Financial Accounting: Tools for

Business Decision Making

Tenth Edition
Kimmel ● Weygandt ● Mitchell

Chapter 5
Merchandising Operations and Multiple-Step Income Statement
Prepared by
Diane Tanner
University of North Florida

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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 Prepare a multiple-step income statement.
LO 5 Determine cost of goods sold under a periodic
inventory system.
LO 6 Compute and analyze gross profit rate and
profit margin.
Learning Objective 1Describe
Merchandising Operations and
Inventory Systems

LO 1
Merchandising Operations and Inventory
SystemsOperating Cycles—Service Company

The time period to turn cash back into cash

Ordinarily shorter than that of a service company

LO 1
Merchandising Companies
Merchandising companies purchase and sell merchandise.
Retailers Wholesalers
Merchandising companies Merchandising
that purchase and sell companies that sell to
directly to consumers retailers

LO 1
Merchandising Operations
Merchandising companies
Primary source of revenue is sales revenue or sales
Two categories of expenses

Cost of goods sold Operating expenses

Total cost of merchandise Incurred in the process of
sold during the period earning sales revenue
Directly related to the Examples include
revenue recognized from the advertising expense and
sale of goods rent expense
Represent a category of
expenses
LO 1
Income Measurement Process for a
Merchandising Company

Cost of goods sold

Gross profit

LO 1
Operating Cycles — Merchandising
Company

Usually longer than a service company due to

Purchase of merchandise inventory
Sale of merchandise inventory

LO 1
Flow of Costs
Cost flows are the same with either inventory system
Perpetual or periodic

LO 1
Perpetual System
Requires maintaining detailed records of cost of
each inventory purchase and sale
Enables the records to continuously show inventory
that should be on hand for every item
Companies determines cost of goods sold each time
a sale occurs

LO 1
Periodic System
Detailed records of inventory not maintained during
the period
Company determines cost of goods sold
“periodically” (only at the end of the period)
Physical inventory required to determine cost of
goods on hand and cost of goods sold

LO 1
Steps to Determine Cost of Goods
Sold

1. Determine the cost of goods on hand at the

beginning of the accounting period
2. Add to the cost of goods purchased
3. Subtract the cost of goods on hand as determined
by the physical inventory count at the end of the
accounting period

LO 1
Knowledge Check: Computing Cost of
Goods Sold

All Shoes’ accounting records show the following at

year-end.
Cost of goods purchased $26,500

Ending inventory 1,420

Beginning inventory 1,700

How much is cost of goods sold for the year?

Cost of goods sold = $1,700 + $26,500 − $1,420 = $26,780

LO 1
Comparing Perpetual and Period
Systems

LO 1
Advantages of the Perpetual System

Allows accounting records to be continuously or

perpetually updated to show the quantity and cost of
the inventory that should be on hand at any time
Provides better control over inventories than a periodic
system
Allows a physical count at any time to compare with
inventory records
o Allows timely investigation if shortages are identified
Minimizes clerical costs of maintaining manual records

LO 1
Investor Insight: Morrow
Snowboards, Inc.

Improving Stock Appeal

Investors are often eager to invest in a company that
has a hot new product. However, when snowboard-
maker Morrow Snowboards, Inc. (now part of
K2 Sports) issued shares of stock to the public for
the first time, some investors expressed reluctance to
invest in Morrow because of a number of accounting
control problems.
To reduce investor concerns, Morrow implemented a
perpetual inventory system to improve its control over
inventory. In addition, the company stated that it would
perform a physical inventory count every quarter until it
felt that its perpetual inventory system was reliable.

LO 1
Knowledge Check: Merchandising
Operations and Inventory Systems
Indicate whether each statement is true or false.
1. The primary source of revenue for a False
merchandising company results from performing
services for customers.
2. The operating cycle of a service company is
usually shorter than that of a merchandising True
company.
3. Sales revenue less cost of goods sold equals
gross profit.
4. Ending inventory plus the cost of goods True
purchased equals cost of goods available for sale.
False

LO 1
Test Your Vocabulary: Flashcards
and Crossword Puzzles
Have some fun! Try out the vocabulary Flashcards and Crossword Puzzles
available in your Wiley Course Resources.
Learning Objective 2Record
Purchases Under a
Perpetual Inventory System

LO 2
Recording Purchases Under
a Perpetual System
Made using cash or on account
Normally recorded when goods are
received
Supported by business documents that
provide evidence of the transaction
o Purchase on credit
Purchase invoice
o Purchase for cash
Canceled check
Cash register receipt

LO 2
Sales Invoice Used as Purchase
Invoice By Sauk Stereo

LO 2
Recording Purchases Under a
Perpetual System

Purchases of merchandise for resale recorded in the

Inventory account
o Does not include assets acquired for use such as
supplies and equipment

Sauk Stereo buys merchandise from PW Audio

Supply for $3,800.

