UNIT 3. ACCOUNTING FOR MERCHANDISING BUSINESSES Contents 3.0 Aims & Objectives 3.1 Introduction 3.

2 Nature of a Merchandising Business 3.2.1 3.2.2 What is a Merchandising Business Comparison of Financial Statements for Merchandising and

Service Businesses 3.3 The Periodic and the Perpetual Inventory Systems 3.3.1 3.3.2 3.4.1 3.4.2 The Periodic Inventory System Perpetual Inventory Systems Recording Sales Recording Purchases

3.4 Recording Purchase and Sales Transactions

3.5 Completing the Worksheet for a Merchandising Business 3.6 Preparing Financial Statements for Merchandising Businesses 3.7 Summary 3.8 Answers to Check Your Progress Questions 3.9 Model Examination Questions 3.10 Glossary of Terms

3.0 AIMS & OBJECTIVES After reading this unit, you will be able to: describe what a merchandising business is and compare it to a service giving business. describe the difference between the two alternative systems of recording inventory (periodic and the perpetual inventory systems) record journal entries for merchandising transactions such as the purchase and sale of merchandise complete the worksheet of a merchandising business and record adjustment journal entries related to the Merchandise Inventory account prepare financial statements for a merchandising business

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3.1 INTRODUCTION In the previous chapters, you saw how to record transactions of a service business. The steps that we go through to prepare the financial statements of other types of businesses (such as a merchandising business) are basically the same. Transactions are first journalized, and then posted to the ledger; a worksheet is prepared and completed. But, there are some transactions in merchandising companies that you dont find in a service giving business, like the purchase of goods for sale and the sale of those goods. The first section of this chapter, therefore, discusses the nature of a merchandising business and how to record merchandising transactions. The next section discusses about the preparation of financial statements for merchandising companies. SECTION-ONE: RECORDING MERCHANDISING TRANSACTIONS 3.2 NATURE OF A MERCHANDISING BUSINESS

3.2.1What is a Merchandising Business?

A merchandising business buys goods in finished form for resale to customers. A merchandising business sells tangible goods to its customers. When we say goods it can be anything that has physical characteristics that you can see and touch (i.e., tangible). These can be goods ranging from television sets, cars, office table and chair (furniture), to chewing gums, toothbrushes and various stationery. These goods that a merchandising company sells to its customers are called merchandise inventory. (A customer is an individual or a firm to inventory. whom a business sells its products.) One final thing that you should know about a merchandising business is that a merchandising company does not produce the goods that it sells. Instead, it buys these goods from manufacturers, which produce the goods using raw materials. manufacturers, The following diagram can help you to better visualize the flow of goods from a manufacturer to the final consumer:

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sells Manufacturers goods wholesalers

Merchandising companies sell goods Retailer final consumer

A wholesaler is a trader, which buys goods from manufacturers and sells them to a retailer or another wholesaler. It is the retailer who sells the goods to the final consumer by buying them from wholesalers (or sometimes from a manufacturer). When you want to buy a soap to wash your clothes, where do you buy it? Who is the manufacturer of the soap? Are there any wholesalers of that soap in your area? Can the wholesaler be taken as the customer of the manufacturer? And finally, can we say the shop from which you buy the soap is a merchandising business?

3.2.2 Comparison of Financial Statements for Merchandising and Service Businesses

Income Statement A model income statement for a merchandising business and another one for a service business are shown below. Compare them carefully. ABC service company Income statement For the year ended Dec.31, 200x Revenue: Service fee.Birr 23,200 XYZ merchandising Income statement For the year ended Dec.31, 200x Revenue: Net SalesBirr 360,000 Cost of goods sold.(256,000) sold.(256,000) Expenses: Various Operating Expenses (7120) (7120) Net Income 16080 Gross Profit .104,000 Various Operating Expenses.(79,400) Expenses.(79,400) Net Income ..24,600 ..24,600

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As you can see from the above Income Statements, merchandising companies have to pay to buy the goods that they sell. Therefore, they have to deduct this cost of goods sold in addition to other operating expenses from their sales revenue to determine their net income. The difference between sales revenue and cost of goods sold is referred to as gross profit. Why gross? Because other expenses have yet to be deducted to arrive at the net profit or net income of the business. Balance Sheet The Balance Sheet of a service business and that of a merchandising business are similar in every aspect except one thing. The current assets section of the Balance Sheet of a merchandising business includes one asset that service companies do not have. That is merchandise inventory. Merchandise inventory refers to goods bought by a merchandising business for resale to customers. So, if a merchandising business has some unsold goods (merchandise) on hand at the end of the year this would be reported as one asset on the Balance Sheet. 3.3 THE PERIODIC AND THE PERPETUAL INVENTORY SYSTEMS The value of goods (merchandise) on hand at the end of the year for resale would be reported on the Balance Sheet as one asset as described above. This means that we need to open a separate ledger account in which to record merchandise inventory information. The two alternatives in dealing with this account are: 1. To up date this account every time goods are bought and sold (continuously = perpetually) or 2. To up date this account only at the end of the period (periodically).

