Chapter 3: Accounting cycle for merchandising business

3.1. Characteristics of merchandising business

A merchandising business earns income by buying and selling goods, which are called merchandise
inventory. Whether a merchandiser is a wholesaler or a retailer, it uses the same basic accounting
methods as a service company. However, the buying and selling of goods adds to the complexity of the
business and of the accounting process. To understand the issues involved in accounting for a
merchandising business, one must be familiar with the operating cycle.

Operating cycles differ, depending upon the nature of the business and its operations. The operating
cycle begins with spending cash and it ends with receiving cash from customers. Most companies buy
merchandise on credit and sell it on credit, thereby engaging in the following four transactions:
 Purchase of merchandise inventory for cash or on credit
 Payment for purchases made on credit
 Sales of merchandise inventory for cash or on credit
 Collection of cash from credit sales

In this chapter, we will illustrate Net Solutions after it becomes a retailer of computer hardware and
software. During 2010, we assume that Aymen implemented the second phase of Net Solutions’
business plan. Accordingly, Aymen notified clients that beginning July 1, 2011, Net Solutions would be
terminating its consulting services. Instead, it would become a personalized retailer.

3.2. Flow of Costs

The flow of costs for a merchandising company is as follows. Beginning inventory plus the cost of
goods purchased is the cost of goods available for sale. As goods are sold, they are assigned to cost of
goods sold. Those goods that are not sold by the end of the accounting period represent ending
inventory. Companies use one of two systems to account for inventory: a perpetual inventory system
or a periodic inventory system.

Perpetual system: In a perpetual inventory system, companies keep detailed records of the cost of
each inventory purchase and sale. These records continuously perpetually show the inventory that
should be on hand for every item. Under a perpetual inventory system, a company determines the cost of
goods sold each time a sale occurs.

Periodic system: In a periodic inventory system, companies do not keep detailed inventory records of
the goods on hand throughout the period. Instead, they determine the cost of goods sold only at the end
of the accounting period that is, periodically. At that point, the company takes a physical inventory
count to determine the cost of goods on hand. To determine the cost of goods sold under a periodic
inventory system, the following steps are necessary:
 Determine the cost of goods on hand at the beginning of the accounting period.
 Add to it the cost of goods purchased.
 Subtract the cost of goods on hand at the end of the accounting period.

3.3. Accounting for purchases of merchandises

Under both perpetual and periodic inventory system, cash purchases of merchandise are recorded as
follows:
On January 3, purchased merchandise for cash from Bowen Company, $2,510.
2012
Jan. 3 Merchandise Inventory 2510 00
Cash 2510 00
Purchased inventory from Bowen Co.
Purchases of merchandise on account are recorded as follows:
On January 4, purchased merchandise on account from Thomas Corporation, $9,250.
Jan. 4 Merchandise Inventory 9250 00
Account Payable – Thomas
Corporation 9250 00
Purchased inventory on account

Purchases Discounts
Purchases discounts taken by the buyer for early payment of an invoice reduce the cost of the
merchandise purchased. Most businesses design their accounting systems so that all available discounts
are taken. Even if the buyer has to borrow to make the payment within a discount period, it is normally
to the buyer’s advantage to do so.

To illustrate, assume that Alpha Technologies issues an invoice for $3,000 to Net Solutions, dated
March 12, with terms 2/10, n/30. The last day of the discount period in which the $60 discount can be
taken is March 22. Assume that in order to pay the invoice on March 22, Net Solutions borrows the
money for the remaining 20 days of the credit period. If we assume an annual interest rate of 6% and a
360-day year, the interest on the loan of $2,940 ($3,000 - $60) is $9.80 ($2,940 X 6% X 20/360). The
net savings to Net Solutions is $50.20, computed as follows:

Discount of 2% on $3,000 $60.00

Interest for 20 days at rate of 6% on $2,940 - 9.80
Savings from borrowing $50.20
Net Solutions would record the Alpha Technologies invoice and its payment at the end of the discount
period as follows:
Mar. 12 Merchandise Inventory 3000 00
Accounts Payable – Alpha
Technologies 3000 00
22 Accounts Payable – Alpha Technologies 3000 00
Cash 2940 00
Purchase Discount 60 00

If Net Solutions does not take the discount because it does not pay the invoice until April 11, it would
record the payment as follows:
Apr. 11 Accounts Payable – Alpha Technologies 3000 00
Cash 3000 00

Purchases Returns and Allowances

When merchandise is returned (purchases return) or a price adjustment is requested (purchases
allowance), the buyer (debtor) usually sends the seller a letter or a debit memorandum. A debit
memorandum, shown below, informs the seller of the amount the buyer proposes to debit to the account
payable due the seller. It also states the reasons for the return or the request for a price reduction.

