Accounting Principles, 6e

Weygandt, Kieso, & Kimmel

Prepared by
Marianne Bradford, Ph. D.
Bryant College

John Wiley & Sons, Inc.

 CHAPTER 5
ACCOUNTING FOR MERCHANDISING OPERATIONS

After studying this chapter, you should be able to:

1 Identify the differences between a service
enterprise and a merchandising company.
2 Explain the entries for purchases under a
perpetual inventory system.
3 Explain the entries for sales revenues under a
perpetual inventory system.
4Explain the steps in the accounting cycle for a
merchandising company.
 CHAPTER 5
ACCOUNTING FOR MERCHANDISING OPERATIONS

After studying this chapter, you should be able to:

5 Distinguish between a multiple-step and a
single-step income statement.
6 Explain the computation and importance of
gross profit.
 PREVIEW OF CHAPTER 5

Accounting for
Merchandising Operations

Merchandising Recording Purchases of

Operations Merchandise

 Operating cycles  Purchase returns and

 allowances
Inventory Systems
 Freight costs
 Purchase discounts
 PREVIEW OF CHAPTER 5

Accounting for
Merchandising Operations

Recording Sales of Completing the

Merchandise Accounting Cycle
 Sales returns and  Adjusting entries
allowances  Closing entries
 Sales Discounts  Summary of entries
PREVIEW OF CHAPTER 5

Accounting for
Merchandising Operations

Forms of Financial
Statements

 Multiple-step income
statement
 Single-step income
statement
 Classified balance sheet
 STUDY OBJECTIVE 1

Identify the differences between a service

enterprise and a merchandising company.
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 merchandiser’s primary source of
revenue is sales.
 MEASURING NET INCOME
 Expenses for a merchandising company are divided
into two categories:
1) cost of goods sold and
2) operating expenses
 Cost of goods sold is the total cost of merchandise
sold during the period.
 Operating expenses are expenses incurred in the
process of earning sales revenue. Examples are sales
salaries and insurance expense.
 Gross profit is equal to Sales Revenue less Cost of
Goods Sold.
 ILLUSTRATION 5-1
INCOME MEASUREMENT PROCESS FOR A
MERCHANDISING COMPANY

Sales Less
Revenue

Equals

Cost of Gross Less

Goods Sold Profit

Equals

Operating Net
Expenses Income
(Loss)
 ILLUSTRATION 5-2
OPERATING CYCLES FOR A SERVICE
COMPANY AND A MERCHANDISING COMPANY
Service Company

Receive Perform
Cash Cash Services

Accounts
Receivable

Merchandising Company
Receive Buy
Cash Inventory
Cash

Sell Inventory

Accounts Merchandise
Receivable Inventory
 INVENTORY SYSTEMS

Merchandising entities may use either of the

following inventory systems:
1) Perpetual
Detailed records of the cost of each item are
maintained, and the cost of each item sold is
determined from records when the sale occurs.
2) Periodic
Cost of goods sold is determined only at the end of
an accounting period.
 COST OF GOODS SOLD

 The cost of goods sold may be determined

each time a sale occurs or at the end of an
accounting period.
 To make the determination when the sale
occurs, a company uses a perpetual inventory
system.
 When the cost of goods sold is determined
only at the end of an accounting period, a
company is said to be using a periodic
inventory system.
 COST OF GOODS SOLD

To determine the cost of goods sold

under a periodic inventory system, it is
necessary to:
1) Determine the cost of goods on hand at
the beginning of the accounting period.
2) Add to it the cost of goods purchased.
3) Subtract the cost of goods on hand at
the end of the accounting period
 STUDY OBJECTIVE 2

Explain the entries for purchases

under a perpetual inventory system.
 PURCHASES OF
MERCHANDISE
 When merchandise is purchased for resale to
customers, the account, Merchandise Inventory, is
debited for the cost of goods.
 Like sales, 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.
 Each credit purchase should be
supported by a purchase invoice.
 PURCHASES OF
MERCHANDISE

GENERAL JOURNAL
Date Account Titles and Explanation Dr. Cr.
May 4 Merchandise Inventory 3,800
Accounts Payable 3,800
(To record goods purchased on
account, terms 2/10, n/30, from
Highpoint Electronic)

For purchases on account,

Merchandise Inventory is debited
and Accounts Payable is credited.
 PURCHASE RETURNS
AND ALLOWANCES
 A purchaser may be dissatisfied with merchandise
received because the goods
1) are damaged or defective,
2) of inferior quality, or
3) not in accord with the purchaser’s
specifications.
 The purchaser initiates the request for a
reduction of the balance due through the issuance of a
debit memorandum.
 The debit memorandum is a document issued by a
buyer to inform a seller that the seller’s account has
been debited because of unsatisfactory merchandise.
 PURCHASE RETURNS
AND ALLOWANCES