3. 3.1 The Periodic Inventory System

Under this system, as the name periodic suggests, the inventory account is updated only periodically i.e., only at the end of a period. When goods are bought, a temporary purchases account is debited instead of the inventory account itself. Likewise, when goods are sold revenue is recorded, but the fact that there is a

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reduction in merchandise inventory is not recognized. This is because the Merchandise Inventory account is not credited every time goods are sold. Therefore, if one wants to know the cost of goods on hand, it is a must that a physical inventory be conducted first. The account doesnt reflect the value of goods on hand because it was not up dated when merchandise was bought and sold. Physical inventory means counting the quantity of goods on hand. Once the quantity of goods on hand has been determined, it is multiplied by the unit price of those goods to determine the cost of goods on hand. In conclusion, under the periodic system, since the merchandise inventory account is not continually updated, the cost of merchandise on hand is determined only at the end of the period after carrying out a physical inventory. Companies such as department stores or super markets, which sell small items, use periodic systems.

3.3.2 Perpetual Inventory Systems

A perpetual inventory system continuously records the amount of inventory on hand (perpetual =continuous). Under this system, the merchandise inventory account is debited or credited every time (goods) are bought or sold. When an item is sold, its cost is recorded in a separate cost of goods sold account in addition to recording sales. The cost of merchandise on hand can be looked up from the merchandise Inventory account any time, without conducting a physical inventory.

Check Your Progress Exercise-1

If you have a supermarket business, would you use the perpetual or periodic system? What if your system is computerized? Explain. 3.4 RECORDING PURCHASES AND SALES TRANSACTIONS The following discussions in the remainder of this chapter all assume the use of a periodic inventory system. The perpetual system will be discussed in part two of this course.

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3.4.1 Recording Sales

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, Sales. Net Sales = Gross Sales Sales Discounts- Sales Returns and Allowances Recording Gross Sales The gross sales amount is obtained from sales invoices. An invoice is a document, prepared by the seller of merchandise to notify to the buyer the details of the sale. These details can include number of items sold, unit price of items, total price, terms of sale and manner of shipment. When goods are delivered to the customer, the Sales account is credited because revenues are increased by credits. A company can sell goods either for cash or on account. Recording Cash Sales When merchandise is sold on cash, the Cash account is debited and the revenue account Sales is credited. Example Ika Company based in Bahir Dar, buys and sells used commodities. On January 14. 2001. Ika sold goods for Birr 20,000. Record the transaction. Answer: January 14, Dr. Cash..20,000.00 Cr. Sales20,000.00 Recording Credit Sales The Accounts Receivable account is debited when goods are sold on account (for credit). Example Ika sold goods worth Birr 35,000 on account on January 15, 2001. Record the transaction. Solution January 15. Accounts Receivable..35,000.00 Sales35,000.00 69

Determining Gross Sales when there are trade discounts A trade discount is a percentage deduction from the specified list price or catalogue price of merchandise. Trade discounts allow us: To avoid publishing a new catalogues every time prices change. To grant quantity discounts Quotation of different prices to different types of customers.

Trade discounts are not recorded in the sellers accounting records; they are only used to calculate the gross selling price. Example: IKA sold 500 T.V. sets, each with a list price of Birr 80, on January 17, 2001 for Example: cash. It gave the customer a 30% trade discount, as the customer was a very loyal one. Record the sale. Answer: List price of goods ( 80 X 500) Invoice price Journal entry: Cash..28,000 Sale28,000 Birr 40,000 28,000 Less: Trade discount (30 % of 40,000) (12,000) (12,000)

Check Your Progress Exercise 2

1. Record the journal entry if IKa Company above sold goods with a list price of Birr 52,000 to a customer on account. Ika offered the customer a trade discount of 20% for purchases above Birr 40,000 as it usually does. Recording Deductions from Gross Sales Go back to illustration 1- and have a look at the model Income Statement of a merchandising company. You will see that the sales reported on the income statement is net sales, i.e., after sales, deduction of sales discounts and sales returns and allowances.

