Accounting

Principles

Second Canadian Edition

Weygandt Kieso Kimmel Trenholm

Prepared by:

Carole Bowman, Sheridan College

CHAPTER

5
ACCOUNTING FOR
MERCHANDISING
OPERATIONS

MERCHANDISING COMPANY
A merchandising company is an enterprise

that buys and sells goods to earn a profit.

1. Wholesalers sell to retailers.
2. Retailers sell to consumers.
A merchandisers primary source of
revenue is sales, whereas a service
companys primary source of revenue is
service revenue.

OPERATING CYCLES FOR A

SERVICE COMPANY AND A
MERCHANDISING COMPANY
Service Company
Receive
Cash

Cash

Perform
Services

Accounts
Receivable
Merchandising Company
Receive
Cash

Cash

Buy
Inventory

Sell Inventory

Accounts
Receivable

Merchandise
Inventory

ILLUSTRATION 5-1

INCOME MEASUREMENT PROCESS

FOR A MERCHANDISING COMPANY
Sales
Revenue

Less

Equals

Cost of
Goods Sold

Gross
Profit

Less

Equals

Operating
Expenses

Net
Income
(Loss)

INVENTORY SYSTEMS
Merchandising entities may use either (or both)
of the following inventory systems:
1. Perpetual where detailed records of each
inventory purchase and sale are maintained.
Cost of goods sold is calculated at the time of
each sale.
2. Periodic detailed records are not
maintained. Cost of goods sold is calculated
only at the end of the accounting period.
This chapter covers the perpetual method.

RECORDING COST OF GOODS

PURCHASED
When merchandise is purchased for resale

to customers, the account, Merchandise

Inventory, is debited for the cost of the
goods.
Purchases may be made for cash or on
account (credit).
The purchase is normally recorded
by the purchaser when the goods
are received from the seller.

PURCHASES OF
MERCHANDISE
General Journal
Date Account Title and Explanation Ref
May 4 Merchandise Inventory
Accounts Payable
To record goods purchased on
account, terms n/30.

Debit
3,800

For purchases on account, Merchandise

Inventory is debited and Accounts
Payable is credited. For cash purchases,
Merchandise Inventory is debited and
Cash is credited.

J1
Credit
3,800

FREIGHT COSTS
The sales agreement should indicate whether the

seller or buyer is to pay the cost of transporting

the goods to the buyers place of business.
FOB Shipping Point
1. Goods delivered to shipping point by seller
2. Buyer pays freight costs from shipping
point to destination
FOB Destination
1. Goods delivered to destination by seller
2. Seller pays freight costs

ACCOUNTING FOR FREIGHT COSTS

Merchandise Inventory is debited by the

buyer, if the buyer pays the freight bill (FOB

shipping point).

Freight Out (or Delivery Expense) is debited

by the seller, if the seller pays the freight bill

(FOB destination).

ACCOUNTING FOR FREIGHT COSTS

General Journal
Date Account Title and Explanation
May 4 Merchandise Inventory
Cash or A/P
To record payment of freight.

Ref

Debit
150

When the purchaser directly incurs the

freight costs, the account Merchandise
Inventory is debited and Cash or A/P is
credited.

J1
Credit
150

PURCHASE
RETURNS AND ALLOWANCES
A purchaser may be dissatisfied with

merchandise received because the goods

1. are damaged or defective,
2. are of inferior quality, or
3. are not in accord with the
purchasers specifications.

PURCHASE
RETURNS AND ALLOWANCES
General Journal
Date Account Title and Explanation
May 8 Accounts Payable or \Cash
Merchandise Inventory
To record return of goods.

Ref

Debit
300

J1
Credit
300

For purchases returns and allowances that

were originally made on account, Accounts
Payable is debited and Merchandise Inventory
is credited. For cash returns and allowances,
Cash is debited and Merchandise Inventory is
credited.

QUANTITY DISCOUNTS (PURCHASE)

Volume purchase terms may permit the
buyer to claim a quantity discount.
The merchandise inventory is simply
recorded at the discounted cost.