GENERAL JOURNAL
Date Account Titles and Explanation Dr. Cr.
May 8 Accounts Payable 300
Merchandise Inventory 300
(To record return of inoperable
goods received from Highpoint
Electronic, DM No. 126)

For purchases returns and allowances,

Accounts Payable is debited and
Merchandise Inventory is credited.
 FREE ON BOARD

 The sales agreement should indicate whether the

seller or the buyer is to pay the cost of transporting
the goods to the buyer’s place of business.
 FOB Shipping Point
1) Goods placed free on board the carrier
by seller
2) Buyer pays freight costs
 FOB Destination
1) Goods placed free on board at
buyer’s business
2) Seller pays freight costs
 ACCOUNTING FOR
FREIGHT COSTS
Merchandise Inventory is debited if
buyer pays freight.
Freight-out (or Delivery Expense) is
debited if seller pays freight.
 ACCOUNTING FOR
FREIGHT COSTS

GENERAL JOURNAL
Date Account Titles and Explanation Dr. Cr.
May 6 Merchandise Inventory 150
Cash 150
(To record payment of freight,
terms FOB shipping point)

When the purchaser directly incurs the freight costs, the account
Merchandise Inventory is debited and Cash is credited.
 ACCOUNTING FOR
FREIGHT COSTS

GENERAL JOURNAL
Date Account Titles and Explanation Dr. Cr.
May 4 Freight-out (Delivery Expense) 150
Cash 150
(To record payment of freight on
goods sold FOB destination)

Freight costs incurred by the seller on outgoing

merchandise are debited to Freight-out (or
Delivery Expense) and Cash is credited.
 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.
 Like a sales discount, a
purchase discount is based on
the invoice cost less returns
and allowances, if any.
 PURCHASE DISCOUNTS

GENERAL JOURNAL
Date Account Titles and Explanation Dr. Cr.
May 14 Accounts Payable 3,500
Cash 3,430
Merchandise Inventory 70
(To record payment within
discount period)

If payment is made within the discount period, Accounts

Payable is debited, Cash is credited, and Merchandise
inventory is credited for the discount taken.
 PURCHASE DISCOUNTS

GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
June 3 Accounts Payable 3,500
Cash 3,500
(To record payment with no
discount taken)

If payment is made after the discount

period, Accounts Payable is debited and
Cash is credited for the full amount.
 SAVINGS OBTAINED BY TAKING
PURCHASE DISCOUNT

A buyer should usually take all available discounts.

If Chelsea Video takes the discount, it pays $70 less in cash.
If it forgoes the discount and invests the $3,500 for 20 days
at 10% interest, it will earn only $19.06 in interest.
The savings obtained by taking the discount is calculated as
follows:

Discount of 2% on $3,500 $ 70.00

Interest received on $3,430 (for 20days at 10%) ( 19.06)
Savings by taking the discount $ 50.94
 STUDY OBJECTIVE 3

Explain the entries for sales revenues

under a perpetual inventory system.
 SALES TRANSACTIONS
 Revenues are reported when earned in accordance
with the revenue recognition principle, and in a
merchandising company, revenues are earned when
the goods are transferred from seller to buyer.
 All sales should be supported
by a document such as a
cash register tape or sales
invoice.
RECORDING CASH SALES

GENERAL JOURNAL
Date Account Titles and Explanation Dr. Cr.
May 4 Cash
2,200
Sales
(To record daily cash sales) 2,200

4 Cost of Goods Sold 1,400

Merchandise Inventory 1,400
(To record cost of merchandise
sold for cash)

 For cash sales, Cash is debited and Sales is credited.

 For the cost of goods sold for cash, Cost of Goods
Sold is debited and Merchandise Inventory is credited.
 RECORDING CREDIT SALES

GENERAL JOURNAL
Date Account Titles and Explanation Dr. Cr.
May 4 Accounts Receivable 3,800
Sales
(To record credit sales to Chelsea 3,800
Video per invoice #731)

4 Cost of Goods Sold 2,400

Merchandise Inventory 2,400
(To record cost of merchandise
sold on invoice #731 to Chelsea
Video)

 For credit sales, Accounts Receivable is debited and Sales is credited.