LO 2
Freight Costs
Are agreed upon between the buyer and seller
Indicate who is responsible for
o Paying the freight costs
o The risk of loss or damage in transit
Expressed as either
o FOB shipping point
o FOB destination

LO 2
Freight Terms and Ownership

LO 2
Freight Costs Incurred by the Buyer

Included as part of the cost of purchasing inventory

o Because inventory includes all costs to acquire the inventory
o Becomes cost of goods sold when goods are sold

Sauk Stereo (the buyer) pays Public Carrier Co. $150 for
freight charges on May 6.

Entry by Sauk Stereo

LO 2
Freight Costs Incurred by the Seller

Included as part of operating expense for outgoing

merchandise
o Because not part of getting the goods ready to sell
Reported as Delivery Expense or Freight-Out

If PW Audio Supply (the seller) pays $150 for freight

charges on May 4.
Entry by PW Audio Supply

LO 2
Knowledge Check: Freight Costs
Identify which company will report the inventory on its balance
sheet at May 31.

On May 28, Haver Company purchased Haver

merchandise from Workman Inc., terms Company
FOB shipping point. The goods arrived June
2.
On May 29, Wallace Company sold Arcs Co.
merchandise to Arcs Co., terms FOB
shipping point. The goods arrived June 4.
On May 27, Smith Company purchased
merchandise from Hanover, terms FOB Hanover
destination. The goods arrived June 1.

LO 2
Purchase Returns and Allowances
Result if the purchaser is dissatisfied because
o Goods are damaged or defective, of inferior quality, or
do not meet specifications

Purchase Return Purchase Allowance

Return goods for credit if purchase was made on Keep merchandise if seller is willing to grant an
credit, or for a cash refund if purchase was for cash allowance (reduction) from purchase price

LO 2
Recording Purchase Returns and
Allowances

If Sauk Stereo returned goods costing $300 that were

purchased on credit to PW Audio Supply on May 8.

If Sauk Stereo had chosen to keep the goods after being

granted a $50 allowance.

LO 2
Knowledge Check: Purchase Returns
and Allowances

In a perpetual inventory system, a return of defective

merchandise by a purchaser is recorded by crediting
a. Accounts Payable
b. Purchase Returns
c. Purchase Allowance
d. Inventory

LO 2
Knowledge Check: Purchase Returns
and AllowancesAnswer

In a perpetual inventory system, a return of defective

merchandise by a purchaser is recorded by crediting
a. Accounts Payable
b. Purchase Returns
c. Purchase Allowance
d. Answer: Inventory

LO 2
Purchase Discounts
Often permitted by credit terms
Buyer can claim a cash discount for prompt
payment
Advantages
o Purchaser saves money
o Seller shortens operating cycle by
converting accounts receivable into cash
earlier
Amount of the discount decreases Inventory
when taken
o Because the discount reduces the cost

LO 2
Purchase Discounts Examples

Components 2/10, n/30

Percentage amount of 2% discount if paid within 10 days, otherwise remaining amount

due within 30 days
the cash discount
Time period in which
discount is offered 1/10 EOM
Time period in which 1% discount if paid within first 10 days of next month
the purchaser should
pay the full invoice
price if the discount is
not taken n/10 EOM

Net amount due within the first 10 days of the next month (no
discount)

LO 2
Recording Purchase Discounts Taken

On May 14 within the discount period, Sauk Stereo pays the

balance due on a $3,800 invoice, terms of 2/10, n/30 less
purchase returns and allowances of $300.

Discount = 2% × ($3,800 − $300) = $70

Payment = $3,500 − $70 = $3,430

Entry by Sauk Stereo on May 14 to

record the payment net of discount

LO 2
Recording Purchase Discounts Not
Taken

On June 3 after the discount period, Sauk Stereo pays the

balance due on a $3,800 invoice, terms of 2/10, n/30 less
purchase returns and allowances of $300.

Payment = $3,800 − $300 = $3,500

Entry by Sauk Stereo on June 3 to record
the payment with no discount

LO 2
Knowledge Check: Recording
Purchases
On October 2, Sea Toys sold $45,000 of merchandise to Eli Gifts,
terms 1/10, n/30.
On October 6, Eli Gifts returned $2,000 of the merchandise
purchased on October 2.
On October 12, Eli Gifts paid the balance due to Sea Toys.

How much cash is paid by Eli Gifts on October 12?

Discount = ($45,000 − $2,000) × 1% = $430

Cash payment = $43,000 − $430 = $42,570

LO 2
 Knowledge Check: Posting Purchase
Transactions
On October 2, Sea Toys sold $45,000 of merchandise to Eli Gifts,
terms 1/10, n/30.
On October 6, Eli Gifts returned $2,000 of the merchandise
purchased on October 2.
On October 12, Eli Gifts paid the balance due to Sea Toys.

