 2
Record Purchases Under a Perpetual
System

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Recording Purchases Under a Perpetual
Inventory System
• Made using cash or credit (on account)
• Normally record when goods are received from the
seller
• Purchase invoice should support each credit purchase

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Recording
Purchases
Purchase invoice
should support
each credit
purchase

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Record Purchase of Merchandise
Illustration: Sauk Stereo (the
buyer) uses as a purchase
invoice the sales invoice
prepared by PW Audio Supply,
Inc. (the seller). Prepare the
journal entry for Sauk Stereo
for the invoice from PW Audio
Supply.

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Freight Costs (1 of 2)

Ownership of the goods Ownership of the goods

passes to the buyer when the remains with the seller until
public carrier accepts the the goods reach the buyer.
goods from the seller.

Freight costs incurred by the seller are an operating expense.

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Freight Costs (2 of 2)
Illustration: Assume upon delivery of the goods on May 6,
Sauk Stereo pays Public Freight Company €150 for freight
charges, the entry on Sauk Stereo’s books is:

Assume the freight terms on the invoice on slide number 13

had required PW Audio Supply to pay the freight charges,
the entry by PW Audio Supply would be:

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Purchase Returns and Allowances (1 of 4)
Purchaser may be dissatisfied because goods are
damaged or defective, of inferior quality, or do not meet
specifications.
Purchase Return
Return goods for credit if the sale was made on credit, or
for a cash refund if the purchase was for cash.
Purchase Allowance
May choose to keep the merchandise if the seller will
grant a reduction of the purchase price.

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Purchase Returns and Allowances (2 of 4)
Illustration: Assume Sauk Stereo returned goods costing
€300 to PW Audio Supply on May 8.

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Purchase Returns and Allowances (3 of 4)
Review 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. Inventory

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Purchase Discounts (1 of 5)
Credit terms may permit buyer to claim a cash discount
for prompt payment.
Advantages:
• Purchaser saves money
• Seller shortens the operating cycle by converting the
accounts receivable into cash earlier

Example: Credit terms may read 2/10, n/30.

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Purchase Discounts (2 of 5)
2/10, n/30
2% discount if paid within 10 days, otherwise net amount
due within 30 days.

1/10 EOM
1% discount if paid within first 10 days of next month.

n/10 EOM
Net amount due within the first 10 days of the next
month.

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Purchase Discounts (3 of 5)
Illustration: Assume Sauk Stereo pays the balance due of
€3,500 (gross invoice price of €3,800 less purchase returns
and allowances of €300) on May 14, the last day of the
discount period. Prepare the journal entry Sauk Stereo makes
on May 14 to record the payment.

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Purchase Discounts (4 of 5)
Illustration: If Sauk Stereo failed to take the discount, and
instead made full payment of €3,500 on June 3, the journal
entry would be:

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Summary of Purchasing Transactions
Inventory
Purchase May 4 3,800 May 8 300 Purchase return
Freight-in 6 150 14 70 Purchase discount
Balance 3,580

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Do It! 2: Purchase Transactions
On September 5, Zhū Company buys merchandise on account
from Gāo Company. The purchase price of the goods paid by
Zhū is ¥15,000, and the cost to Gāo Company was ¥8,000. On
September 8, Zhū returns defective goods with a selling price
of ¥2,000. Record the transactions on the books of Zhū
Company.

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Learning Objective 3
Record Sales Under a Perpetual System

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Recording Sales Under a Perpetual
Inventory System
• Sales may be made on credit or for cash
• Sales revenue, like service revenue, is recorded when
the performance obligation is satisfied
• Performance obligation is satisfied when goods are
transferred from seller to buyer
• Sales invoice should support each credit sale

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Sales invoice
should
support each
credit sale

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Recording Sales (1 of 2)
Journal Entries to Record a Sale

#1 Accounts Receivable XXX Selling

Sales Revenue XXX Price

#2 Cost of Goods Sold XXX

Cost
Inventory XXX

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Recording Sales (2 of 2)
Illustration: PW Audio Supply records the sale of €3,800 on
May 4 to Sauk Stereo on account as follows (assume the
merchandise cost PW Audio Supply €2,400).

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Sales Returns and Allowances (1 of 5)
• “Flip side” of purchase returns and allowances
• Contra revenue account to Sales Revenue (debit)
• Sales not reduced (debited) because:
§ Would obscure importance of sales returns and
allowances as a percentage of sales
§ Could distort comparisons

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Sales Returns and Allowances (2 of 5)
Illustration: Prepare the entry PW Audio Supply would make
to record the credit for returned goods that had a €300
selling price (assume a €140 cost). Assume the goods were
not defective.