 For the cost of goods sold on account, Cost of Goods Sold is debited
and Merchandise Inventory is credited.
 SALES RETURNS AND
ALLOWANCES
 Sales Returns result when customers are
dissatisfied with merchandise and are allowed
to return the goods to the seller for credit or a
refund.
 Sales Allowances result when
customers are dissatisfied, and the
seller allows a deduction from
the selling price.
 SALES RETURNS AND
ALLOWANCES
To grant the return or allowance, the
seller prepares a credit memorandum to
inform the customer that a credit has
been made to the customer’s account
receivable.
Sales Returns and Allowances is a contra
revenue account to the Sales account.
The normal balance of Sales Returns
and Allowances is a debit.
 RECORDING SALES RETURNS
AND ALLOWANCES
GENERAL JOURNAL
Date Account Titles and Explanation Dr. Cr.
May 8 Sales Returns and Allowances 300
Accounts Receivable 300
(To record return of inoperable
goods delivered to Chelsea Video,
per credit memorandum)

8 Merchandise Inventory 140

Cost of Goods Sold 140
(To record cost of goods returned
per credit memorandum)

 The seller’s entry to record a credit memorandum involves a debit to

the Sales Returns and Allowances account and a credit to Accounts
Receivable. The entry to record the cost of the returned goods involves
a debit to Merchandise Inventory and a credit to Cost Goods Sold.
 SALES DISCOUNTS

 A sales discount is the offer of a cash discount

to a customer for the prompt payment of a
balance due.
 Example: If a credit sale has the terms 3/10,
n/30, a 3% discount is allowed if payment is
made within 10 days. After 10 days there is no
discount, and the balance is due in 30 days.
 Sales Discounts is a contra revenue account
with a normal debit balance.
 CREDIT TERMS
 Credit terms specify the amount and time
period for the cash discount.
 They also indicate the length of time in which
the purchaser is expected to pay the full
invoice price.
T E R M S E X P L A N A T I O N
2/10, n/30 A 2% discount may be taken if payment is made
within 10 days of the invoice date.

1/10 EOM A 1% discount is available if payment is made

by the 10th of the next month.
 RECORDING
SALES DISCOUNTS

GENERAL JOURNAL
Date Account Titles and Explanation Dr. Cr.
May 14 Cash 3,430
Sales Discounts 70
Accounts Receivable 3,500
(To record collection within 2/10,
n/30 discount period from Chelsea
Video)

When cash discounts are taken by

customers, the seller debits Sales Discounts.
 STUDY OBJECTIVE 4

Explain the steps in the accounting

cycle for a merchandising company.
 CLOSING ENTRIES

 Adjusting entries are journalized from the adjustment

columns of the work sheet.
 All accounts that affect the determination of net income are
closed to Income Summary.
 Data for the preparation of closing entries may be obtained
from the income statement columns of the work sheet.

GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
2002 (1)
Dec. 31 Sales 480,000
Income Summary 480,000
(To close income statement
accounts with credit balances)
 CLOSING ENTRIES
Cost of Goods Sold is a new account that must be closed to
Income Summary.

GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
2002 (2)
Dec. 31 Income Summary
450,000
Sales Returns and Allowances
12,000
Sales Discounts
8,000
Cost of goods sold 316,000
Store Salaries Expense 45,000
Rent Expense 19,000
Freight-out 7,000
Advertising Expense 16,000
Utilities Expense 17,000
Depreciation Expense 8,000
Insurance Expense 2,000
(To close income statement
accounts
with debit balances)
 CLOSING ENTRIES
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
2002 (3)
Dec. 31 Income Summary 30,000
R. A. Lamb, Capital 30,000
(To close net income to capital)

(4)
31 R. A. Lamb, Capital 15,000
R. A. Lamb, Drawing 15,000
(To close drawings to capital)

 After the closing entries are posted, all temporary accounts

have zero balances.
 It addition, R. A. Lamb, Capital has a credit balance of
$98,000 ($83,000 + $30,000 - $15,000).
 STUDY OBJECTIVE 5

Distinguish between a multiple-step

and a single-step income statement.
 MULTIPLE-STEP
INCOME STATEMENT
 Includes sales revenue, cost of goods
sold and gross profit sections
 Additional nonoperating sections may
be added for:
1) Revenues and expenses resulting
from secondary or auxiliary
operations
2) Gains and losses unrelated to
operations
 MULTIPLE-STEP
INCOME STATEMENT
Nonoperating sections are reported after
income from operations and are classified as:
1) Other revenues and gains
2) Other expenses and losses
3) Operating expenses may be subdivided
into:
a) Selling Expenses
b) Administrative Expenses
 ILLUSTRATION 5-11
SINGLE-STEP INCOME STATEMENT

HIGHPOINT ELECTRONIC
Income Statement
For the Year Ended December 31, 2002

Revenues
Net sales All data are classified under $ 460,000
Interest revenue two categories: 3,000
Gain on sale of equipment 1 Revenues 600
Total revenues 2 Expenses 463,600
Expenses Only one step is required in
Cost of goods sold determining net income or $ 316,000
Selling expenses net loss. 76,000
Administrative expenses 38,000
Interest expense 1,800
Casualty loss from vandalism 200
Total expenses 432,000
Net income $ 31,600
STUDY OBJECTIVE 6