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Gross sales (from invoice)..XXX Less: Sales discounts.(XX) Sales returns and allowances ...(XX) ...(XX) Net sales.XX sales.XX Sales Discounts Sales Discounts are deductions from invoice price to customers who pay early when goods are sold on credit. As a seller, you would usually want to be paid as soon as possible. This is because, as you can imagine, you can use the money for various purposes once you have been paid. If you want your customers to pay you early the customary practice is to offer them a (deduction) discount from the invoice price if they pay early. How much discount is given usually depends on the credit terms. These terms (agreements) terms. are usually stated on the invoice. The most frequently used terms are stated below: n/30 or Net 30 means there is no discount even if the customer pays before the payment date. 2/10, n/30 means the due date of the payment is after 30 days of the sale. But if the customer pays with in 10 days she will get a 2% discount. 2/EOM, n/60- means the normal due date is with in 60 days of the sale but the customer will get a 2% discount if she pays before the end of month of sale.

Check Your Progress Exercise -3

1. What do the credit terms 1/15,n/60; 2/10, n/EOM; and n/60 mean? Sales discounts are purchase discounts from the side of the buyer. Sales discounts and purchase discounts are the same thing seen from different sides. They are generally called cash discounts together. A cash discount is, therefore, deduction from original invoice price for early payment when goods are sold on credit (on account).

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Example: On January 21, 2001 IKA Company sold merchandise for birr 20,000 on account. The credit terms are 2/30, n/30. The customer paid on January 31, (10 days after invoice date). A. How much would IKA Company collect from this sale? B. Record the necessary journal entries on January 21 and January 31. Solution: A- Since the customer paid with in the discount period, i.e., with in 10 days, she will get a 2% discount. Therefore, Invoice price..20,000 Less: Sales Discount (2% X 20,000)(400) 20,000)(400) Cash collected . 19,600 B- Journal Entries: January 21 A/R..20,000 Sales..20,000 January 31, Cash.19600 Sales Discounts ...400 A/R..20,000 You might initially have thought of debiting the Sales account for Birr 400 on January 31, since the actual cash collected from the sales of those goods is birr 400 less than what was recorded as Sales on January 21. But it is better to record the reduction in sales in a separate contra Sales account. A contra account reduces another account. In this case, the amount in the Sales Discount account will be deducted from (Gross) Sales on the income statement. That way, we can disclose how much sales discount was offered and taken during the year on the income statement, separately.

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Check Your Progress Exercise - 4

IKA Company sold goods worth Birr 120,000 on account to Gizu company terms 1/10, n/60 on January 18, 2001. Gizu Company paid on January 28, 2001. A- How much would IKA Company collect from this sale? B- Record the necessary journal entries on January 18 and on January 28. Sales Returns and Allowances Customers can return merchandise they have bought if they find it to be defective or of the wrong model, or unsatisfactory for a variety of reasons. A sales return is merchandise returned by a buyer. The buyer would be paid back her money if she has already paid. A sales allowance is a deduction from the original invoice price when the customer keeps the merchandise but is dissatisfied. If, for example, a customer buys an item worth birr 100 and finds it to be of the wrong color after receiving it, she may still want to retain the item even if she is dissatisfied with its color. In that case the seller may let her pay only, say, Birr 95 by giving her an allowance of Birr 5. Example: IKA Company sold merchandise worth Birr 15, 000 on February 3, 2001 on account terms 2/10, n/30. On February 5, the buyer returned a portion of the goods worth Birr 5,000 as they were found to be of the wrong model. The buyer then paid on February 13, 2001. Record the necessary journal entries on February 3,5 and 13. Solution: February 3 A/R.15,000 Sales .15,000 February 5 Sales Returns and Allowances 5,000 A/R.5,000 February 13 Cash..9800 Sales Discount .. 200

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A/R10,000 Here, the buyer paid with in the discount period. Therefore, the amount that would be collected is: 15,000 5,000 = 10,000 Deduct: 2% Cash discount (200) Deduct: Cash collected 9800

Check Your Progress Exercise -5

Assume the customer in the above example returned the goods on February 15 instead of February 5, after paying with in the discount period on February 13. Record the relevant Journal entries on February 3, 13 and 15. Go back to illustration (1) once again on page and you will see that we have so far been dealing with what net sales is composed of. You should by now be able to figure out how the net sales figure on the income statement is arrived at. In the following section, we will see how to record purchase transactions. Keep in mind that a merchandising company both buys and sells goods.