Post the transactions to the T-accounts.

Accounts Payable Inventory

LO 2
Should Discounts Be Taken When
Offered?
Cost of passing up a discount
o Viewed as paying interest for use of the money
Failure to take the discount offered is costly
Compare to prevailing bank interest rates of 6% to 10%
Cost of failure to take discount offered by PW Audio Supply

Annual cost of 2% for the use of $3,500 for 20 days = 2% x (365 ÷ 20) = 36.5%

LO 2
Summary of Purchasing Transactions

Sauk Stereo’s transactions

May 4: Purchase of $3,800 of inventory on account
May 6: Paid $150 in freight charges
May 8: Returned $300 of goods
May 14: Paid within discount period and received a $70
purchase discount

LO 2
Knowledge Check: Purchase
Transactions
On May 10, Stark Co. buys $800 of merchandise on account from
Hong Supply, terms 3/10, n/30.
On May 12, Stark returns defective goods with a selling price of
$100.
On May 19, Stark pays the amount due.

What is the amount due from Stark to Hong Supply?

Discount = ($800 − $100) × 3% = $21
Amount due = $700 − $21 = $679
By what net amount will Inventory increase?
$800 − $100 − $21 = $679

LO 2
Learning Objective 3Record
Sales Under a Perpetual
Inventory System

LO 3
Recording Sales Under a Perpetual
System: Revenue Recognition

Can be recognized whether for cash or on account

Must comply with the revenue recognition principle
o Requires that sales revenue be recorded when the
performance obligation is satisfied
o Performance obligation is satisfied when the goods
transfer from the seller to the buyer because
The sales transaction is complete
The sales price is established

LO 3
Sales Transactions
Can be cash or on account
Supported by business documents that provide evidence of
the transaction
o Cash register documents
o Sales invoice
Requires the seller to make
two entries in a perpetual
inventory system
o To record revenue
o To record the cost of sales

LO 3
Recording Sales – Perpetual Inventory
System

On May 4, PW Audio Supply sold $2,400 of goods for $3,800

to Sauk Stereo.
Entry by PW Audio Supply to record the revenue

Entry by PW Audio Supply to record the cost of the sale

LO 3
Reporting Sales Revenue
Internal record-keeping
Often use many revenue accounts
Income statement presented externally
Reported normally as a single sales amount
o Sum of all of its individual sales revenue accounts
o Detail not reported because
Income statement would be too long
Companies do not want their competitors to know
details

LO 3
Anatomy of a Fraud
Holly Harmon was a cashier at a national superstore for only a short time when she began stealing
merchandise using three methods. Under the first method, her husband or friends took UPC labels
from cheaper items and put them on more expensive items. Holly then scanned the goods at the
register. Using the second method, Holly scanned an item at the register but then voided the sale
and left the merchandise in the shopping cart. A third approach was to put goods into large plastic
containers. She scanned the plastic containers but not the goods within them. After Holly quit, a
review of past surveillance tapes enabled the store to observe the thefts and to identify the
participants.
Total take: $12,000
The Missing Controls
Human resource controls. A background check would have revealed Holly’s previous
criminal record. She would not have been hired as a cashier.
Physical controls. Software can flag high numbers of voided transactions or a high number of
sales of low-priced goods. Random comparisons of video records with cash register records can
ensure that the goods reported as sold on the register are the same goods that are shown being
purchased on the video recording. Finally, employees should be aware that they are being
monitored.
Source: Adapted from Wells, Fraud Casebook (2007), pp. 251–259.

LO 3
Sales Returns and Allowances

The “flip side” of purchase returns and allowances

Sales returns
o Result when seller accepts goods back from the buyer
Sales allowances
o Result when seller grants a reduction in the purchase
price so the buyer will keep the goods

LO 3
Entries for a Sales Return—No Defects

On May 8, PW Audio Supply accepted a return of

salable goods that had a $300 selling price and a $140
cost.

Entry by PW Audio to record the sales part of the return

Entry by PW Audio to record the cost of the return

LO 3
Entries for a Sales Return—
With Defects
On May 8, PW Audio Supply accepted a return of defective
goods with a fair value of $50.

Entry by PW Audio to record the sales part of the return

Entry by PW Audio to record the fair value of the return

LO 3
Accounting for Sales Returns and
Allowances

Recorded in a contra-revenue account to Sales

Revenue
Normal balance is a debit
Sales Revenue account not reduced because
o Would obscure importance of sales returns and
allowances as a percentage of sales
o Could distort comparisons between total sales in
different accounting periods

LO 3
Importance of the Sales Returns and
Allowances Account
Tracks returns and allowances separately in the
accounts
Flags excessive returns and allowances which may
suggest problems
Enables the reporting of returns and allowances
separately in the income statement
o To determine sales returns and allowances as a
percentage of sales
o To compare total sales between different accounting
periods

LO 3
Accounting Across the Organization:
Costco Wholesale

The Point of No Return?