2012

The buyer may use a copy of the debit memorandum as the basis for recording the return or allowance
or wait for approval from the seller (creditor). In either case, the buyer must debit Accounts Payable and
credit Merchandise Inventory. To illustrate, Net Solutions records the return of the merchandise
indicated in the debit memo as follows:
Mar. 7 Accounts Payable – Maximum System 900 00
Merchandise Inventory 900 00
Debit Memo No. 18
When a buyer returns merchandise or has been granted an allowance prior to paying the invoice, the
amount of the debit memorandum is deducted from the invoice amount. The amount is deducted before
the purchase discount is computed. For example, assume that on May 2, Net Solutions purchases $5,000
of merchandise from Delta Data Link, subject to terms 2/10, n/30. On May 4, Net Solutions returns
$3,000 of the merchandise, and on May 12, Net Solutions pays the original invoice less the return. Net
Solutions would record these transactions as follows:
May 2 Merchandise Inventory 5000 00
Accounts Payable – Delta Data Link 5000 00
Purchased merchandise
4 Accounts Payable – Delta Data Link 3000 00
Merchandise Inventory 3000 00
Returned portion of merchandise purchased
12 Accounts Payable – Delta Data Link 2000 00
Cash 1960 00
Purchase discount 40 00
Paid invoice (($5000 - $3000) X 2%
= $40; $2000 - $40 = $1960)

3.4. Accounting for sales of merchandises

When a merchandising company transfers goods to the buyer, in exchange for cash or a promise top at a
later date, revenue is produced to the company. This revenue is recorded in a Sales account. However,
the sales revenue, which is reported on the Income Statement, is Net Sales. That is,

Net Sales = Gross Sales – Sales Discounts- Sales Returns and Allowances
Cash Sales
A business may sell merchandise for cash. Cash sales are normally rung up (entered) on cash register
and recorded in the accounts. To illustrate, assume that on January 3, 2012 Net Solutions sells
merchandise for $1,800. These cash sales can be recorded as follows:
2012
Jan. 3 Cash 1800 00
Sales 1800 00
To record cash sales

Under the perpetual inventory system, the cost of merchandise sold and the reduction in merchandise
inventory should also be recorded. In this way, the merchandise inventory account will indicate the
amount of merchandise on hand (not sold). To illustrate, assume that the cost of merchandise sold on
January 3 was $1,200. The entry to record the cost of merchandise sold and the reduction in the
merchandise inventory is as follows:
 Jan. 3 Cost of Merchandise Sold 1200 00
Merchandise Inventory 1200 00
To record the cost of merchandise sold

Sales on Account
A business may sell merchandise on account. The seller records such sales as a debit to Accounts
Receivable and a credit to Sales. An example of an entry for Net Solutions sale on January 12, on
account of $510 follows. The cost of merchandise sold was $280.
Jan. 12 Accounts Receivable-Sims Co. 510 00
Sales 510 00
Invoice No. 7172.
12 Cost of Merchandise Sold 280 00
Merchandise Inventory 280 00
Cost of merchandise sold on invoice No. 7172

Sales Discounts
The terms of a sale are normally indicated on the invoice or bill that the seller sends to the buyer. An
example of a sales invoice is shown below.

2012

2012 2012

The terms for when payments for merchandise are to be made, agreed on by the buyer and the seller, are
called the credit terms. If payment is required on delivery, the terms are cash or net cash. Otherwise,
the buyer is allowed an amount of time, known as the credit period, in which to pay. The credit period
usually begins with the date of the sale as shown on the invoice. If payment is due within a stated
number of days after the date of the invoice, such as 30 days, the terms are net 30 days. These terms may
be written as n/30. If payment is due by the end of the month in which the sale was made, the terms are
written as n/eom.
As a means of encouraging the buyer to pay before the end of the credit period, the seller may offer a
discount. For example, a seller may offer a 2% discount if the buyer pays within 10 days of the invoice
date. If the buyer does not take the discount, the total amount is due within 30 days. These terms are
expressed as 2/10, n/30 and are read as 2% discount if paid within 10 days, net amount due within 30
days. Discounts taken by the buyer for early payment are recorded as sales discounts by the seller. Since
managers may want to know the amount of the sales discounts for a period, the seller normally records
the sales discounts in a separate account. The sales discounts account is a contra (or offsetting) account
to Sales.

