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CHAPTER5
Accounting for
Merchandising
Operations

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 PreviewofCHAPTER5

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 Merchandising Operations

Merchandising Companies
Buy and Sell Goods

Wholesaler Retailer Consumer

The primary source of revenues is referred to as

sales revenue or sales.
5-4 SO 1 Identify the differences between service and merchandising companies.
 Merchandising Operations

Income Measurement

Not used in a
Service business.

Illustration 5-1

Cost of goods sold is the total

cost of merchandise sold during
the period.

5-5 SO 1 Identify the differences between service and merchandising companies.

 Merchandising Operations
Illustration 5-2

Operating
Cycles

The operating cycle

of a merchandising
company ordinarily
is longer than that of
a service
company.

5-6 SO 1 Identify the differences between service and merchandising companies.

 Merchandising Operations

Flow of Costs
Illustration 5-3

Companies use either a perpetual inventory system or a periodic inventory

system to account for inventory.

5-7 SO 1 Identify the differences between service and merchandising companies.

 Merchandising Operations

Flow of Costs
Perpetual System
 Maintain detailed records of the cost of each inventory
purchase and sale.
 Records continuously show inventory that should be on
hand.
 Company determines cost of goods sold each time a
sale occurs.

5-8 SO 1 Identify the differences between service and merchandising companies.

 Merchandising Operations

Flow of Costs
Periodic System
 Do not keep detailed records of the goods on hand.
 Cost of goods sold determined by count at the end of
the accounting period.
 Calculation of Cost of Goods Sold:
Beginning inventory

$ 100,000
Add: Purchases, net

800,000
5-9 Goods available for sale SO 1
 Merchandising Operations

Flow of Costs
Additional Consideration
Perpetual System:
 Traditionally used for merchandise with high unit
values.
 Provides better control over inventories.
 Requires additional clerical work and additional cost
to maintain inventory records.

5-10 SO 1 Identify the differences between service and merchandising companies.

5-11
 Recording Purchases of Merchandise

 Made using cash or credit (on account).

Illustration 5-5

 Normally recorded when

goods are received.

 Purchase invoice should

support each credit
purchase.

5-12 SO 2 Explain the recording of purchases under a perpetual inventory system.

 Recording Purchases of Merchandise
Illustration 5-5

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.

May 4 Inventory 3,800

Accounts payable 3,800
5-13 SO 2 Explain the recording of purchases under a perpetual inventory system.
 Recording Purchases of Merchandise

Freight Costs – Terms of Sale Illustration 5-6

Shipping terms

Seller places goods Free On

Board the carrier, and buyer
pays freight costs.

Seller places goods Free On

Board to the buyer’s place of
business, and seller pays
freight costs.

Freight costs incurred by the seller are an operating expense.

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SO 2
 Recording Purchases of Merchandise

Illustration: Assume upon delivery of the goods on May 6, Sauk

Stereo pays Acme Freight Company $150 for freight charges, the
entry on Sauk Stereo’s books is:

May 6 Inventory 150

Cash 150

Assume the freight terms on the invoice in Illustration 5-5 had

required PW Audio Supply to pay the freight charges, the entry by
PW Audio Supply would have been:

May 4 Freight-out 150

Cash 150
5-15 SO 2 Explain the recording of purchases under a perpetual inventory system.
 Recording Purchases of Merchandise

Purchase Returns and Allowances

Purchaser may be dissatisfied because goods are
damaged or defective, of inferior quality, or do not meet
specifications.

Purchase Return Purchase Allowance

Return goods for credit if the May choose to keep the
sale was made on credit, or merchandise if the seller will
for a cash refund if the grant an allowance
purchase was for cash. (deduction) from the
purchase price.

5-16 SO 2 Explain the recording of purchases under a perpetual inventory system.

 Recording Purchases of Merchandise

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

5-17 SO 2 Explain the recording of purchases under a perpetual inventory system.

 Recording Purchases of Merchandise

Purchase Discounts
Credit terms may permit buyer to claim a cash discount for
prompt payment.