In most industries, sales returns are relatively minor. But returns of consumer
electronics can really take a bite out of profits. At one time, the marketing
executives at Costco Wholesale faced a difficult decision. Costco
always prided itself on its generous return policy. Most goods had an
unlimited grace period for returns. However, a new policy required that
certain electronics must be returned within 90 days of their purchase. The
reason? The cost of returned products such as high-definition TVs,
computers, and iPods cut an estimated 8¢ per share off Costco’s earnings per
share, which was $2.30.
Online sales have accentuated the return problem. Many retailers have
found that to compete, they must offer free shipping for returned goods.
However, to address the significant costs of returns, many retailers now
encourage customers to return goods directly to stores. These retailers have
benefited from the additional purchases that customers make once in the
stores.
Sources: Kris Hudson, “Costco Tightens Policy on Returning Electronics,” Wall Street Journal
(February 27, 2007), p. B4; Loretta Chao, “More Retailers Offering Free Shipping on Returns,’’ Wall
Street Journal (October 11, 2015); and Erica Phillips, “Retailers Offer Myriad Returns Options to
Retain Customers; Traditional and Online Retailers Are Expanding Returns Strategies, Aiming to Boost
Convenience, Cut Costs,” Wall Street Journal Online (December 27, 2017).

LO 3
Sales Discounts
Offered by the seller to the buyer as an incentive for
prompt payment
Based on the invoice price less returns and
allowances
Sales discounts account
o Tracks sales discounts taken by customers separately
in the accounts
o A contra-revenue account
If the amount of discounts is material
o Company should estimate discounts and record an
adjusting entry for estimated discounts

LO 3
 Entry for a Sales Discount
On May 14, PW Audio Supply receives the balance due from Sauk
Stereo for the $3,800 sales price less returns and allowances of
$300, terms 2/10, net 30, within the discount period.

Discount = 2% × ($3,800 − $300) = $70

Payment = $3,800 − $300 − $70 = $3,430

Entry by PW Audio to record cash received from Sauk

Stereo

LO 3
Net Effect of Sales-Related
Transactions
Reported on the income statement
o Contra-revenue accounts subtracted from sales
revenue
o Often reported as a single amount, net sales

LO 3
Data Analytics and Credit Sales
Enables analysis of current and potential customers
o Expand the sales base
o Minimize the risk of unpaid receivables
Enables refinement of customer return policies
Helps achieve an optimal cost-benefit balance on sales
discounts percentages and discount periods
Enables AI to decide whether it would be more profitable
to process a return or simply refund a customer's money
without return of the product
Allows the integration of algorithms to detect fraudulent
returns by cybercriminals

LO 3
People, Planet, and Profit Insight:
REI
Selling Green
REI had sustainable business practices long before
social responsibility became popular at other
companies. A recent stewardship report states, “we
reduced the absolute amount of energy we use
despite opening four new stores and growing our
business; we grew the amount of FSC-certified paper
we use to 58.4 percent of our total paper footprint—
including our cash register receipt paper; we facilitated
2.2 million volunteer hours and we provided $3.7
million to more than 330 conservation and recreation
nonprofits.” So, while REI, like other retailers, closely
monitors its financial results, it also strives to succeed
in other areas.

LO 3
Knowledge Check: Sales Transactions

On May 2, Ace Depot buys merchandise on account

from LinCo from $650, terms 1/10, net 30 and the cost
to LinCo was $400.

Record the transactions for LinCo.

May 2 Accounts Receivable 650.00

Sales Revenue 650.00

(To record credit sale)

May 2 Cost of Goods Sold 400.00

Inventory
(To record cost of goods sold) 400.00

LO 3
Knowledge Check: Defective Return
On May 6, Ace Depot returns defective goods with a
selling price of $100 and a fair value of $40 to LinCo and
receives a credit on account.

Record the transaction for LinCo.

LO 3
Knowledge Check: Payment from
Customer on Account
On May 11, LinCo receives payment from Ace Depot for
its $650 May 2 purchase with terms of 1/10, net 30 less
the return of defective goods with a selling price of
$100 and a fair value of $40.

Record the transaction for LinCo.

Cash discount = ($650 − $100) × 1% = $5.50
Cash received = $650 − $100 − $5.50 = $544.50

LO 3
Learning Objective 4Prepare a
Multiple-Step Income
Statement

LO 4
Preparing the Multiple Step Income
Statement: Single-Step Income Statement

Uses only one step in determining net income

o Subtract total expenses from total revenues
Classifies all data into two categories
o Revenues
Includes both operating revenues and nonoperating
revenues and gains
o Expenses
Includes cost of goods sold, operating
expenses, and nonoperating expenses and
losses

LO 4
Reasons for Using a Single-Step
Income Statement

1. Companies do not realize any type of profit or

income until total revenues exceed total expenses
2. Form is simple and easy to read

LO 4
Single-Step Income Statement for REI

Recreational Equipment, Inc.