To illustrate, assume that cash is received within the discount period from the credit sale of $1,500,
shown on the invoice above. Net Solutions would record the receipt of the cash as follows:
Jan. 21 Cash 1470 00
Sales Discounts 30 00
Account Receivable-Omega
Technologies 1500 00
Collection on invoice No. 106-8, less 2%
discount.

Sales Return and Allowances

Merchandise sold may be returned to the seller (sales return). In addition, because of defects or for
other reasons, the seller may reduce the initial price at which the goods were sold (sales allowance). If
the return or allowance is for a sale on account, the seller usually issues the buyer a credit
memorandum. This memorandum shows the amount of and the reason for the seller’s credit to an
account receivable. A credit memorandum issued by Net Solutions Company is illustrated bellow:

2012
Like sales discounts, sales returns and allowances reduce sales revenue. They also result in additional
shipping and other expenses. Since managers often want to know the amount of returns and allowances
for a period, the seller records sales returns and allowances in a separate account. Sales Returns and
Allowances is a contra (or offsetting) account to Sales. The seller debits Sales Returns and Allowances
for the amount of the return or allowance. If the original sale was on account, the seller credits Accounts
Receivable.

Since the merchandise inventory is kept up to date in a perpetual system, the seller adds the cost of the
returned merchandise to the merchandise inventory account. The seller must also credit the cost of
returned merchandise to the cost of merchandise sold account, since this account was debited when the
original sale was recorded. To illustrate, assume that the cost of the merchandise returned was $140. Net
Solutions records the credit memo as follows:

Jan. 13 Sales Return and Allowances 225 00

Account Receivable-Krier Company 225 00
Credit Memo No. 32.
13 Merchandise Inventory 140 00
Cost of Merchandise Sold 140 00
Cost of merchandise returned, Credit Memo
No. 32.

What if the buyer pays for the merchandise and the merchandise is later returned? In this case, the seller
may issue a credit and apply it against other accounts receivable owed by the buyer, or the cash may be
refunded. If the credit is applied against the buyer’s other receivables, the seller records entries similar to
those preceding. If cash is refunded for merchandise returned or for an allowance, the seller debits Sales
Returns and Allowances and credits Cash.

3.5. Transportation Costs, Sales Taxes and trade discount

Transportation costs
The terms of a sale should indicate when the ownership (title) of the merchandise passes to the buyer.
This point determines which party, the buyer or the seller, must pay the transportation costs. The
ownership of the merchandise may pass to the buyer when the seller delivers the merchandise to the
transportation company or freight carrier. There are two terms namely: FOB (free on board) shipping
point and FOB (free on board) destination. The buyer bears the transportation costs if the shipping
terms are FOB shipping point. The seller bears the transportation costs if the shipping terms are FOB
destination.
FOB (free on board) shipping point means that the dealer pays the transportation costs from the shipping
point (factory) to the final destination. Such costs are part of the dealer’s total cost of purchasing
inventory and should be added to the cost of the inventory by debiting Merchandise Inventory.

To illustrate, assume that on June 10, Net Solutions buys merchandise from Magna Data on account,
$900, terms FOB shipping point, and pays the transportation cost of $50. Net Solutions records these
two transactions as follows:
June 10 Merchandise Inventory 900 00
Accounts Payable – Magna Data 900 00
Purchased merchandise, terms FOB shipping point
10 Merchandise Inventory 50 00
Cash 50 00
Paid shipping cost on merchandise purchased

The ownership of the merchandise may pass to the buyer when the buyer receives the merchandise. In
this case, the terms are said to be FOB (free on board) destination. This term means that the seller
delivers the merchandise to the buyer’s final destination, free of transportation charges to the buyer. The
seller thus pays the transportation costs to the final destination. The seller debits Transportation Out or
Delivery Expense, which is reported on the seller’s income statement as an expense.

To illustrate, assume that on June 15, Net Solutions sells merchandise to Kranz Company on account,
$700, terms FOB destination. The cost of the merchandise sold is $480, and Net Solutions pays the
transportation cost of $40. Net Solutions records the sale, the cost of the sale, and the transportation cost
as follows:

June 15 Accounts Receivable – Kranz Company 700 00

0
Sales 700 0

Sold merchandise, terms FOB destination

15 Cost of Merchandise Sold 480 00

0
Merchandise Inventory 480 0
Recorded cost of merchandise sold to Kranz Company.
15 Transportation Out 40 00
0
Cash 40 0
Paid shipping cost on merchandise sold

As a convenience to the buyer, the seller may prepay the transportation costs, even though the terms are
FOB shipping point. The seller will then add the transportation costs to the invoice. The buyer will debit
Merchandise Inventory for the total amount of the invoice, including the transportation costs. Any
discount terms would not apply to the prepaid transportation costs.