Advantages: Example: Credit

terms may read 2/10,
 Purchaser saves money. n/30.

 Seller shortens the operating cycle.

5-18 SO 2 Explain the recording of purchases under a perpetual inventory system.

 Recording Purchases of Merchandise

Purchase Discounts

2/10, n/30 1/10 EOM n/10 EOM

2% discount if 1% discount if Net amount due

paid within 10 paid within first 10 within the first 10
days, otherwise days of next days of the next
net amount due month. month.
within 30 days.

5-19 SO 2 Explain the recording of purchases under a perpetual inventory system.

 Recording Purchases of Merchandise

Illustration: Assume that on May 8 Sauk Stereo returned to

PW Audio Supply goods costing $300.

May 8 Accounts payable 300

Inventory 300

5-20 SO 2 Explain the recording of purchases under a perpetual inventory system.

 Recording Purchases of Merchandise

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 to record its May 14 payment.

May 14 Accounts payable 3,500

Inventory 70
Cash 3,430

(Discount = $3,500 x 2% = $70)

5-21 SO 2 Explain the recording of purchases under a perpetual inventory system.

 Recording Purchases of Merchandise

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:

June 3 Accounts payable 3,500

Cash 3,500

5-22 SO 2 Explain the recording of purchases under a perpetual inventory system.

 Recording Purchases of Merchandise

Purchase Discounts

Should discounts be taken when offered?

Discount of 2% on $3,500 $ 70.00

$3,500 invested at 10% for 20 days 19.18
Savings by taking the discount $ 50.82

Example: 2% for 20 days = Annual rate of 36.5%

(365/20 = 18.25 twenty-day periods x 2% = 36.5%)

5-23 SO 2 Explain the recording of purchases under a perpetual inventory system.

 Recording Purchases of Merchandise

Summary of Purchasing Transactions

Inventory
Debit Credit

4th - Purchase $3,500 $300 8th - Return

6th – Freight-in 150 70 14th - Discount

Balance $3,580

5-24 SO 2 Explain the recording of purchases under a perpetual inventory system.

 Recording Sales of Merchandise

 Made using cash or credit (on account). Illustration 5-5

 Normally recorded when

earned, usually when
goods transfer from seller
to buyer.

 Sales invoice should

support each credit sale.

5-25
SO 3 Explain the recording of sales revenues
under a perpetual inventory system.
 Recording Sales of Merchandise

Journal Entries to Record a Sale

#1 Cash or Accounts receivable XXX Selling

Sales revenue XXX Price

#2 Cost of goods sold XXX

Cost
Inventory XXX

5-26
SO 3 Explain the recording of sales revenues
under a perpetual inventory system.
 Recording Sales of Merchandise

Illustration: Assume PW Audio Supply records its May 4

sale of $3,800 to Sauk Stereo on account (Illustration 5-5)
as follows. Assume the merchandise cost PW Audio Supply
$2,400.

May 4 Accounts receivable 3,800

Sales revenue 3,800

4 Cost of goods sold 2,400

Inventory 2,400

5-27
SO 3 Explain the recording of sales revenues
under a perpetual inventory system.
5-28
 Recording Sales of Merchandise

Sales Returns and Allowances

 “Flipside” of purchase returns and allowances.

 Contra-revenue account (debit).

 Sales not reduced (debited) because:

► Would obscure importance of sales returns and

allowances as a percentage of sales.

► Could distort comparisons.

5-29
SO 3 Explain the recording of sales revenues
under a perpetual inventory system.
 Recording Sales of Merchandise

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.

May 8 Sales returns and allowances 300

Accounts receivable 300

8 Inventory 140
Cost of goods sold 140

5-30
SO 3 Explain the recording of sales revenues
under a perpetual inventory system.
 Recording Sales of Merchandise

Illustration: Assume the returned goods were defective and

had a scrap value of $50, PW Audio would make the following
entries:

May 8 Sales returns and allowances 300

Accounts receivable 300

8 Inventory 50
Cost of goods sold 50

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SO 3 Explain the recording of sales revenues
under a perpetual inventory system.
 Recording Sales of Merchandise

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.