Income Statement
For the Year Ended December 28, 2019
(in thousands)
Revenues

$3,122,994
Net sales
Other 3,656
3,126,650
Expenses
Cost of goods sold 1,715,246
Payroll-related expenses 630,531
Occupancy, general and administrative 619,877
Patronage refunds and other 134,153
Income taxes 5,799
3,105,606

Net income $ 21,044

LO 4
Multiple-Step Income Statement
Highlights the components of net income
Contains three important line items
o Gross profit
Equals Net sales − Cost of goods sold
o Income from operations
Equals Gross profit − Operating expenses
o Net income
Equals Income from operations
+ / − Results of activities not related to operations
− Income tax expense

LO 4
Multiple-Step Income Statement for
REI
Recreational Equipment, Inc. Income Statement For the Year Ended December
28, 2019 (in thousands)

$3,122,99
Net sales 4
Cost of goods sold 1,715,246
Gross profit 1,407,748
Operating expenses
Payroll-related expenses 630,531
Occupancy, general and administrative 619,877
Total operating expenses 1,250,408
Income from operations 157,340
Other revenues and gains
Other revenues 3,656
Other expenses and losses
Patronage refunds and other 134,153
Income before income taxes 26,843
Income taxes 5,799
Net income $ 21,044

LO 4
Multiple-Step Income
Statement: Sales
Contra revenue accounts are deducted from sales

PW Audio Supply, Inc.

Income Statement (Partial)
Sales

Sales revenue $480,000

Less: Sales returns and allowances $12,000

Sales discounts 8,000 20,000

Net sales 460,000

LO 4
Multiple-Step Income
Statement: Gross Profit
Sometimes referred to as gross margin
Represents the merchandising profit of a company
Watched closely by management
Indicates the effectiveness of a company’s purchasing
and pricing policies

PW Audio Supply, Inc.

Income Statement (Partial)
Net sales $460,000

Cost of goods sold 316,000

Gross profit $144,000

LO 4
Knowledge Check: Calculating Gross
Profit
Presented here is information for Jong Company for the
month of January.
Cost of goods sold $14,600 Sales revenue $32,450
Accounts receivable 1,350 Cash 1,565
Sales returns and allowances 760 Sales discounts 840
Salaries and wages expense 8,700 Inventory 2,560

Calculate net sales and gross profit.

Net sales = $32,450 − $760 − $840 = $30,850
Gross profit = $30,850 − $14,600 = $16,250

LO 4
Multiple-Step Income Statement:
Operating Expenses

Subtracted from gross profit to determine income from

operations
Consist of payroll-related, occupancy, and general and
administrative expenses

Gross profit $144,000

Operating expenses 114,000

Income from operations $ 30,000

LO 4
Nonoperating Activities and Income
Tax Expense
Other Revenues and Gains

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

Other Expenses and Losses

Interest expense on notes and loans payable
Casualty losses from such causes as vandalism and accidents
Loss from the sale or abandonment of property, plant, and equipment
Loss from strikes by employees and suppliers

LO 4
Multiple-Step Income Statement:
Nonoperating Activities

Consist of various revenues and expenses and gains

and losses that are unrelated to the company’s main
line of operations
Reported in the income statement immediately
after income from operations
Net amount resulting from Other revenues and
gains and Other expenses and losses is added or
subtracted from Income from operations to arrive at
Income before income taxes

LO 4
Reporting Nonoperating Activities on
the Multiple-Step Income Statement

Income from operations $30,000

Other revenues and gains

Interest revenue $3,000

Gain on disposal of plant assets 600 3,600

Other expenses and losses

Interest expense 1,800

Casualty loss from vandalism 200 2,000

Income before income taxes $31,600

LO 4
Knowledge Check: Determining
Nonoperating Activities

Presented here is information for Lyons Company.