To illustrate, assume that on June 20, Net Solutions sells merchandise to Planter Company on account,
$800, terms FOB shipping point. Net Solutions pays the transportation cost of $45 and adds it to the
invoice. The cost of the merchandise sold is $360. Net Solutions records these transactions as follows:

June 20 Accounts Receivable – Planter Company 800 00

0
Sales 800 0

Sold merchandise, terms FOB shipping point

20 Cost of Merchandise Sold 360 00

0
Merchandise Inventory 360 0
Recorded cost of merchandise sold to Planter
Company.
15 Accounts Receivable – Planter Company 45 00
0
Cash 45 0
Prepaid shipping cost on merchandise sold

Sales Taxes
Almost all states and many other taxing units levy a tax on sales of merchandise. The liability for the
sales tax is incurred when the sale is made. At the time of a cash sale, the seller collects the sales tax.
When a sale is made on account, the seller charges the tax to the buyer by debiting Accounts Receivable.
The seller credits the sales account for the amount of the sale and credits the tax to Sales Tax Payable.
For example, the seller would record a sale of $100 on account, subject to a tax of 6%, as follows:
Aug. 21 Accounts Receivable – Lemon Co. 106 00
Sales 100 00
Sales Tax Payable 6 00
Invoice No. 339

Normally on a regular basis, the seller pays to the taxing unit the amount of the sales tax collected. The
seller records such a payment as follows:
Sept. 15 Sales Tax Payable 2900 00
Cash 2900 00
Payment for sales taxes collected during August

Trade Discounts
Wholesalers are businesses that sell merchandise to other businesses rather than to the general public.
Many wholesalers publish catalogs. Rather than updating their catalogs frequently, wholesalers often
publish price updates, which may involve large discounts from the list prices in their catalogs. In
addition, wholesalers may offer special discounts to certain classes of buyers, such as government
agencies or businesses that order large quantities. Such discounts are called trade discounts.

Sellers and buyers do not normally record the list prices of merchandise and the related trade discounts
in their accounts. For example, assume that an item has a list price of $1,000 and a 40% trade discount.
The seller records the sale of the item at $600 [$1,000 less the trade discount of $400 ($1,000 X 40%)].
Likewise, the buyer records the purchase at $600.

3.6. Chart of accounts for a merchandising business

The chart of accounts for a merchandising business should reflect the types of merchandising
transactions. As a basis for illustration, we use Net Solutions. On July 1, 2011, when Net Solutions
began its operations as a personalized retailer of software and hardware, its chart of accounts changed
from that of a service business to that of a merchandiser. The new chart of accounts is shown in bellow.
The accounts related to merchandising transactions are shown in italics.
Balance Sheet Accounts Income Statement Accounts
100 Assets 400 Revenues
110 Cash 410 Sales
112 Accounts Receivable 411 Sales Returns and Allowances
115 Merchandise Inventory 412 Sales Discounts
116 Office Supplies 500 Costs and Expenses
117 Prepaid Insurance 510 Cost of Merchandise Sold
120 Land 520 Sales Salaries Expense
123 Store Equipment 521 Advertising Expense
124 Accumulated Depreciation – Store Equipment 522 Depreciation Expense - Store Equipment
125 Office Equipment 523 Transportation Out
126 Accumulated Depreciation – Office Equipment 529 Miscellaneous Selling Expense
200 Liabilities 530 Office Salaries Expense
210 Accounts Payable 531 Rent Expense
211 Salaries Payable 532 Depreciation Expense - Office Equipment
212 Unearned Rent 533 Insurance Expense
215 Notes Payable 534 Office Supplies Expense
300 Owner’s Equity 539 Misc. Administrative Expense
310 Aymen, Capital 600 Other Income
311 Aymen, Drawing 610 Rent Revenue
312 Income Summary 700 Other Expense
710 Interest Expense
Net Solutions is now using three-digit account numbers, which permits it to add new accounts as they
are needed. The first digit indicates the major financial statement classification (1 for assets, 2 for
liabilities, and so on). The second digit indicates the sub classification (e.g., 11 for current assets, 12 for
noncurrent assets). The third digit identifies the specific account (e.g., 110 for Cash, 123 for Store
Equipment).

