Chapter Three

Accounting for
Merchandising Operations
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1. Identify the differences between service and merchandising
companies.
2. Explain the recording of purchases under a perpetual
inventory system.
3. Explain the recording of sales revenues under a perpetual
inventory system.
4. Explain the steps in the accounting cycle for a merchandising
company.
5. Prepare an income statement for a merchandiser.
 3.1. Merchandising Operations
Merchandising Companies
Buy and Sell Goods

Retailer

Wholesaler Consumer

The primary source of revenues is referred to as sales revenue

or sales.
 Cont’d
Income Measurement

Sales Less
Not used in a Service Illustration 5-1
Business. Income Measurement Process
Revenue for A Merchandising Company

Cost of Equals Gross Less

Goods Sold Profit

Operating Equals
Net Income
Cost of goods sold is the Expenses (Net Loss)
total cost of merchandise
sold during the period.
Operating Cycles
Illustration 5-2
The operating
cycle of a
merchandising
company
ordinarily is
longer than that
of a service
company.

Illustration 5-3
Flow of Costs
Illustration 5-4

Companies use either a Perpetual Inventory System or a

Periodic Inventory System to account for inventory.
 Cont’d
PERPETUAL SYSTEM
 Maintain detailed records of the cost of each
inventory purchase and sale.
 Records continuously show inventory that should
be on hand for every item.
 Company determines cost of goods sold each time
a sale occurs.
 Cont’d
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
Goods Available for Sale 900,000
Less: Ending Inventory 125,000
Cost of Goods Sold € 775,000
 Cont’d
ADVANTAGES OF THE PERPETUAL SYSTEM

 Traditionally used for merchandise with high unit

values.

 Shows the quantity and cost of the inventory that

should be on hand at any time.

 Provides better control over inventories than a

periodic system.
 > DO IT!
Indicate whether the following statements are True or False.
1. The primary source of revenue for a merchandising company
results from performing services for customers.
2. The operating cycle of a service company is usually shorter
than that of a merchandising company.
3. Sales revenue less cost of goods sold equals gross profit.
4. Ending inventory plus the cost of goods purchased equals cost
of goods available for sale.
3.2. Recording Purchases of Merchandise
 Made using cash or credit (on account).

 Normally record when

goods are received from
the seller.

 Purchase invoice should

support each credit
purchase.

Illustration 5-6
Sales Invoice Used As Purchase
Invoice By Sauk Stereo
 Cont’d
Illustration 5-6
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
Freight Costs
Ownership of the goods
passes to the buyer when
the public carrier accepts
the goods from the seller.

Ownership of the goods

remains with the seller until
the goods reach the buyer.

Illustration 5-7
Freight costs incurred by the seller are an
Shipping Terms operating expense.
 Cont’d
Illustration: Assume upon delivery of the goods on May 6,
Sauk Stereo pays Public 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 5-6

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

May 4 Freight-Out (Delivery Expense) 150

Cash 150
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
for a cash refund if the will grant a reduction from
purchase was for cash. the purchase price.
 Cont’d
Illustration: Assume Sauk Stereo returned goods costing
€300 to PW Audio Supply on May 8.

May 8 Accounts Payable 300

Inventory 300
 Cont’d
Question #1
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
Purchase Discounts
Credit terms may permit buyer to claim a cash discount
for prompt payment.

Advantages:

 Purchaser saves money.

 Seller shortens the operating cycle by converting the

accounts receivable into cash earlier.

Example: Credit terms

may read 2/10, n/30.
 Cont’d

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

2% discount if 1% discount if Net amount due

paid within 10 paid within within the first
days, otherwise first 10 days of 10 days of the
net amount due next month. next month.
within 30 days.
 Cont’d
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 on May 14 to record the payment.

May 14 Accounts Payable 3,500

Inventory 70
Cash 3,430

(Discount = €3,500 x 2% = €70)

 Cont’d
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
 Cont’d
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%

€3,500 x 36.5% x 20 ÷ 365 = €70
Summary of Purchasing Transactions

Inventory
Debit Credit

4th - Purchase 3,800 300 8th - Return

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

Balance 3,580
 > DO IT!
On September 5, Zhu Company buys merchandise on account
from Gao Company. The selling price of the goods is ¥15,000,
and the cost to Gao Company was ¥8,000. On September 8,
Zhu returns defective goods with a selling price of ¥2,000.
Record the transactions on the books of Zhu Company.

Sept. 5 Inventory 15,000

Accounts Payable 15,000
Sept. 8 Accounts Payable 2,000
Inventory 2,000
 3.3. Recording Sales of Merchandise
 Made using cash or credit (on account). Illustration 5-6

 Sales revenue, like service

revenue, is recorded when
the performance obligation
is satisfied.

 Performance obligation is
satisfied when the goods
are transferred from the
seller to the buyer.

 Sales invoice should

support each credit sale.
 Cont’d

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
 Cont’d
Illustration: PW Audio Supply records the sale of €3,800
on May 4 to Sauk Stereo on account (Illustration 5-6) 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
Sales Returns and Allowances
 “Flip side” of purchase returns and allowances.

 Contra-revenue account to Sales Revenue (debit).

 Sales not reduced (debited) because:

► Would obscure importance of sales returns and

allowances as a percentage of sales.

► Could distort comparisons.

 Cont’d
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
 Cont’d
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
 Cont’d
Question #2
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.
Sales Discount
 Offered to customers to promote prompt payment of
the balance due.