Income tax expense $14,200 Sales revenue $95,100
Casualty loss 1,350 Rent expense 1,800
Loss from the sale of land 1,900 Interest expense 2,300
Sales returns and allowances 900 Dividend revenue 1,200

Interest revenue 1,100

Calculate the amount reported as “Other expenses and

losses”.
Other expenses and losses
= $1,350 + $1,900 + $2,300 = $5,550

LO 4
Distinction of Operating and Nonoperatin

Crucial to external users

o Users’ views
Operating income is sustainable
Many nonoperating activities are non-recurring
o When forecasting next year’s income
Analysts put the most weight on this year’s operating
income and less weight on this year’s nonoperating
activities
Often very significant in amount

LO 4
Multiple-Step Income Statement:
Income Taxes

Reported in the income statement immediately

after income before income taxes
Income tax expense

Income tax expense = Income before income taxes × Corporate income tax rate

Income before income taxes $31,600

Income tax expense 10,100

Net income $21,500

LO 4
Ethics Insight: IBM
Disclosing More Details
After Enron, increased investor criticism and regulator scrutiny forced many
companies to improve the clarity of their financial disclosures. For example, IBM
began providing more detail regarding its Other gains and losses. It had previously
included these items in its selling, general, and administrative expenses, with little
disclosure. For example, previously if IBM sold off one of its buildings at a gain, it
included this gain in the selling, general, and administrative expense line item, thus
reducing that expense. This made it appear that the company had done a better job of
controlling operating expenses than it actually had.
As another example, when eBay sold the remainder of its investment in Skype
to Microsoft, it reported a gain in Other revenues and gains of $1.7 billion. Since
eBay’s total income from operations was $2.4 billion, it was very important that the
gain from the Skype sale not be buried in operating income.

LO 4
Complete PW Audio Supply, Inc.
Income Statement
Multiple-Step For the Year Ended December 31, 2025
Income Statement Sales

Service revenue $480,000

Less: Sales returns and allowances $12,000
Sales discounts 8,000 20,000
Net sales 460,000
Cost of goods sold 316,000
Gross profit 144,000
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
Income from operations 30,000
Other revenues and gains
LO 4
Knowledge Check: Multiple-Step
Income Statement

The multiple-step income statement for a merchandiser

shows each of the following features except
a. gross profit.
b. cost of goods sold.
c. other expenses and losses.
d. investing activities section.

LO 4
Knowledge Check: Multiple-Step
Income StatementAnswer

The multiple-step income statement for a merchandiser

shows each of the following features except
a. gross profit.
b. cost of goods sold.
c. other expenses and losses.
d. Answer: investing activities section.

LO 4
Knowledge Check: Arranging Multiple-
Step Income Statement Items

Arrange the multiple-step income statement

components in the order in which they are reported.
Cost of goods sold Sales

Gross profit Cost of goods sold

Income before income taxes Gross profit

Income from operations Operating expenses

Income tax expense Income from operations

Net income Other expenses and losses

Operating expenses Income before income taxes

Other expenses and losses Income tax expense

Sales Net income

LO 4
Learning Objective 5Determine
Cost of Goods Sold Under a
Periodic Inventory System

LO 5
Cost of Goods Sold Under a Periodic
Inventory System

Cost of goods sold determined at the end of the

period
Ending inventory determined by physical count to
determine ending balance of inventory

Beginning Inventory

+ Cost of Goods Purchased

Cost of Goods Available for Sale

− Ending Inventory

Cost of Goods Sold

LO 5
Accounting Under a Periodic
Inventory System

Uses different accounts for purchases, freight costs,

purchase returns, and purchase discounts
Inventory account is not adjusted inventory-related
costs
Presentation on the balance sheet is the same as
under perpetual inventory

LO 5
 Periodic Inventory System Reporting

PW Audio Supply, Inc.

Cost of Goods Sold
For the Year Ended December 31, 2025
Cost of goods sold

$ 36,000
Inventory, January 1
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

LO 5
Knowledge Check: Computing Cost
of Goods Sold—Periodic System
Iron Works’ uses a periodic inventory system. Its accounting
records show the following as of December 31, 2025.
Inventory, Dec. 31, 2025 $4,100 Freight-In $ 1,700
Purchase Returns and Allowances 700 Purchases 96,400
Inventory, Jan. 1, 2025 5,200 Purchase Discounts 1,200

Compute cost of goods purchased.

$96,400 − $700 − $1,200 + $1,700 = $96,200
Compute cost of goods sold.

$5,200 + $96,200 − $4,100 = $97,300

LO 5
Knowledge Check: Cost of Goods Sold
At the end of May, South Park has the following in its general ledger: Beginning
Inventory $15,700, Purchases $165,000, Sales Revenue $190,000, Freight-In
$2,800, Sales Returns and Allowances $2,000, Freight-Out $1,500, and Purchase
Returns and Allowances $4,000. The May 31 inventory is $14,200.

Calculate cost of goods sold for May.

Inventory, May 1 $ 15,700

Purchases $165,000

Less: Purchase returns and allowances 4,000

Net purchases 161,000

Add: Freight-in 2,800

Cost of goods purchased 163,800

Cost of goods available for sale 179,500

Inventory, May 31 (14,200)

Cost of goods sold $165,300

LO 5
Learning Objective 6
Compute and Analyze Gross
Profit Rate and Profit Margin

LO 6
Gross Profit Rate and Profit Margin
Is an important element derived from the
amount of gross profit in a multiple-step income
statement
Higher is better
May decline due to several causes
o Selling products with a lower “markup”
o Increased competition causing reductions in
selling prices
o Paying higher prices to suppliers without being
able to pass these costs on to its customers

LO 6
Gross Profit Rates by Industry

Gross profit rates differ greatly across industries.