PURCHASE DISCOUNTS
Credit terms may permit the buyer to claim

a cash discount for the prompt payment of a

balance due.
The buyer calls this discount a
purchase discount.
A purchase discount is based on
the invoice cost less any returns
and allowances granted.

SALES TRANSACTIONS
Revenues are reported when earned in

accordance with the revenue recognition

principle. In a merchandising company.
revenues are earned when the goods are
transferred from seller to buyer.

SALES TRANSACTIONS
General Journal
Date Account Title and Explanation
May 4 Accounts Receivable
Sales
To record credit sale.
May 4 Cost of Goods Sold
Merchandise Inventory
To record cost of merchandise
sold.

Ref

Debit
3,800

J1
Credit
3,800

2,400
2,400

1. The first entry records the sale of goods to a

customer at the retail (selling) price.
2. The second entry releases the goods from inventory
at cost and charges the goods to cost of goods sold.

SALES TAXES
Sales tax is expressed as a percentage of the
sales price on selected goods sold to
customers by a retailer. They are collected on
most revenues, and paid on many costs.
Sales taxes may include the federal goods and
services tax (GST) and the provincial sales tax
(PST), if any. These two taxes have been
combined into one harmonized sales tax
(HST) in some Atlantic Provinces.

SALES TAXES ON REVENUES

The retailer collects the tax from the
customer when the sale occurs, and
periodically (usually monthly) remits the
collections to the Receiver General.
Sales taxes are not revenue but are a current
liability until remitted.

SALES TAX PST AND GST

Date Account Title and Explanation
May 4 Accounts Receivable
Sales
Pst Payable
Gst Payable
To record credit sale with
taxes
4-May Cost of goods sold
Merchandise Inventory

Ref

Debit
1,150

Credit
1,000
80
70

900
900

1. The first entry records the sale of goods to a

customer at the retail (selling) price plus tax.
2. The second entry releases the goods from inventory
at cost and charges the goods to cost of goods sold.

SALES TAX Purchase

Date Account Title and Explanation
May 4 Merchandise Inventory
GST Refundable
Accounts Payable/Cash
To record credit purchase with
tax

Ref

Debit
1,000
70

Credit

1,070

SALES RETURNS AND ALLOWANCES

Sales Returns occur when customers are

dissatisfied with merchandise and are

allowed to return the goods to the seller
for credit or a refund.
Sales Allowances occur when
customers are dissatisfied, and the
seller allows a deduction from
the selling price.

SALES RETURNS AND ALLOWANCES

The normal balance of Sales Returns and

Allowances is a debit.
Sales Returns and Allowances is a contra
revenue account to the Sales account.

RECORDING SALES RETURNS

AND ALLOWANCES
General Journal
Date Account Title and Explanation
May 8 Sales Returns and Allowances
Accounts Receivable
To record returned goods.
May 8 Merchandise Inventory
Cost of Goods Sold
To record cost of goods
returned.

Ref

Debit
300

J1
Credit
300

140
140

1. The first entry reduces the balance owed by the customer

and records the goods returned at retail price.
2. The second entry records the physical return of goods to
inventory at cost and removes the goods from the cost
of goods sold account.

QUANTITY DISCOUNTS (SALES)

A quantity discount is the offer of a cash
discount to a customer in return for a volume
sale.
Quantity discounts result in a sales price
reduction. They are not separately journalized.
Instead the sale is recorded at the reduced
price.

SALES DISCOUNTS
A sales discount is the offer of a cash discount

to a customer in exchange for the prompt

payment of a balance due.
Similar to Sales Returns and Allowances, Sales
Discounts is also a contra revenue account
with a normal debit balance.

COMPLETING
THE ACCOUNTING CYCLE
A merchandising company requires the same

types of adjusting entries as a service

company, with one additional adjustment for
inventory to ensure the recorded inventory
amount agrees with the actual quantity on
hand.
A physical count is an important control
feature since a perpetual system indicates
what should be there but a count will
determine what is actually there.