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Sales Returns and Allowances (3 of 5)
Illustration: Assume the returned goods were defective and
had a scrap value of €50, PW Audio would make the
following entries:

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Sales Returns and Allowances (4 of 5)
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.

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Sales Discounts
• Offered to customers to promote prompt payment
of balance due
• Contra-revenue account (debit) to Sales Revenue
Sales Returns and
Sales Revenue Allowances Sales Discounts
3,800 300 70

Net Sales
€3,430
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Sales Discounts (2 of 2)
Illustration: Assume Sauk Stereo pays the balance due of
€3,500 (gross invoice price of €3,800 less purchase returns
and allowances of €300) on May 14, the last day of the
discount period. Prepare the journal entry PW Audio Supply
makes to record the receipt on May 14.

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Do It! 3: Sales Transactions (1 of 2)
On September 5, Zhū Company buys merchandise on
account from Gāo Company. The selling price of the goods is
¥15,000, and the cost to Gāo Company was ¥8,000. On
September 8, Zhū returns defective goods with a selling price
of ¥2,000 and a fair value of ¥300. Record the transactions
on the books of Gāo Company.

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Do It! 3: Sales Transactions (2 of 2)
On September 5, Zhū Company buys merchandise on
account from Gāo Company. The selling price of the goods is
¥15,000, and the cost to Gāo Company was ¥8,000. On
September 8, Zhū returns defective goods with a selling price
of ¥2,000 and a fair value of ¥300. Record the transactions
on the books of Gāo Company.

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Learning Objective 4
Apply the Steps in the Accounting Cycle
to a Merchandising Company

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The Accounting Cycle for a
Merchandising Company
Adjusting Entries
• Generally same as a service company
• One additional adjustment to make records agree
with actual inventory on hand
• Involves adjusting Inventory and Cost of Goods Sold

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Adjusting Entries
Illustration: Suppose that PW Audio Supply has an unadjusted
balance of €40,500 in Inventory. Through a physical count, PW
Audio Supply determines that its actual merchandise inventory
at December 31 is €40,000. The company would make an
adjusting entry as follows.

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Closing Entries
Dec. 31 Service Revenue 480,000
Income Summary 480,000
(Close credit balance accounts)
31 Income Summary 450,000
Cost of Goods Sold 316,000
Salaries and Wages Expense 64,000
Utilities Expense 17,000
Advertising Expense 16,000
Sales Returns and Allowances 12,000
Sales Discounts 8,000
Depreciation Expense 8,000
Freight-Out 7,000
Insurance Expense 2,000
(Close debit balance accounts)
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Closing Entries

Dec. 31 Income Summary 30,000

Retained Earnings 30,000
(To close net income to retained
earnings)
31 Retained Earnings 15,000
Dividends 15,000
(To close dividends to retained
earnings)

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DO IT! 4: Closing Entries (1 of 2)
The trial balance of Celine’s Sports Wear Shop at December
31 shows Inventory €25,000, Sales Revenue €162,400, Sales
Returns and Allowances €4,800, Sales Discounts €3,600, Cost
of Goods Sold €110,000, Rent Revenue €6,000, Freight-Out
€1,800, Rent Expense €8,800, and Salaries and Wages
Expense €22,000. Prepare the closing entries for the above
accounts.

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DO IT! 4: Closing Entries (2 of 2)
Prepare the closing entries for the above accounts.

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Learning Objective 5
Prepare Financial Statements for a
Merchandising Company

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Income Statement (1 of 7)
• Primary source of information for evaluating a
company’s performance
• Format is designed to differentiate between various
sources of income and expense

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Income Statement (2 of 7)
Income Statement Presentation of Sales

PW Audio Supply
Income Statement (partial)
For the Year Ended December 31, 2020
Sales
Sale revenue €480,000
Less: Sales returns and allowances €12,000
Sales discounts 8,000 20,000
Net sales €460,000

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Income Statement (3 of 7)
Gross Profit
On the basis of the sales data for PW Audio Supply (net sales
of €460,000) and cost of goods sold under the perpetual
inventory system (assume €316,000), PW Audio Supply’s
gross profit is €144,000, computed as shown.