3.4.2 Recording Purchases

Under the periodic inventory system a merchandising company uses the Purchases account to record the cost of goods bought for resale to customers. Example: IKA Company bought goods worth Birr 43,000 from Saba Co., which is based in Addis Ababa, on account on January 4, 2001, terms 20/10, n/30. Record the transaction. Solution: January 4 Purchases ..43,000 Accounts payable..43,000

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Check Your Progress Exercise - 6

Record the same transaction for IKA Company if the merchandise were bought for cash. . Deductions from Purchases Purchase Discounts A merchandising company can buy goods under credit terms that permit it to get a discount if it pays with in a specified period of time. The deduction from the original purchase price is recorded in a separate contra Purchase account called Purchase Discounts. Example: IKA Company bought goods worth Birr 50,000 from Gibir Company on account on January 14, 2001, terms 1/10,n/60. Ika Company paid on January 24, 2001. Record the transactions on both dates. Solution: Jan. 14. Jan. 24. Purchases..50,000 A/P50,000 A/P 50,000 Purchase Discounts .......500 Cash.. 49,500

Check your Progress Exercise -7

1. What would Gibir Company record on January 14, and January 24? Purchase Returns and allowances A purchase return occurs when a buyer returns merchandise to a seller. A purchase allowance is a reduction on the price of goods bought for dissatisfaction on the side of the buyer.

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Both purchase returns and purchase allowances are recorded in a contra purchase account called Purchase Returns and Allowances. Example: In the previous example for IKA Company, a portion of the goods worth birr 5,000 bought on January 14 from Gibir Company were of the wrong size. Gibir Company acknowledged this and gave IKa Company a 5% price allowance on January 17. What should IKA Company record on January 17? Solution: January 17 A/P250 Purchase Returnes and Allowance250

Check your Progress Exercise - 8

1. What would Gibir Co. record on January 17? When both purchase discounts and purchase returns and allowances are deducted from purchases what is obtained is called Net purchase. That is, Gross PurchaseXX Less: Purchase discounts.(XX) Less: Purchase returns and allowances(XX) allowances(XX) Net Purchases.XX Purchases.XX Transportation costs Once merchandise has been bought it has to be moved from the sellers place to the buyers place. A third party comes in to the scene here: the transportation company who moves the goods between the two places. That is:

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Seller

Goods

goods Freighter

goods

Buyer

So, the question is, who is going to pay to the freighter (transportation) company. Who covers the transportation costs depends, as you might have guessed, on the agreement between the buyer and seller. The agreements are usually stated in the either of these two terms: FOB Destination means free on board at destination . That is, since the

destination of the goods is the buyers place, it is free at destination means transportation cost is paid when the goods are loaded. It simply means the seller pays transportation cost. FOB Destination means goods are shipped to their destination (to the buyer) with out transportation charge to the buyer. FOB shipping Point means free on board at shipping point. That is, goods are means loaded (on a truck or train) or shipped free of charge. It is, therefore, the buyer, which pays to the transportation company when the goods reach the buyer (their destination) Briefly, when the terms are FOB Shipping Point the buyer pays transportation costs. Transportation costs paid by a buyer of merchandise increase the cost of merchandise. They are recorded in a separate Transportation-In account that is used to record freight costs incurred in the acquisition of merchandise. Example IKA Company bought goods worth Birr 85,000 on account, terms 2/10,n/60 FOB shipping point on March 2, 2001.Transportoin cost of Birr 1,500 was paid on March 2. Ika Company paid on March 31, 2001. Record the necessary journal entries Solution: Here, since the terms are FOB Shipping Point, the buyer (Ika) pays transportation. March 2 -Purchase..85,000 A/P..85,000 -Transportation In.....1500 Cash1500

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March 31

A/P85,000 Cash..85,000

Check Your Progress Exercise -9

1. What would have been recorded by IKA, if it paid on March 12, 2001? What if the terms were FOB destination? Example: IKA Company sold goods worth Birr 135,000 terms 1/15, n/EOM on February 1, 2001. FOB Destination. It also paid transportation costs of Birr 800 on Feb. 1. The customer paid IKA on February 16, 2001. Record the relevant Journal entries. Answers: Feb 1 Feb 16 A/R..135,000 Sales..135,000 Sales discount .1,350 Cash.133,650 A/R135,000 Delivery Expense800 Cash800 The Delivery Expense account shows how much was incurred to deliver goods sold to customers. It is, therefore, shown on the income statement as a selling expense.