COMPLETING
THE ACCOUNTING CYCLE
A merchandising company also requires the

same types of closing entries as a service

company.
The additional accounts that need to be
closed out in a merchandising account
include Sales, Sales Returns and Allowances,
Cost of Goods Sold, and Freight Out.
Merchandise Inventory is an asset account
and is not closed at the end of the period.

ILLUSTRATION 5-9

STATEMENT PRESENTATION OF
SALES REVENUE SECTION
As contra revenue accounts, sales returns and
allowances (and sales discounts, if any) are
deducted from sales in the income statement to
arrive at Net Sales.
HIGHPOINT ELECTRONIC
Income Statement (Partial)
For the Year Ended December 31, 2002
Sales revenue
Sales
$ 480,000
Less: Sales returns and allowances
20,000
Net sales
$ 460,000

ILLUSTRATION 5-10

CALCULATION OF GROSS PROFIT

Gross profit is calculated by deducting cost of
goods sold from net sales as follows:
Net
Net sales
sales
Cost
Cost of
of goods
goods sold
sold
Gross
Gross profit
profit

$$ 460,000
460,000
316,000
$ 144,000

100%
69%
31%

Gross profit is often expressed as a

percentage of sales.

ILLUSTRATION 5-12

CALCULATION OF NET INCOME

Net income is calculated by deducting operating
expenses from gross profit as follows:

Gross profit
Operating expenses
Net income

$ 144,000
114,000
$ 30,000

Net income is the bottom line of a

companys income statement.

ILLUSTRATION
5-14

This is the format

of a multi-step
income statement
that has both
operating and nonoperating
activities.
As shown, the nonoperating activities
are reported
immediately after
the companys
primary operating
activities.

HIGHPOINT ELECTRONIC
Income Statement
For the Year Ended December 31, 2002
Sales revenue
Sales
Less: Sales returns and allowances
Net sales
Cost of goods sold
Gross profit
Operating expenses
Selling expenses
Salaries expense
$
Advertising expense
Amortization expense
Freight out
Total selling expenses
Administrative expenses
Rent expense
$
Utilities expense
Insurance expense
Total administrative expenses
Total operating expenses
Income from operations
Other revenue and gains
Interest revenue
$
Gain on sale of equipment
Total non-operating revenue and gain
Other expenses and losses
Interest on expense
$
Casualty loss from vandalism
Total non-operating expense and loss
Net non-operating revenue
Net income

$ 480,000
20,000
460,000
316,000
144,000

45,000
16,000
8,000
7,000
$ 76,000
19,000
17,000
2,000
38,000
114,000
30,000
3,000
600
$

3,600

1,800
200
2,000
$

1,600
31,600

CLASSIFIED BALANCE SHEET

HIGHPOINT ELECTRONIC
Balance Sheet (partial)
December 31, 2002
Assets
On the balance sheet,
Current assets
merchandise inventory is
Cash
reported as a current asset
Accounts receivable
and appears immediately
Merchandise inventory
below accounts receivable.
Prepaid insurance
This is because current
assets are listed in the
Total current assets
order of their liquidity.
Capital assets
Store equipment
$ 80,000
Less: Accumulated amortization
24,000
Total assets

9,500
16,100
40,000
1,800
67,400

56,000
$ 123,400

USING THE INFORMATION IN

THE FINANCIAL STATEMENTS
Inventory is particularly important because:
It is a large current asset
on the balance sheet
It becomes a large
expense on the income
statement
It is vulnerable to theft or
misuse

USING THE INFORMATION IN

THE FINANCIAL STATEMENTS
A balancing act is needed to ensure that a

sufficient, but not excessive, quantity of

inventory is on hand.
Two ratios help evaluate the management of
inventory:
Inventory turnover
Days sales in inventory

INVENTORY TURNOVER
Inventory turnover =
Cost of goods sold

Average inventory
= ? Times

DAYS SALES IN INVENTORY

Days sales in inventory =
365 days
Inventory turnover
= ? Days