Net Solutions is using a more complex numbering system because it has a greater variety of
transactions. In addition, its growth creates a need for more detailed information for use in managing it.
For example, a wages expense account was adequate for Net Solutions when it was a small service
business with few employees. However, as a merchandising business, Net Solutions now uses two
payroll accounts, one for Sales Salaries Expense and one for Office Salaries Expense.
3.7. Financial statements for a merchandising business
Income Statement
There are two form of income statement namely: multiple step income statement and single step
income statement.
Multiple – step income statement
It contains several sections, subsections, and subtotals.
Sales are the total amount charged customers for merchandise sold, including cash sales and sales on
account. Both sales returns and allowances and sales discounts are subtracted in arriving at net sales.
Sales returns and allowances are granted by the seller to customers for damaged or defective
merchandise. Sales returns and allowances are recorded when the merchandise is returned or when the
allowance is granted by the seller.
Sales discounts are granted by the seller to customers for early payment of amounts owed. Sales
discounts are recorded when the customer pays the bill.
Net sale is determined by subtracting sales returns and allowances and sales discounts from sales.
Cost of merchandise sold is the cost of the merchandise sold to customers. For periodic inventory
method cost of merchandise sold can be determined as follows.
Cost of merchandise sold = Beginning inventory + Net Purchase – Ending inventory
Merchandise available for sale
Net Purchase = Purchase + Transportation in – Purchase return and allowance – Purchase discount
In contrast, under the perpetual method of accounting for merchandise inventory, each purchase and
sale of merchandise is recorded in the inventory and the cost of merchandise sold accounts. As a
result, the amount of merchandise available for sale and the amount sold are continuously
(perpetually) disclosed in the inventory records.

Gross profit is determined by subtracting the cost of merchandise sold from net sales. Operating
income, sometimes called income from operations, is determined by subtracting operating expenses
from gross profit. Most merchandising businesses classify operating expenses as either selling expenses
or administrative expenses. Expenses that are incurred directly in the selling of merchandise are selling
expenses. They include such expenses as salespersons’ salaries, store supplies used, depreciation of
store equipment, and advertising. Expenses incurred in the administration or general operations of the
business are administrative expenses or general expenses. Examples of these expenses are office
salaries, depreciation of office equipment, and office supplies used.

Other income and expense is revenue from sources other than the primary operating activity of a
business is classified as other income. In a merchandising business, these items include income from
interest, rent, and gains resulting from the sale of fixed assets. Expenses that cannot be traced directly to
operations are identified as other expense. Interest expense that results from financing activities and
losses incurred in the disposal of fixed assets are examples of these items.
Net Solutions
Income Statement
For the Year Ended December 31, 2012
Revenue from sales:
Sales $720185 00
Less: Sales returns and allowances $6140 00
Sales discounts 5790 00 11930 00
Net sales $708255 00
Cost of merchandise sold 525305 00
Gross profit $182950 00
Operating expenses:
Selling expenses:
Sales salaries expense $56230 00
Advertising expense 10860 00
Depr. expense––store equipment 3100 00
Miscellaneous selling expense 630 00
Total selling expenses $70820 00
Administrative expenses:
Office salaries expense $21020 00
Rent expense 8100 00
Depr. expense––office equipment 2490 00
Insurance expense 1910 00
Office supplies expense 610 00
Misc. administrative expense 760 00
Total administrative expenses 34890 00
Total operating expenses 105710 00
 Income from operations $77240 00
Other income and expense:
Rent revenue $600 00
Interest expense (2440 00) (1840 00)
Net income $75400 00

Single-Step Income Statement

An alternate form of income statement is the single-step income statement. The single-step form
emphasizes total revenues and total expenses as the factors that determine net income. A criticism of the
single-step form is that such amounts as gross profit and income from operations are not readily
available for analysis.
Net Solutions
Income Statement
For the Year Ended December 31, 2012
Revenue:
Net sales $708255 00
Rent revenue 600 00
Total Revenue $708855 00
Expense:
Cost of merchandise sold 525305 00
Selling expenses 70820 00
Administrative expenses 34890 00
Interest expense 2440 00
Total expenses 633455 00
Net income $75400 00

Statement of Owner’s Equity

The statement of owner’s equity is prepared in the same manner that we described previously for a
service business.
Statements of financial positions
As we discussed and illustrated in previous chapters, the balance sheet may be presented with assets on
the left-hand side and the liabilities and owner’s equity on the right-hand side. Merchandise inventory at
the end of the period is reported as a current asset.