Explain the computation and

importance of gross profit.
 ILLUSTRATION 5-7
COMPUTATION OF GROSS PROFIT

Gross profit is determined as

follows:
Net sales $ 460,000
Cost of goods sold 316,000
Gross profit $ 144,000
 ILLUSTRATION 5-9
OPERATING EXPENSES IN
COMPUTING NET INCOME

Net income is determined as

follows:
Gross profit $ 144,000
Operating expenses 114,000
Net income $ 30,000
STUDY OBJECTIVE 7

Prepare a worksheet for a

merchandiser
 ILLUSTRATION 5-A1
WORK SHEET FOR A
MERCHANDISING COMPANY
HIGHPOINT ELECTRONIC
Work Sheet
For the Year Ended December 31, 2002
Adjusted
Trial Balance Adjustments Trial Balance
Account Titles Dr. Cr. Dr. Cr. Dr. Cr.
Cash 9,500 9,500
Accounts Receivable 16,100 16,100
Merchandise Inventory 40,500 A 500 40,000
Prepaid Insurance 3,800 B 2,000 1,800
Store Equipment 80,000 80,000
Accumulated Depreciation 16,000 C 8,000 24,000
Accounts Payable 20,400 20,400
R.A. Lamb, Capital 83,000 83,000
R.A. Lamb, Drawing 15,000 15,000
Sales 480,000 480,000
Sales Returns and Allowances 12,000 12,000
Sales Discounts 8,000 8,000
Cost of Goods Sold 315,500 A 500 316,000
Freight-out 7,000 7,000
Advertising Expense 16,000 16,000
Rent Expense 19,000 19,000
Store Salaries Expense 40,000 D 5,000 45,000
Utilities Expense 17,000 17,000
Totals 599,400 599,400
Insurance Expense B 2,000 2,000
Depreciation Expense C 8,000 8,000
Salaries Payable D 5,000 5,000
Totals 15,500 15,500 612,400 612,400
 USING A WORK SHEET

Trial Balance Columns

1 Data from the trial balance are obtained from
the ledger balances of Sellers Electronic at
December 31.
2 The amount shown for Merchandise
Inventory, $40,500, is the year-end inventory
amount which results from the application of
a perpetual inventory system.
 USING A WORK SHEET

Adjustments Columns
1 A merchandising company usually has the
same types of adjustments as a service
company.
2 Work sheet adjustments b, c, and d are for
insurance, depreciation, and salaries.
Adjusted Trial Balance - The adjusted trial
balance shows the balance of all accounts after
adjustment at the end of the accounting period.
 ILLUSTRATION 5-11
WORK SHEET FOR A
MERCHANDISING COMPANY
HIGHPOINT ELECTRONIC
Work Sheet
For the Year Ended December 31, 2002
Adjusted Income
Trial Balance Statement Balance Sheet
Account Titles Dr. Cr. Dr. Cr. Dr. Cr.
Cash 9,500 9,500
Accounts Receivable 16,100 16,100
Merchandise Inventory 40,000 40,000
Prepaid Insurance 1,800 1,800
Store Equipment 80,000 80,000
Accumulated Depreciation 24,000 24,000
Accounts Payable 20,400 20,400
R.A. Lamb, Capital 83,000 83,000
R.A. Lamb, Drawing 15,000 15,000
Sales 480,000 480,000
Sales Returns and Allowances 12,000 12,000
Sales Discounts 8,000 8,000
Cost of Goods Sold 316,000 316,000
Freight-out 7,000 7,000
Advertising Expense 16,000 16,000
Rent Expense 19,000 19,000
Store Salaries Expense 45,000 45,000
Utilities Expense 17,000 17,000
Totals
Insurance Expense 2,000 2,000
Depreciation Expense 8,000 8,000
Salaries Payable 5,000 5,000
Totals 612,400 612,400 450,000 480,000 162,400 132,400
Net Income 30,000 30,000
Totals 480,000 480,000 162,400 162,400
 USING A WORK SHEET

Income Statement Columns

1 The accounts and balances that affect the
income statement are transferred from the
adjusted trial balance columns to the income
statement columns for Sellers Electronic at
December 31.
2 All of the amounts in the income statement
credit column should be totaled and compared
to the total of the amounts in the income
statement debit column.
 USING A WORK SHEET

Balance Sheet Columns

1 The major difference between the balance
sheets of a service company and a
merchandising company is inventory.
2 For Sellers Electronic, the ending
Merchandise Inventory amount of $40,000 is
shown in the balance sheet debit column.
3 The information to prepare the owner’s equity
statement is also found in these columns.
 COPYRIGHT

Copyright © 2002 John Wiley & Sons, Inc. All rights reserved. Reproduction or
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 CHAPTER 5
ACCOUNTING FOR MERCHANDISING OPERATIONS