5-32
SO 3 Explain the recording of sales revenues
under a perpetual inventory system.
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 Recording Sales of Merchandise

Sales Discount
 Offered to customers to promote prompt payment.

 “Flipside” of purchase discount.

 Contra-revenue account (debit).

5-34
SO 3 Explain the recording of sales revenues
under a perpetual inventory system.
 Recording Sales of Merchandise

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.

May 14 Cash 3,430 *

Sales discounts 70
Accounts receivable 3,500

* [($3,800 – $300) X 2%]

5-35
SO 3 Explain the recording of sales revenues
under a perpetual inventory system.
 Completing the Accounting Cycle

Adjusting Entries
 Generally the same as a service company.

 One additional adjustment to make the records agree with

the actual inventory on hand.

 Involves adjusting Inventory and Cost of Goods Sold.

5-36 SO 4 Explain the steps in the accounting cycle for a merchandising company.
 Completing the Accounting Cycle

Illustration: Suppose that PW Audio Supply has an unadjusted

balance of $40,500 in Merchandise Inventory. Through a physical
count, PW Audio determines that its actual merchandise inventory
at year-end is $40,000. The company would make an adjusting
entry as follows.

Cost of goods sold 500

Inventory 500

5-37 SO 4 Explain the steps in the accounting cycle for a merchandising company.
 Completing the Accounting Cycle

Closing
Entries

5-38 SO 4 Explain the steps in the accounting cycle for a merchandising company.
 Completing the Accounting Cycle

Closing Entries

5-39 SO 4 Explain the steps in the accounting cycle for a merchandising company.
 Forms of Financial Statements

Multiple-Step Income Statement

 Shows several steps in determining net income.

 Two steps relate to principal operating activities.

 Distinguishes between operating and non-operating

activities.

5-40 SO 5 Distinguish between a multiple-step and a single-step income statement.

 Forms of Financial Statements Illustration 5-13

Income
Statement
Presentation
of Sales

5-41 SO 5 Distinguish between a multiple-step and a single-step income statement.

 Forms of Financial Statements Illustration 5-13

Gross Profit

Key Items:
 Net sales
 Gross profit
 Gross profit
rate
Illustration 5-10

5-42 SO 6 Explain the computation and importance of gross profit.

 Forms of Financial Statements Illustration 5-13

Operating
Expenses

Key Items:
 Net sales
 Gross profit
 Operating
expenses

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 Forms of
Financial
Statements

Key Items:
 Net sales
 Gross profit
 Operating
expenses
 Non-
operating
activities
 Net income

Illustration 5-13
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 Forms of
Financial
Statements

Key Items:
 Net sales
 Gross profit
 Operating
expenses
 Non-
operating
activities
 Net income

Illustration 5-12
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 Forms of Financial Statements

Question
The multiple-step income statement for a merchandiser
shows each of the following features except:

a. gross profit.

b. cost of goods sold.

c. a sales revenue section.

d. investing activities section.

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 Forms of Financial Statements

Single-Step Income Statement

 Subtract total expenses from total revenues

 Two reasons for using the single-step format:

1. Company does not realize any profit until total

revenues exceed total expenses.

2. Format is simpler and easier to read.

5-47 SO 5 Distinguish between a multiple-step and a single-step income statement.

 Forms of Financial Statements

Single-Step Income Statement

Illustration 5-14

5-48 SO 5 Distinguish between a multiple-step and a single-step income statement.

 Forms of Financial Statements

Classified Balance Sheet

Illustration 5-15

5-49 SO 5 Distinguish between a multiple-step and a single-step income statement.

 APPENDIX5A
Periodic Inventory System
 Record revenues when sales are made.
 Do not record cost of merchandise sold on the 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.