3.8. Adjusting and closing entries for a merchandising business

Merchandise Inventory Shrinkage
Under the perpetual inventory system, a separate merchandise inventory account is maintained in the
ledger. During the accounting period, this account shows the amount of merchandise for sale at any
time. However, merchandising businesses may experience some loss of inventory due to shoplifting,
employee theft, or errors in recording or counting inventory. As a result, the physical inventory taken at
the end of the accounting period may differ from the amount of inventory shown in the inventory
records. Normally, the amount of merchandise for sale, as indicated by the balance of the merchandise
inventory account, is larger than the total amount of merchandise counted during the physical inventory.
For this reason, the difference is often called inventory shrinkage or inventory shortage.

To illustrate, Net Solutions’ inventory records indicate that $63,950 of merchandise should be available
for sale on December 31, 2007. The physical inventory taken on December 31, 2007, however, indicates
that only $62,150 of merchandise is actually available. Thus, the inventory shrinkage for the year ending
December 31, 2007, is $1,800 ($63,950 - $62,150), as shown at the left. This amount is recorded by the
following adjusting entry:
Dec. 31 Cost of Merchandise Sold 1800 00
Merchandise inventory 1800 00
Recording inventory shrinkage

After this entry has been recorded, the accounting records agree with the actual physical inventory at the
end of the period. Since no system of procedures and safeguards can totally eliminate it, inventory
shrinkage is often considered a normal cost of operations. If the amount of the shrinkage is abnormally
large, it may be disclosed separately on the income statement. In such cases, the shrinkage may be
recorded in a separate account, such as Loss from Merchandise Inventory Shrinkage.

The data needed for adjusting the accounts of Net Solutions and Trial Balance are as follows:
a) Physical merchandise inventory on December 31, 2011 . . . . . . . . $62,150
b) Office supplies on hand on December 31, 2011 . . . . . . . . . . . . . . . . . . . 480
c) Insurance expired during 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,910
d) Depreciation during 2011 on: Store equipment . . . . . . . . . . . . . . . . . . 3,100
Office equipment . . . . . . . . . . . . . . . . . 2,490
e) Salaries accrued on December 31, 2011: Sales salaries . . . $780
Office salaries . . . 360 1,140
f) Rent earned during 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 600
 Net Solutions
Trial Balance
December 31, 2011
Cash 52950 00
Accounts Receivable 91080 00
Merchandise inventory 63950 00
Office Supplies 1090 00
Prepaid Insurance 4560 00
Land 20000 00
Store Equipment 27100 00
Accumulated Depreciation – Store Equipment 2600 00
Office Equipment 15570 00
Accumulated Depreciation – Office Equipment 2230 00
Accounts Payable 22420 00
Unearned Rent 2400 00
Notes Payable 25000 00
Aymen, Capital 153800 00
Aymen, Drawing 18000 00
Sales 720185 00
Sales Returns and Allowance 6140 00
Sales Discounts 5790 00
Cost of Merchandise Sold 523505 00
Sales Salaries Expense 55450 00
Advertising Expense 10860 00
Miscellaneous Selling Expense 630 00
Office Salaries Expense 20660 00
Rent Expense 8100 00
Miscellaneous Administrative Expense 760 00
Interest expense 2440 00
928635 00 928635 00