Check Your Progress Exercise -10

1. What would the customer (buyer) recorded, in the above example, on February 1, and 13, 2001?

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 Sometimes, the seller prepays the freight as a convenience to the buyer and later collects it on the due date of the invoice even though the terms are FOB shipping Point. Example Raey Co. sold goods worth Birr 40,000 on April 1, 2001 to IKA company terms 2/10, n/30 FOB Shipping Point. It also paid Birr 2,500 to Ergib Movers for transporting the goods and added the amount to the invoice. What would each of these companies record assuming IKA paid on April 31, 2001 Raey Co. (seller) April 1- A/R.40,000 Sales40,000 A/R.2500 Cash.2500 April 31-Cash42,500 A/R42500 IKa Co (Buyer) April 1-Purchases 40,000 A/P.40,000 Transport-in 2500 A/P2500 April 31- A/P42,500 Cash42,500

Check Your Progress Exercise 11

1. What would have been recorded on the above dates if IKa Co. Paid on April 11, 2001? If the buyer pays the transportation costs for the seller (when the terms are FOB Destination) the buyer simply deducts the freight paid from the amount to be paid to the seller. Example:

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X Company bought merchandise worth Birr 14,000 terms FOB destination from Y Co. on account. It paid Birr 350 transportation costs. What would be recorded on the books of the buyer and seller on the date of the sale? Buyer (X Co) -Purchase.14,000 -A/P14,000 Seller Y Co. -. A/R.14,000 Sales.14,000

-A/P350 Cash..350 Transfer of Title

-Delivery exp.350 A/R350

Shipping terms determine not only determine who pays for transportation. They also determine at what point ownership title of the goods sold transfers to the buyer. Put briefly, whose property is it when merchandise is in transit? 1. When terms are FOB Destination we have seen that the seller covers transportation costs. By implication the seller takes the responsibility of safely moving and delivering the goods to the buyer. The buyer is not responsible for any damage that can happen to these goods in transit. Therefore, the goods become the buyers property only when they are delivered to him /her. Conclusion: Ownership title of the goods transfers to the buyer at destination when the terms are FOB destination. 2. When the terms are FOB shipping point the buyer pays freight costs. The buyer takes the responsibility of safely moving these goods to his /her own place. The merchandise, therefore, becomes his/her property as soon as they are loaded on a truck or a train. Conclusion: Ownership title of goods transfers to the buyer at shipping point when terms are Conclusion: FOB shipping point.

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The following table summarizes it all. Sipping terms Transportation paid by Title Transfers When goods are FOB Destination FOB shipping point Seller Buyer Delivered to Buyer Freighter (transportation company) Summary of Section One Lets once again present the model Income Statement that we saw at the beginning of this chapter. This time around, however, it is a bit detailed. Please study the relationship between each item on the Income Statement carefully. Also try to remember how each item was recorded in journal entry form when the transactions affecting these accounts happened. XYZ Merchandising Co. Income statement For the year ended Dec. 31,2001 Gross Sales Less: Sales Discounts (15,000) Sales Ret &All (25,000) . (40,000) (40,000) Net sales.360,000 Cost of goods sold: Beginning merchandise inventory (January 1, 2001)10,000 Add: Purchases..210,000 Less: Purchase Disc..(5,000) Purchase Ret & All(5,000) All(5,000) Net purchase..200,000 Add: Transportation In.66,000 In.66,000 Total cost of goods Available for sale...276,000 Less: Ending M.I (Dec. 31,2001)(20.000) 31,2001)(20.000) 81 400,000

Cost of goods sold (256,000) (256,000) Gross profit 104,000 Less: Various Selling and Administrative Expenses (79,400) (79,400) Net Income 24,600 Note: Under a periodic inventory system, the cost of goods sold during a period is determined only indirectly after comparing what was on hand at the beginning of the period, and the cost of goods purchased during the period with what is left on hand at the end of the period. That is, Beg inventory + Total cost of purchase Ending inventory=Cost of Goods Sold. Under periodic inventory procedures no attempt is made to determine the cost of goods sold at the time of each sale. Instead, the cost of all the goods sold during the accounting period is determined at the end of the period. Summary of Important Relationships on the Income Statement 1. Net sales = Gross sales- (Sales Discounts + Sales Returns and allowances) 2. Net purchases = Purchases (Purchase Disc. + Purchase Ret. & allowance) 3. Total cost of Purchase = Net purchase + Transportation In 4. Cost of goods sold = Beg inventory + Total cost of purchase Ending inventory 5. Gross profit = Net sales Cost of goods sold 6. Net Income = Gross Profit operating (i.e., selling & administrative) expenses. SECTION TWO: REPORTING MERCHANDISING TRANSACTIONS In the previous section, we saw how purchase and sales transactions are recorded. In this section, we will see how those transactions are summarized and reported on the financial statements. 3.5 COMPLETING THE WORKSHEET FOR A MERCHANDISING COMPANY The use of a worksheet, as you remember, assists in preparing adjusting and closing entries. In addition it contains all of the information needed for the preparation of the financial statements. Except for the merchandise related accounts, the work sheet for a merchandising Co. is the same as for a service company.