LO 6
Calculating the Gross Profit Rate
Expressed as a percentage
Indicates the cents of gross profit generated by per dollar
of sales

REI ($ in thousands)

REI generated about 1.4 cents more of gross profit

out of every sales dollar in 2019 than in 2018.
LO 6
Strategy Choices of Retailers

Revealed in gross profit rates

Which differ across retailers due to differences in
o Nature of goods
o Product sectors
o Economic changes
o Weather patterns
Patterned by the adoption of either
o High-volume−low-margin approach
o Low-volume−high-margin approach

LO 6
Knowledge Check: Gross Profit
SaveCo reported the following in its income statements.
2025 2024

Net sales $96,000 $115,000

Cost of goods sold 52,800 66,700

Operating expenses 16,400 19,600

Income tax expense 12,000 15,000

Net income $14,800 $13,700

Calculate the The gross profit

gross profit rate increased to 45
rate. cents of every sales
dollar in 2025.

LO 6
Profit Margin
Measures the percentage of each dollar of sales that
results in net income
Measures the extent by which selling price covers all
expenses including cost of goods sold
Can be improved
o By increasing the gross profit rate
o By controlling operating expenses and other costs

LO 6
Calculating Profit Margin
Profit margin reflects how well revenue covers all expenses.

REI ($ in thousands)

While slight, the decrease from 2018 to 2019 is unfavorable,

and significantly less than Dick’s Sporting Goods.

LO 6
Knowledge Check: Profit Margin
SaveCo reported the following in its income statements.
2025 2024

Net sales $96,000 $115,000

Cost of goods sold 52,800 66,700

Operating expenses 16,400 19,600

Income tax expense 12,000 15,000

Net income $14,800 $13,700

Calculate Profit margin

profit increased by 3.5
margin. cents of every
sales dollar from
2024 to 2025.

LO 6
Learning Objective 7Appendix A
Record Purchases and Sales of
Inventory Under a Periodic
Inventory System

LO 7
Recording Merchandise Transactions:
Periodic Inventory System
Record revenues when sales are made
Record cost of merchandise sold
o Based on a physical inventory count at the end of the period
which determines cost of merchandise on hand and sold during
the period
o Not recorded on the date of sale
Record in separate accounts
o Purchases
o Freight costs
o Purchase returns and allowances
o Purchase discounts

LO 7
Recording Purchases of Merchandise:
Periodic System

Purchases of merchandise for resale

o Recorded in the Purchases account

Sauk Stereo buys merchandise form PW Audio Supply for

$3,800 on May 4.

LO 7
Freight Costs: Periodic System
Included as part of cost of goods purchased by the buyer
Recorded in the Freight-In account
Sauk Stereo (the buyer) pays Public Carrier Co. $150 for freight
charges on May 6.

Entry by Sauk Stereo

LO 7
Purchase Returns and Allowances:
Periodic System

Included as a reduction of cost of goods purchased

Recorded in the Purchase Returns and Allowances
account

Sauk Stereo returned goods costing $300 that were

purchased on credit to PW Audio Supply on May 8.

LO 7
Purchase Discounts: Periodic System

On May 14 within the discount period, Sauk Stereo pays the

balance due on a $3,800 invoice, terms of 2/10, n/30 less
purchase returns and allowances of $300.

Discount = 2% × ($3,800 − $300) = $70

Entry by Sauk Stereo on May 14 to
record the payment net of discount

LO 7
Knowledge Check: Recording Purchase
Transactions – Periodic System

Transactions for West Company for May are provided here.

Identify the account(s) to be debited for each transaction for
West using a periodic inventory stem.

1. Purchased calculators from Mat Purchases

Supply at a total cost of $1,650,
terms 2/10, net 30.
2. Paid freight of $50 on calculators
purchased from Mat Supply. Freight-In
3. Returned calculators to Mat
Supply costing $66. Accounts
Payable

LO 7
Recording Sales of Merchandise:
Periodic System

Recording the cost of the merchandise sold occurs

only at the end of the period when the inventory is
physically counted

On May 4, PW Audio Supply sold $2,400 of goods for

$3,800 to Sauk Stereo.

Entry by PW Audio Supply

LO 7
Sales Returns and Allowances:
Periodic System

Recording the cost of the merchandise returns

occurs when a physical count of inventory is taken

On May 8, PW Audio Supply accepted a return of goods

with a cost of $140 and an original sales value of $300.