Adjusting Entries
2011
Dec. 31 Cost of Merchandise Sold 510 1800 00
Merchandise Inventory 115 1800 00
31 Office Supplies Expense 534 610 00
Office Supplies 116 610 00
31 Insurance Expense 533 1910 00
Prepaid Insurance 117 1910 00
31 Depreciation Expense – Store Equipment 522 3100 00
Accumulated Depreciation – Store
Equipment 124 3100 00
31 Depreciation Expense – Office Equipment 532 2490 00
Accumulated Depreciation – Office
Equipment 126 2490 00
0
31 Office Salaries Expense 520 360 0
0
Sales Salaries Expense 530 780 0
Salaries Payable 211 1140 00
31 Unearned Rent 212 600 0
 0
Rent Revenue 610 600 00
 Work Sheet
Net Solution
Work Sheet
For the Year Ended December 31, 2011
Trial Balance Adjustments Adjusted Trial Balance Income Statement Statement of financial position
Account Title Dr Cr Dr Cr Dr Cr Dr Cr Dr Cr
0
Cash 52950 00 52950 00 52950 0
0 0
Accounts Receivable 91080 00 91080 0 91080 0
0 0 0
Merchandise inventory 63950 00 a1800 0 62150 0 62150 0
0 0 0 0
Office Supplies 1090 0 b610 0 480 0 480 0
0 0 0 0
Prepaid Insurance 4560 0 c1910 0 2650 0 2650 0
0 0 0
Land 20000 0 20000 0 20000 0
0 0 0
Store Equipment 27100 0 27100 0 27100 0
Accumulated Dep. – 0
Store Equipment 2600 00 d3100 0 5700 00 5700 00
0 0 0
Office Equipment 15570 0 15570 0 15570 0
Accumulated Dep. – 0 0 0
Office Equipment 2230 0 e2490 0 4720 00 4720 0
0 0 0
Accounts Payable 22420 0 22420 0 22420 0
0 0 0
Salaries Payable f1140 0 1140 0 1140 0
0 0 0
Unearned Rent 2400 0 g600 00 1800 0 1800 0
0 0 0
Notes Payable 25000 0 25000 0 25000 0
0 0 0
Aymen, Capital 153800 0 153800 0 153800 0
0 0 0
Aymen, Drawing 18000 0 18000 0 18000 0
0 0 0
Sales 720185 0 720185 0 720185 0
Sales Returns and 0 0
Allowance 6140 00 6140 0 6140 0
0 0 0
Sales Discounts 5790 0 5790 0 5790 0
Cost of Merchandise 0 0 0
Sold 523505 0 a1800 00 525305 0 525305 0
Sales Salaries 0 0 0 0
Expense 55450 0 f780 0 56230 0 56230 0
0 0 0
Advertising Expense 10860 0 10860 0 10860 0
Depreciation Expense 0 0 0
– Store Equipment d3100 0 3,100 0 3100 0
Miscellaneous Selling 0 0 0
Expense 630 0 630 0 630 0
Office Salaries 0 0 0 0
Expense 20660 0 f360 0 21020 0 21020 0
0 0 0
Rent Expense 8100 0 8100 0 8100 0
Depreciation Expense 0 0 0
– Office Equipment e2490 0 2490 0 2490 0
0 0 0
Insurance Expense c1910 0 1910 0 1910 0
Office Supplies 0 0 0
Expense b610 0 610 0 610 0
Miscellaneous 0 0 0
Administrative Expense 760 0 760 0 760 0
0 0 0
Rent Revenue g600 0 600 0 600 0
0 0 0
Interest expense 2440 0 2440 0 2440 0
0 0 0 0 0 0 0
928635 00 928635 11650 0 11650 00 935365 0 935365 0 645385 0 720785 0 289980 0 214580 0
0 0
Net Income 75400 0 75400 0
0 0 0
720785 0 720785 0 289980 0 289980
Closing Entries
The closing entries for a merchandising business are similar to those for a service business. The first
entry closes the temporary accounts with credit balances, such as Sales, to the income summary account.
The second entry closes the temporary accounts with debit balances, including Sales Returns and
Allowances, Sales Discounts, and Cost of Merchandise Sold, to the income summary account. The third
entry closes the balance of the income summary account to the owner’s capital account. The fourth entry
closes the owner’s drawing account to the owner’s capital account.
Journal Page __
Post.
Date Description Ref. Debit Credit
2010
Dec. 31 Sales 410 720,185 00
Rent Revenue 610 600 00
Income Summary 312 720,785 00

645,3
31 Income Summary 312 85 00
Sales Returns and Allowances 411 6,140 00
Sales Discounts 412 5,790 00
Cost of Merchandise Sold 510 525,305 00
Sales Salaries Expense 520 56,230 00
Advertising Expense 521 10,860 00
Depr. Expense—Store Equipment 522 3,100 00
Miscellaneous Selling Expense 529 630 00
Office Salaries Expense 530 21,020 00
Rent Expense 531 8,100 00
Depr. Expense—Office Equipment 532 2,490 00
Insurance Expense 533 1,910 00
Office Supplies Expense 534 610 00
Misc. Administrative Expense 539 760 00
Interest Expense 710 2,440 00