Net Sales €460,000

Cost of goods sold 316,000
Gross profit €144,000

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Income Statement (4 of 7)
Gross Profit
We also can express a company’s gross profit as a percentage,
called the gross profit rate.

Gross Profit ÷ Net Sales = Gross Profit Rate

€144,000 ÷ €460,000 = 31.3%

Analysts generally consider the gross profit rate to be more

useful than the gross profit amount.

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Income Statement (5 of 7)
Operating Expenses
Incurred in the process of earning sales revenue. Operating
expense for PW Audio Supply include the following.
Operating expenses
Salaries and wages expense € 64,000
Utilities expense 17,000
Advertising expense 16,000
Depreciation expense 8,000
Freight-out 7,000
Insurance expense 2,000
Total operating expenses €114,000

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Income Statement (6 of 7)
Other Income and Expense
Various revenues and gains and expenses and losses that are
unrelated to the company’s main line of operations.
Other Income
• Interest revenue from notes receivable and marketable
securities
• Dividend revenue from investments in capital stock
• Rent revenue from subleasing a portion of the store
• Gain from the sale of property, plant, and equipment
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Operating Income and Expense
Other Expense
• Casualty losses from such causes as vandalism and
accidents
• Loss from sale or abandonment of property, plant, and
equipment
• Loss from strikes by employees and suppliers
Interest expense, if material, must be disclosed on the face of
the income statement.

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Income PW Audio Supply
Income Statement
For the Year Ended December 31, 2020
Statement Sales
Service revenue €480,000
(7 of 7)
Less: Sales returns and allowances €12,000
Sales discounts 8,000 20,000
Net sales 460,000
Key Items: Cost of goods sold 316,000
Gross profit 144,000
• Sales Operating expenses
Salaries and wages expense 64,000
• Gross Profit Utilities expense 17,000
Advertising expense 16,000
Depreciation expense 8,000
• Operating Freight-out 7,000
Expenses Insurance expense 2,000
Total operating expenses 114,000
• Other Income and Income from operations 30,000
Other income and expense
Expense Interest revenue 3,000
Gain on disposal of plant assets 600
• Net Income Casualty loss from vandalism 200 3,400
Interest expense 1,800
Net income € 31,600

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Comprehensive Income Statement
Presents items not included in the determination of net
income.
Items included in comprehensive income are either reported
in a combined statement of net income and comprehensive
income, or in a separate comprehensive income statement.
PW Audio Supply
Comprehensive Income Statement
For the Year Ended December 31, 2020
Net income
Other comprehensive income €31,600
Unrealized holding gain on investment securities 2,300
Comprehensive income €33,900

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Classified Statement of Financial Position
PW Audio Supply
Statement of Financial Position (Partial)
December 31, 2020
Assets
Property, plant, and equipment
Equipment €80,000
Less: Accumulated depreciation 24,000 € 56,000
Current assets
Prepaid insurance 1,800
Inventory 40,000
Accounts receivable 16,100
Cash 9,500 67,400
Total assets €123,400

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DO IT! 5: Financial Statement
Classification (2 of 3)
Indicate in which financial statement and under what
classification each of the following would be reported.
Financial
Account Statement Classification
Accounts payable
Accounts receivable
Accumulated Depreciation-
Buildings Depreciation-
Accumulated
Equipment
Advertising Expense
Buildings
Cash
Depreciation Expense
Dividends

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DO IT! 5: Financial Statement
Classification (2 of 3)
Indicate in which financial statement and under what
classification each of the following would be reported.
Financial
Account Statement Classification
Equipment
Freight-Out
Gain on Disposal of Plant Assets
Insurance Expense
Interest Expense
Interest Payable
Inventory
Land
Notes Payable (due in 3 years)

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DO IT! 5: Financial Statement
Classification (3 of 3)
Indicate in which financial statement and under what
classification each of the following would be reported.
Financial
Account Statement Classification
Property Taxes Payable
Salaries and Wages Expense
Salaries and Wages Payable
Sales Returns and Allowances
Sales Revenue
Share Capital—Ordinary
Utilities Expense

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Learning Objective 6
Prepare a Worksheet for a
Merchandising Company

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 Worksheet for a
Appendix 5A
Merchandising Company
As indicated in Chapter 4, a worksheet enables
companies to prepare financial statements before they
journalize and post adjusting entries. The steps in
preparing a worksheet for a merchandising company are
the same as for a service company. The following
Illustration shows the worksheet for PW Audio Supply
(excluding non-operating items). The unique accounts for
a merchandiser using a perpetual inventory system are in
red.