Entry by PW Audio

LO 7
Sales Discounts: Periodic System

On May 14, PW Audio Supply receives the balance due from Sauk
Stereo for the $3,800 sales price less purchase returns and
allowances of $300, terms 2/10, net 30, within the discount
period.

Discount = 2% × ($3,800 − $300) = $70

Cash received = $3,800 − $300 − $70 = $3,430
Entry by PW Audio to record cash
received from Sauk Stereo

LO 7
Knowledge Check: Recording Sales
Transactions – Periodic System

Transactions for West Company for May are provided here.

Identify the accounts to be debited and credited for each
transaction for West using a periodic inventory stem.

1. Sold calculators to Mat Supply at a total DR. Accounts Receivable

cost of $1,650, terms 2/10, net 30. CR. Sales Revenue
2. Paid freight of $50 on calculators sold to
White Products. DR. Freight-Out
3. Received calculators from a customer as CR. Cash
a return on account for a credit of $400.
DR. Sales Returns and
Allowances
CR. Accounts
Receivable

LO 7
Comparison of Entries—Perpetual vs.
Periodic

Perpetual Periodic
Merchandise purchases and Merchandise purchases increase
freight costs increase Inventory Purchases
Purchase returns and Freight costs to acquire
allowances and purchase inventory increase Freight-In
discounts directly decrease Purchase returns and
Inventory
allowances and purchase
Sales of inventory decrease discounts affect separate
inventory and recognize cost of accounts
goods sold at each sale
Inventory and the cost of goods
sold accounts are updated at the
end of period

LO 7
Comparison of Purchase Entries—
Perpetual vs. Periodic

LO 7
Comparing Sales Entries—Perpetual
vs. Periodic

LO 7
Knowledge Check: Perpetual vs.
Periodic
Identify each of the statements as true or false.
1. When a customer returns merchandise, the True
seller debits Sales Returns and Allowances in a
perpetual inventory system.
2. In a periodic inventory system, Purchases is True
debited when merchandise is acquired.
3. In a perpetual inventory system, when
merchandise is returned by the buyer to the False
seller, the buyer debits Inventory.
4. When cash is received within the discount
period for a sale on account, the seller credits False
Sales Discounts for the amount of the discount
taken when a periodic inventory system is used.

LO 7
Learning Objective 8Appendix B
Prepare Adjusting Entries for
Credit Sales with Returns and
Allowances

LO 8
Adjusting Entries for Credit Sales with Returns and
Allowances: Estimating Returns and Allowances

Adjusting entries are recorded for estimates of the

amount of goods sold during the period that will be
returned in subsequent periods
Two adjusting entries required
To recognize the reduction of revenue through the Sales
Returns and Allowances account
To recognize the reduction of the expense in the Cost of
Goods Sold account

LO 8
Recording Sales When Returns and
Allowances are Expected

On January 12, Rainbow Company sells 100 pairs of shoes

costing $60 each for $100 each on account to Tanner Inc.
with a return period within 45 days of purchase.

Entries to record the sale

LO 8
Recording Sales Returns When
Returns are Expected

On January 24, Tanner returns two pairs of shoes because

they were the wrong color.

Entries by Rainbow to record the return

in a perpetual inventory system

LO 8
Adjusting Entries for Estimated Credit
Sales Returns

On January 31, Rainbow prepares monthly financial

statements and estimates that it is likely that one more pair
of shoes will be returned.

Entries by Rainbow to estimate the return

for credit in a perpetual inventory system

LO 8
Recording Credit Returns After
Estimates Have Been Recorded

On February 18, Tanner returns another pair of shoes to

Rainbow. Tanner has not previously paid for the shoes.

Entries by Rainbow to record the return

in a perpetual inventory system

LO 8
Recording Returns After Estimates
Have Been Recorded and Cash Paid

On February 18, Tanner returns a pair of shoes to

Rainbow for which it had previously paid.

Entries by Rainbow to record the return

in a perpetual inventory system

LO 8
Reporting Effects of Estimated Sales
Returns
Estimated Inventory Returns
An asset with a normal debit balance
Represents the cost of goods a company expects that will be
returned by the purchaser.
Added to the Inventory account at the end of the reporting
period
Refund Liability
A liability with a normal credit balance
Reflects the estimated future amount owed to customers for
future returned goods

LO 8
Knowledge Check: Adjusting Entries
for Estimated Credit Sales Returns

On May 31, HarCo sold 80 toy robots costing $20 each for $50 each
on account with a 60-day return period policy. HarCo prepares
monthly financial statements and estimates that it is likely that 3
robots will be returned.

How much will HarCo report as Refund Liability in its May 31

balance sheet in a perpetual inventory system?
Estimated sales returns = 3 × $50 = $150
How much will HarCo report as Estimated Inventory Returns in
its May 31 balance sheet in a perpetual inventory system?

Estimated inventory returns = 3 × $20 = $60

LO 8
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