31 Income Summary 312 75,400 00

Aymen, Capital 310 75,400 00

31 Aymen, Capital 310 18,000 00

Aymen, Drawing 311 18,000 00

Worksheet for Chapter Three

1. Record the following transaction by both the buyer (Burton Co.) and the seller (Scully Co.) by
using both perpetual and periodic inventory system.
July 1. Scully Company sold merchandise on account to Burton Co., $7,500, terms FOB shipping
point, n/45. The cost of the merchandise sold was $4,500.
July 2. Burton Co. paid transportation charges of $150 on July 1 purchase from Scully Company.
July 5. Scully Company sold merchandise on account to Burton Co., $5,000, terms FOB destination,
n/30. The cost of the merchandise sold was $3,500.
July 7. Scully Company paid transportation costs of $250 for delivery of merchandise sold to Burton
Co. on July 5.
July 13. Scully Company issued Burton Co. a credit memorandum for merchandise returned $1,000.
The merchandise had been purchased by Burton Co. on account on July 5. The cost of the
merchandise returned was $700.
July 15. Scully Company received payment from Burton Co. for purchase of July 5.
July 18. Scully Company sold merchandise on account to Burton Co., $12,000, terms FOB shipping
point, 2/10, n/eom. Scully Company prepaid transportation costs of $500, which were added
to the invoice. The cost of the merchandise sold was $7,200.
July 28. Scully Company received payment from Burton Co. for purchase of July 18, less discount
(2% X $12,000).
2. The following transactions were completed by Montrose Company during May of the current year.
Montrose Company uses a perpetual inventory system.
May 3. Purchased merchandise on account from Floyd Co., $4,000, terms FOB shipping point, 2/10,
n/30, with prepaid transportation costs of $120 added to the invoice.
5. Purchased merchandise on account from Kramer Co., $8,500, terms FOB destination, 1/10, n/30.
6. Sold merchandise on account to C. F. Howell Co., list price $4,000, trade discount 30%, terms
2/10, n/30. The cost of the merchandise sold was $1,125.
8. Purchased office supplies for cash, $150.
10. Returned merchandise purchased on May 5 from Kramer Co., $1,300.
13. Paid Floyd Co. on account for purchase of May 3, less discount.
14. Purchased merchandise for cash, $10,500.
15. Paid Kramer Co. on account for purchase of May 5, less return of May 10 and discount.
16. Received cash on account from sale of May 6 to C. F. Howell Co., less discount.
 19. Sold merchandise on account to ABC Company, $2,450. The cost of the merchandise sold was
$980.
22. Sold merchandise on account to Comer Co., $3,480, terms 2/10, n/30. The cost of the
merchandise sold was $1,400.
24. Sold merchandise for cash, $4,350. The cost of the merchandise sold was $1,750.
25. Received merchandise returned by Comer Co. from sale on May 22, $1,480. The cost of the
returned merchandise was $600.
31. Received cash from ABC Company for sales of May 19, less $140 service fee.
Instructions
a. Journalize the preceding transactions.
b. Journalize the adjusting entry for merchandise inventory shrinkage, $3,750.
3. During the current year, merchandise is sold for $250,000 cash and for $975,000 on account. The
cost of the merchandise sold is $735,000. What is the amount of the gross profit?

4. The following data were extracted from the accounting records of Meniscus Company for the year
ended April 30, 2006:
Merchandise Inventory, May 1, 2005
Merchandise Inventory, April 30, 2006
Purchases
Purchases Returns and Allowances
Purchases Discounts
Sales
Transportation In
$ 121,200
142,000
985,000
23,500
21,000
1,420,000
11,300
 a. Prepare the cost of merchandise sold section of the income statement for the year ended
April 30, 2006, using the periodic inventory method.
b. Determine the gross profit to be reported on the income statement for the year ended
April 30, 2006.

5. The following selected accounts and their current balances appear in the ledger of Sombrero
Co. for the fiscal year ended November 30, 2006:
Cash $91,800 Sales Returns and Allowances 25,200
Accounts Receivable 74,400 Sales Discounts 13,200
Merchandise Inventory 120,000 Cost of Merchandise Sold 1,284,000
Office Supplies 3,120 Rent Expense 26,580
Prepaid Insurance 8,160 Insurance Expense 15,300
Office Equipment 12,960 Depreciation Expense - Office Equipment 10,800
Accumulated Depreciation - Store Equipment 58,320 Sales Salaries Expense 252,000
Store Equipment 141,000 Advertising Expense 33,960
Accumulated Depreciation - Office Equipment 76,800 Office Supplies Expense 1,080
Accounts Payable 32,400 Depreciation Expense - Store Equipment 5,520
Salaries Payable 2,400 Miscellaneous Administrative Expense 1,440
Note Payable (final payment due 2016) 36,000 Miscellaneous Selling Expense 1,320
Hector Rodrique, Capital 321,600 Interest Expense 1,200
Hector Rodrique, Drawing 30,000 Office Salaries Expense 49,200
Sales 1,802,400
Instructions
1. Prepare both multiple-step and single-step income statement.
2. Prepare a statement of owner’s equity.
3. Prepare statement of financial position, assuming that the current portion of the note payable
is $3,000.