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The following illustration, therefore, assumes that all selling and administrative expenses have been adjusted. That accomplished, the only account, which remains to be adjusted, is the Merchandise Inventory account. Illustration The following is the trial balance of Hard Works, a merchandising business owned by Yibeltal. All accounts have been adjusted except the Merchandise Inventory account. Hard Works Trial Balance December 31, 2002 Account title Cash Account Receivable Merchandise Inventory Accounts Payable Yibeltal, Capital Yibeltal,Drawings Sales Sales Discounts Sales Returns and Allowances Purchases Purchase discounts Purchase Returns and allowances Transportation In Selling expenses Administrative expenses Dr 19,663 1,880 7,000 2,000 14,600 44 20 6,000 82 100 75 2,650 1,150 40,482 ________ 40,482 CR

700 25,000

A physical inventory of merchandise carried out on December 31, 2002 showed Birr

10,000 of goods on hand. Required: A- Prepare a worksheet for Hard Works. B- Prepare financial statements from the worksheet C- Record the necessary adjustment journal entry in relation to merchandise inventory 83

D- Record closing entries

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Hard Works Co. Worksheet for the year ended December 31,2002
Account title Trial Balance Dr. Cr. 19,663 1,880 7,000 700 25,000 2,000 7,000 14,600 44 20 6,000 82 100 75 2,650 1,150 40,482 40,482 17,000 17,000 75 2,650 1,150 50,482 50,482 44 20 6,000 82 100 75 2,650 1,150 16,939 7,843 24,782 24782 24782 33,543 33,543 25,700 78,43 33,543 10,000 2,000 7,000 Dr. Adjustment Cr. Adjusted Trial balance Income statement Balance sheet Dr. Cr. Dr. Cr. Dr. Cr. 19,663 19,663 1,880 1,880 10,000 700 25,000 2,000 10,000 14,600 7,000 44 20 6,000 82 100 10000 14600 10,000 700 2,5000

Cash Account Receivable Merchandise Inventory Accounts Payable Yibeltal, Capital Yibeltal, Drawings Income summery Sales Sales Discounts Sales Returns and Allowances Purchases Purchase discounts Purchase Returns and allowances Transportation In Selling expenses Administrative expenses

10,000

7,000

Note: The merchandise inventory account before adjustment shows the inventory on hand at the beginning of the period. This is because, since purchases and sales of merchandise have not been debited or credited to the merchandise inventory account, this account would still show the beginning inventory amount at the end of the period. Therefore, an adjustment journal entry is needed to update this account. At the end of the period, a physical inventory would be conducted to determine the amount of inventory on hand. The adjustment journal entry removes beginning inventory amount from the merchandise inventory account and replaces it with the (ending) actual value of merchandise inventory on hand as determined by the physical inventory.

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The adjustment is: Income summary (beginning inventory)..XXX Merchandise amount inventoryXXX Merchandise Inventory.XXX Income Summary..XXX An adjustment journal entry for Hard Works is presented latter in (c). 3.6 PREPARING FINANCIAL BUSINESSES STATEMENTS FOR MERCHANDISING

We will discuss financial statements as we work on requirement (b) of our illustration. Once the worksheet has been completed, the financial statements are prepared. Next, any adjusting and closing entries are entered in the journal and posted to the ledger. Income Statement There are two widely used formats of the income statement. These are: The single Step Income Statement This format is shown below for Hard Works Co. It shows cost of goods sold and operating expense but has only one subtotal for total expenses. Hard Works Co. Income statement For the year ended December 31, 2002 Net sales..Br.14536 Expenses: Cost of goods sold2893 Operating Expenses .3800 .3800 (6693) Net Income.7843 Income.7843

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The Multiple Step Income Statement Hard Works Co. Income statement For the year ended December 31, 2002 Revenue: Gross Sales Less: Sales Discounts ..44 Sales Returns &All20 Net Sales Less: Cost of goods sold: Less: Beg. Inventory (Jan 1)..7,000 Add: Purchase6,000 Less: Purchase..(82) Purchase Ret & all.(100) all.(100) Net Purchases..5818 Add: Transportation In 75 75 Total cost of purchase..5893 purchase..5893 Total cost of Goods Available for sale..12,893 Less: ending Inventory (Dec.31)(10,000) Less: (Dec.31)(10,000) Cost of Goods sold..(2893) sold..(2893) Gross Profit11,643 Operating Expenses: Selling Expenses.2,650 Admin. Exp.1,150 Exp.1,150 Total operating expenses.. Net Income (3800) (3800) 7,843 (64) 14536 Br. 14600