5-50
SO 7 Explain the recording of purchases and sales of
inventory under a periodic inventory system.
 Periodic Inventory System

Determining Cost of Goods Sold

Illustration 5A-2

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 Periodic Inventory System

Recording Purchases of Merchandise

Illustration: On the basis of the sales invoice (Illustration 5-5)
and receipt of the merchandise ordered from PW Audio Supply,
Sauk Stereo records the $3,800 purchase as follows.

May 4 Purchases 3,800

Accounts payable 3,800

5-52
SO 7 Explain the recording of purchases and sales of
inventory under a periodic inventory system.
 Periodic Inventory System

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

May 6 Freight-in (Transportation-in) 150

Cash 150

5-53
SO 7 Explain the recording of purchases and sales of
inventory under a periodic inventory system.
 Periodic Inventory System

Purchase Returns and Allowances

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

May 8 Accounts payable 300

Purchase returns and allowances 300

5-54
SO 7 Explain the recording of purchases and sales of
inventory under a periodic inventory system.
 Periodic Inventory System

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.

May 14 Accounts payable 3,500

Purchase discounts 70
Cash 3,430

5-55
SO 7 Explain the recording of purchases and sales of
inventory under a periodic inventory system.
 Periodic Inventory System

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,
Illustration 5-5) as follows.

May 4 Accounts receivable 3,800

Sales revenue 3,800

No entry is recorded for cost of goods sold at the time of the

sale under a periodic system.

5-56
SO 7 Explain the recording of purchases and sales of
inventory under a periodic inventory system.
 Periodic Inventory System

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.

May 4 Sales returns and allowances 300

Accounts receivable 300

5-57
SO 7 Explain the recording of purchases and sales of
inventory under a periodic inventory system.
 Periodic Inventory System

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.

May 14 Cash 3,430

Sales discounts 70
Accounts receivable 3,500

5-58
SO 7 Explain the recording of purchases and sales of
inventory under a periodic inventory system.
 Periodic Inventory System

Comparison of Entries—Perpetual Vs. Periodic

Illustration 5A-3

5-59
SO 7 Explain the recording of purchases and sales of
inventory under a periodic inventory system.
 Periodic Inventory System

Comparison of Entries—Perpetual Vs. Periodic

Illustration 5A-3

5-60
SO 7 Explain the recording of purchases and sales of
inventory under a periodic inventory system.
 APPENDIX5B Illustration 5B-1

Worksheet for a
Merchandising
Company

5-61 SO 8 Prepare a worksheet for a merchandising company.

 Key Points
 Under both GAAP and IFRS, a company can choose to use
either a perpetual or a periodic system.
 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 providing of services.
 Under GAAP, companies generally classify income statement
items by function. Classification by function leads to
descriptions like administration, distribution, and
manufacturing.

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 Key Points
 Under IFRS, companies must classify expenses by either nature
or 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.
 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.

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 Key Points
 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.
 IAS 1, “Presentation of Financial Statements,” provides general
guidelines for the reporting of income statement information.
Subsequently, a number of international standards have been
issued that provide additional guidance to issues related to
income statement presentation.
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 Key Points
 Similar to GAAP, comprehensive income under IFRS includes
unrealized gains and losses (such as those on so-called
“available-for-sale securities”) that are not included in the
calculation of net income.
 IFRS requires that two years of income statement information
be presented, whereas GAAP requires three years.

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 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 of this new approach 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
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 Looking to the Future
liabilities used to generate the income. Finally, 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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 IFRS Self-Test Questions
Which of the following would not be included in the definition of
inventory under IFRS?

a) Photocopy paper held for sale by an office-supply store.

b) Stereo equipment held for sale by an electronics store.

c) Used office equipment held for sale by the human

relations department of a plastics company.

d) All of the above would meet the definition.

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 IFRS Self-Test Questions
Which of the following would not be a line item of a company
reporting costs by nature?

a) Depreciation expense.

b) Salaries expense.

c) Interest expense.

d) Manufacturing expense.

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 IFRS Self-Test Questions
Which of the following would not be a line item of a company
reporting costs by function?

a) Administration.

b) Manufacturing.

c) Utilities expense.

d) Distribution.

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 Copyright

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