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 PW Audio Supply
Worksheet
For the Year Ended December 31, 2020
Adjusted Income Statement of
Trial Balance Adjustments Trial Balance Statement Financial Position
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 9,500 9,500 9,500
Accounts Receivable 16,000 1,6100 1,6100
Inventory 40,500 (a) 500 40,000 40,000
Prepaid Insurance 3,800 (b) 2,000 1,800 1,800
Equipment 80,000 80,000 80,000
Accumulated Depreciation 16,000 (c) 8,000 24,000 24,000
Accounts Payable 20,400 20,400 20,400
Share Capital-Ordinary 50,000 50,000 50,000
Retained Earnings 33,000 33,000 33,000
Dividends 15,000 15,000 15,000
Service Revenue 480,000 480,000 480,000
Sales Returns and Allow. 12,000 12,000 12,000
Sales Discounts 8,000 8,000 8,000
Cost of Goods Sold 315,500 (a) 500 316,000 316,000
Freight-Out 7,000 7,000 7,000
Advertising Expense 16,000 16,000 16,000
Salaries and Wages Expense 59,000 (d) 5,000 64,000 64,000
Utilities Expense 17,000 17,000 17,000
Totals 599,400 599,400
Insurance Expense (b) 2,000 2,000 2,000
Depreciation Expense (c) 8,000 8,000 8,000
Salaries and Wages Payable (d) 5,000 5,000 5,000
Totals 15,500 15,500 612,400 612,400 450,000 450,000 162,400 132,400
Net Income 30,000 30,000
Totals 480,000 480,000 162,400 162,400

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Learning Objective 7
Record Purchases and Sales of
Inventory Under a Periodic Inventory
System

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Appendix 5B Periodic Inventory System
Determining Cost of Goods Sold Under a Periodic
Inventory System
• No running account of changes in inventory
• Ending inventory determined by physical count
• Cost of goods sold not determined until the end of
the period

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Periodic Inventory System
PW Audio Supply
Cost of Goods Sold
For the Year Ended December 31, 2020
Cost of goods sold
Inventory, January 1 € 36,000
Purchases €325,000
Less: Purchase returns and allowances €10,400
Purchase discounts 6,800 17,200
Net purchases 307,800
Add: Freight-in 12,200
Cost of goods purchased 320,000
Cost of goods available for sale 356,000
Inventory, December 31 40,000
Cost of goods sold €316,000
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Recording Merchandise Transactions
• Record revenues when sales are made
• Do not record cost of merchandise sold on date of
sale.
• Physical inventory count determines:
§ Cost of merchandise on hand and
§ Cost of merchandise sold during the period
• Record purchases in Purchases account
• Purchase returns and allowances, Purchase
discounts, and Freight costs are recorded in separate
accounts
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Recording Purchase of Merchandise
Illustration: On the basis of the sales invoice (slide 31) and
receipt of the merchandise ordered from PW Audio Supply,
Sauk Stereo records the €3,800 purchase as follows.

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Freight Costs
Illustration: If Sauk pays Public Freight Company €150 for
freight charges on its purchase from PW Audio Supply on
May 6, the entry on Sauk’s books is:

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Purchase Returns and Allowances
Illustration: Sauk Stereo returns €300 of goods to PW Audio
Supply and prepares the following entry to recognize the
return.

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Purchase Discounts
Illustration: On May 14 Sauk Stereo pays the balance due on
account to PW Audio Supply, taking the 2% cash discount
allowed by PW Audio for payment within 10 days. Sauk
Stereo records the payment and discount as follows.

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Recording Sales of Merchandise
Illustration: PW Audio Supply, records the sale of €3,800 of
merchandise to Sauk Stereo on May 4 (sales invoice No. 731,
slide 31) as follows.

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Sales Returns and Allowances
Illustration: To record the returned goods received from
Sauk Stereo on May 8, PW Audio Supply records the €300
sales return as follows.

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Sales Discounts
Illustration: On May 14, PW Audio Supply receives payment
of €3,430 on account from Sauk Stereo. PW Audio honors
the 2% cash discount and records the payment of Sauk’s
account receivable in full as follows.