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Hard Works Co. Statement of Owners Equity For the year Ended December 31, 2002 Yibeltal Capital Jan1,2002Br..25,000 Add: Net Income for the year7843 Deduct: Owners withdrawal during the year....2,000 year....2,000 Yibeltal Capital December 31, 200230843 200230843 Hard Works Co. Balance sheet For the year Ended December 31, 2002 Assets: Cash..19663 A/R 1880 Merch. Inventory.10,000 Inventory.10,000 30843 Total Assets.31,843 Assets.31,843 C. Adjustment Journal entry -Income summary..7,000 Merchandise Inventory7,000 -Merchandise Inventory.10,000 Income Summary.10,000 D. Closing entries -Sales..14,600 Income summary..14,600 -Income summary66 Sales discount44 Sales Returns and Allowances 20 88 Total Liab. & O/E31,843 O/E31,843 Liabilities & capital Liabilities: A/P700 Owners Equity: Yibeltal Capital

-Income summary6,075 Purchases.6,000 Transportation-In..75 - Purchase Discounts..82 Purchase Ret. &All...100 Income Summary.182 - Income summary.3,800 Selling Expenses2650 Administrative expense..1150 - Income summary.7,843 Yibeltal Capital7,843 - Yibeltal Captal..2,000 Yibeltal Drawings2,000 3.7 SUMMARY Even though the steps and procedures that we go through to prepare the financial statements of merchandising companies are the same with that of service businesses, there are transactions peculiar to merchandising companies. These include the purchase and sale of merchandise. You should be able to record these transactions by now. Go back and study the relationships between financial statement items summarized at the end of section one of this unit. 3.8 ANSWERS TO CHECK YOUR PROGRESS EXERCISE Check Your Progress Exercise - 1 List price of goods.52,000 Less: Trade discount (20% X [52,000-40,000]) (2400) Invoice Price..49,600

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Journal entry: A/R49,600 Sales49,600 Check Your Progress Exercise - 2 1/15, n/60 1% discount if customer pays with in 15 days, otherwise amount is due with in 60 days with out any discount. 2/10, n/EOM 2% discount if paid with in 10 days, otherwise the whole amount due at the end of the month of sale n/60 No discount amount is due in 60 days

Check Your Progress Exercise - 3 A since the customer paid with in the discount period, i.e., with in 10 days, amount collected would be: 120,000 1% (120,000) = 118,800 B Jan. 18 A/R..120,000 Sales.120,000 Jan. 28 Cash.118800 Sales Discount.1200 A/R.120,000 Check Your Progress Exercise - 4 Feb 3 A/R .15,000 Sales .15,000 Feb 13Cash..14,700 Sales Discount...300 A/R.15,000 Feb 15Sales Returns &Allowances5,000 90

Cash.4900 Sales Discount100 Check Your Progress Exercise - 5 January 4 Purchase .43,000 Cash.43,000 Check Your Progress Exercise - 6 Jan 14. A/R.50,000 Sales50,000 Jan 24. Cash49,500 Sales Discounts 500 A/R..50,000 Check Your Progress Exercise - 7 Jan 17. Sales Returns & Allowances250 A/R..250 Check Your Progress Exercise - 8 FOB shipping point March 12. A/P85,300 Cash..83,300 Purchase Discounts. 1,700 FOB Destination March 2 Purchase.85,000 A/P..85,000 March 31A/P.85,000 Cash85,000

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Check Your Progress Exercise - 9 Feb 1Purchase..135,000 A/P.135,000 Feb 13A/P..135,000 Cash133,650 Purchase Discounts 1,350 Check Your Progress Exercise - 10 Seller April 1-A/R40,000 Sales40,000 A/R2,500 Cash..2,500 April 11- Cash (39200 + 2500)41,700 Sales Discount...800 A/R (40,000 +2500).42,500 Buyer Purchase40,000 A/P40,000 Transportation-In..2,500 A/P2,500 April 11-A/P42,500 Cash.41,700 Purchase Discounts...800

3.9 MODEL EXAMINATION QUESTIONS 1. You are provided with the following data from the records of three merchandising companies:(a), (b) and (c). Determine each of the missing numbers for each company. a Invoice cost of merchandise purchase Purchase discounts Purchase returns and allowances Transportatiln-In Merchandise inventory (beginning of period) Total cost of merchandise purchases Br.90, 000 4000 3,000 ? 7,000 89,400 b Br.40, 000 ? 1,500 3,500 ? 39,500 c Br.30, 500 650 1,100 4,000 9,000 ? 92

Merchandise inventory (end of period) Cost of goods sold

4,400 ?

7,500 41,600

? 34,130

2. Prepare journal entries to record the following merchandising transactions of Shiach Company. The company uses the periodic inventory system. July 1 Purchased merchandise form Gizhy Company for $6,000 under credit terms of

1/15, n/30, FOB shipping point. 2 Sold merchandise to Terra Co. for $800 under credit terms of 2/10, n/60, FOB shipping point. 3 Paid $100 for freight (transportation) charges on the purchase of July 1. 8 Sold merchandise for $1,600 cash. 9 Purchased merchandise from Chilalo Co. for $2,300 under credit terms of 2/15, n/60, FOB destination. 12 Received a $200 credit memorandum acknowledging the return of merchandise purchased on July 9. 12 Received the balance due from Terra Co. for the credit sale dated July 2, net of the discount. 16 Paid the balance due to Gizhy Company within the discount period. 19 Sold merchandise to Urban Co. for $1,250 under credit terms of 2/15, n/60, FOB shipping point. 21 Issued a $150 credit memorandum to Urban Co. for an allowance on goods sold on July 19. 22 Received a debit memorandum from Urban Co. for an error that overstated the total sales invoice by $50. 24 Paid Chilalo Co. the balance due after deducting the discount. 30 Received the balance due from Urban Co. for the credit sale dated July 19, net of the discount. 31 Sold merchandise to Terra Co. for $5,000 under credit terms of 2/10, n/60, FOB shipping point. 3. The following unadjusted trial balance was prepared at the end of the fiscal year for Tenkir Company: 93

TENKIR COMPANY Unadjusted Trail Balance July 31, 2000 Cash.. $ 4,200 Merchandise Inventory 11,500 Store supplies.. 4,800 Prepaid Insurance 2,300 Store equipment.. 41,900 Accumulated deprecation-Store Equipment Accounts payable. Gidey Tinker, capital.. Gidey Tenkir, withdrawals . 3,200 Sales.. Sales discounts 1,000 Sales returns and allowances 2,000 Cost of goods sold... 37,400 Depreciation expense Store equipment.. Salaries expense 31,000 Insurance expense. Rent expense.. 14,000 Store supplies expense. Advertising expense.. 9,900 Totals... $163,200 Rent and salaries expense are equally divided between the selling and the general and administrative functions. Tenkir Company uses the periodic inventory system. Required: 1. Prepare adjusting journal entries for the following: a. Store supplies on hand at year-end amount to $1,650. b. Expired insurance, an administrative expense, for the year is $1,500. c. Depreciation expense, a selling expense, for the year is $1,400. d. A physical count of the ending merchandise inventory shows $11,100 of goods on hand. 2. Prepare a multiple-step income statement. 94

$ 15,000 9,000 35,200 104,000

. $163,200

3. Prepare a single-step income statement. 4. Prepare all the necessary closing entries. 3.10 GLOSSARY OF TERMS A Merchandising Business- a business that buys and sells goods at a profit. BusinessMerchandise- anything that a merchandising company buys in order to resale it to its Merchandisecustomers. Periodic Inventory System- a system of recording inventories that updates inventory records Systemonly once in an accounting period. Perpetual Inventory System- a system of recording inventories that continuously shows the Systembalance of inventory on hand as the records about inventory are continuously updated. Physical Inventory- the act of counting (measuring, weighing, etc) merchandise in order to Inventorydetermine the quantity of goods on hand on a particular date. Trade Discount- deduction from the normal selling price (list price) to determine the invoice Discountprice of goods. Cash Discount- deduction from the invoice price of goods for early payment when goods are Discountsold on credit. Cash discounts are called sales discounts for the seller whereas they are referred to as purchase discounts by the buyer. Purchase (or Sales) Returns- merchandise returned to the seller after it has already been sold Returnsor bought. Purchase (or Sales) Allowance- a deduction from the invoice price of goods when the goods Allowancebought or sold are agreed to be of defective or unsatisfactory for any reason. Contra Account- if an account is a contra account; its balance would be deducted from Accountanother account when it is presented in the financial statements. FOB Destination- an agreement that requires the seller of the goods to cover transportation Destinationcosts. It is read as free on board at destination.

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FOB Shipping Point- an agreement that requires the buyer of merchandise to cover Pointtransportation costs. It is read as free on board at shipping point.

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