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Comparison of Entries—Perpetual vs.
Periodic (1 of 2)

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Comparison of Entries—Perpetual vs.
Periodic (2 of 2)

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Closing Entries
• All accounts that affect the determination of net
income are closed to Income Summary
• In journalizing, all debit column amounts are
credited, and all credit columns amounts are debited
• Beginning inventory balance is debited to Income
Summary and credited to Inventory
• Ending inventory balance is debited to Inventory and
credited to Income Summary

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 PW Audio Supply
Worksheet
For the Year Ended December 31, 2020
Adjusted Income Statement of Financial
Trial Balance Adjustments Trial Balance Statement Position
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 9,500 9,500 9,500
Accounts Receivable 16,000 1,6100 1,6100
Inventory 36,000 36,000 36,000 40,000 40,000
Prepaid Insurance 3,800 (a) 2,000 1,800 1,800
Equipment 80,000 80,000 80,000
Accumulated Depreciation 16,000 (b) 8,000 24,000 24,000
Accounts Payable 20,400 20,400 20,400
Share Capital-Ordinary 50,000 50,000 50,000
Retained Earnings 33,000 33,000 33,000
Dividends 15,000 15,000 15,000
Service Revenue 480,000 480,000 480,000
Sales Returns and Allow. 12,000 12,000 12,000
Sales Discounts 8,000 8,000 8,000
Purchases 325,000 325,000 325,000
Purchase Returns and Allow 10,400 10,400 10,400
Purchase Discounts 6,800 6,800 6,800
Freight-In 12,200 12,200 12,200
Freight-Out 7,000 7,000 7,000
Advertising Expense 16,000 16,000 16,000
Salaries and Wages Expense 59,000 (c) 5,000 64,000 64,000
Utilities Expense 17,000 17,000 17,000
Totals 616,600 616,600
Insurance Expense (a) 2,000 2,000 2,000
Depreciation Expense (b) 8,000 8,000 8,000
Salaries and Wages Payable (d) 5,000 5,000 5,000
Totals 15,500 15,500 629,600 629,600 507,200 537,200 162,400 132,400
Net Income 30,000 30,000
Totals 537,200 537,200 162,400 162,400

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Learning Objective 8
Compare the Accounting for
Merchandising Under G A A P and
I F R S.

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A Look at U.S. GAAP
Key Points
Similarities
• Under both GAAP and IFRS, a company can choose to use either a
perpetual or periodic inventory systems.
• Inventories are defined by IFRS as held-for-sale in the ordinary course of
business, in the process of production for such sale, or in the form of
materials or supplies to be consumed in the production process or in
the performing of services. The definition under GAAP is essentially the
same.
• Similar to GAAP, comprehensive income under IFRS includes unrealized
gains and losses (such as those on non-trading securities) that are not
included in the calculation of net income.

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A Look at U.S. GAAP
Key Points
Differences
• Under GAAP companies generally classify income statement items by
function. Classification by function leads to descriptions like
administration, distribution (selling), and manufacturing. Under IFRS,
companies must classify expenses either by nature or by function.
Classification by nature leads to descriptions such as the following:
salaries, depreciation expense, and utilities expense. If a company
uses the functional-expense method on the income statement,
disclosure by nature is required in the notes to the financial
statements.

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A Look at U.S. GAAP
Key Points
Differences
• Presentation of the income statement under GAAP follows either a
single-step or multiple-step format. IFRS does not mention a single-
step or multiple-step approach.
• Under IFRS revaluation of land, buildings, and intangible assets is
permitted. The initial gains and losses resulting from this revaluation
are reported as adjustments to equity, often referred to as other
comprehensive income. The effect of this difference is that the use
of IFRS results in more transactions affecting equity (other
comprehensive income) but not net income.
• IFRS requires that two years of income statement information be
presented, whereas GAAP requires three years.
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A Look at U.S. GAAP
Looking to the Future
The IASB and FASB are working on a project that would rework the structure
of financial statements. Specifically, this project will address the issue of how
to classify various items in the income statement. A main goal is to provide
information that better represents how businesses are run. In addition, this
approach draws attention away from just one number—net income. It will
adopt major groupings similar to those currently used by the statement of
cash flows (operating, investing, and financing), so that numbers can be
more readily traced across statements. For example, the amount of income
that is generated by operations would be traceable to the assets and
liabilities used to generate the income. This approach would also provide
detail, beyond that currently seen in most statements (either GAAP or IFRS),
by requiring that line items be presented both by function and by nature.
The new financial statement format was heavily influenced by suggestions
from financial statement analysts.

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