 Contra-revenue account (debit) to Sales Revenue.

 Cont’d
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%]

 > DO IT!
On September 5, Zhu Company buys merchandise on account
from Gao Company. The selling price of the goods is ¥15,000,
and the cost to Gao Company was ¥8,000. On September 8,
Zhu returns defective goods with a selling price of ¥2,000
and the fair value of ¥300. Record the transactions on the
books of Gao Company.

Sept. 5 Accounts Receivable 15,000

Sales Revenue 15,000
Sept. 5 Cost of Goods Sold 8,000
Inventory 8,000
 > DO IT!
On September 5, Zhu Company buys merchandise on account
from Gao Company. The selling price of the goods is ¥15,000,
and the cost to Gao Company was ¥8,000. On September 8,
Zhu returns defective goods with a selling price of ¥2,000
and the fair value of ¥300. Record the transactions on the
books of Gao Company.

Sept. 8 Sales Returns and Allowances 2,000

Accounts Receivable 2,000
Sept. 8 Inventory 300
Cost of Goods Sold 300
 3.4. Completing the Accounting Cycle
 Up to this point, we have illustrated the basic
entries for transactions relating to purchases and
sales in a perpetual inventory system.

 Now we consider the remaining steps in the

accounting cycle for a merchandising company.

 Each of the required steps described in Chapter 2

for service companies apply to merchandising
companies.
Adjusting Entries
 A merchandising company generally has the same types
of adjusting entries as a service company.

 However, a merchandiser using a perpetual system will

require one additional adjustment to make the records
agree with the actual inventory on hand.

 At the end of each period, for control purposes, a

merchandising company that uses a perpetual system
will take a physical count of its goods on hand.

 The company’s Unadjusted Balance in Inventory usually

does not agree with the actual amount of Inventory on
hand.
 Cont’d
 The perpetual inventory records may be incorrect due
to recording errors, theft, or waste.

 Thus, the company needs to adjust the perpetual

records to make the recorded inventory amount agree
with the inventory on hand.

 This involves adjusting Inventory and Cost of Goods

Sold.
 Cont’d
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
Closing Entries
Cont’d
Cont’d
 > DO IT!
The trial balance of Celine’s Sports Wear Shop at December
31 shows Inventory €25,000, Sales Revenue €162,400, Sales
Returns and Allowances €4,800, Sales Discounts €3,600, Cost
of Goods Sold $110,000, Rent Revenue €6,000, Freight-Out
€1,800, Rent Expense €8,800, and Salaries and Wages
Expense €22,000. Prepare the closing entries for the above
accounts.

Dec. 31 Sales Revenue 162,400

Rent Revenue 6,000
Income Summary 168,400
The trial balance of Celine’s Sports Wear Shop at December
31 shows Inventory €25,000, Sales Revenue €162,400, Sales
Returns and Allowances €4,800, Sales Discounts €3,600, Cost
of Goods Sold $110,000, Rent Revenue €6,000, Freight-Out
€1,800, Rent Expense €8,800, and Salaries and Wages
Expense €22,000. Prepare the closing entries for the above
accounts.

Dec. 31 Income Summary 151,000

Cost of Goods Sold 110,000
Sales Returns and Allowances 4,800
Sales Discounts 3,600
Freight-Out 1,800
Rent Expense 8,800
Salaries and Wages Expense 22,000
 3.5. Forms of Financial Statements
Income Statement
 Primary source of information for evaluating a
company’s performance.

 Format is designed to differentiate between the

various sources of income and expense.
Income
Statement
The income
statement is a
primary source of
information for
evaluating a
company’s
performance.

Illustration 5-14
Income
Statement
Key Items:
 Net Sales

Illustration 5-14
Income
Statement
Key Items:
 Net Sales
 Gross Profit

Illustration 5-14
Income
Statement
Key Items:
 Net Sales
 Gross Profit

Illustration 5-11
Gross Profit Rate Formula
& Computation

Illustration 5-14
Income
Statement
Key Items:
 Net Sales
 Gross Profit
 Operating
Expenses

Illustration 5-14
Income
Statement
Key Items:
 Net Sales
 Gross Profit
 Operating
Expenses
 Other Income
And Expense

Illustration 5-14
Income
Statement
Key Items:
 Net Sales
 Gross Profit
 Operating
Expenses
 Other Income
And Expense

Illustration 5-14
Income
Statement
Key Items:
 Net Sales
 Gross Profit
 Operating
Expenses
 Other Income And
Expense
 Interest Expense

Illustration 5-14
Income
Statement
Key Items:
 Net Sales
 Gross Profit
 Operating
Expenses
 Other Income And
Expense
 Interest Expense
 Net Income

Illustration 5-14
 Cont’d
Question #3
The Income Statement for a merchandiser shows
each of the following features except:
a. Gross Profit.
b. Cost of Goods Sold.
c. A Sales Section.
d. Investing Activities Section.
Comprehensive Income
Examples includes certain adjustments to pension plan assets,
gains and losses on foreign currency translation, and
unrealized gains and losses on certain types of investments.
Reported in a combined statement of net income &
comprehensive income, or in a separate schedule that reports
only comprehensive income.
Illustration 5-15: Separate Statement of Net Income and Comprehensive Income
Inventory Presentation in the Classified SoFP
Illustration 5-16: Assets Section of a Classified Statement of Financial Position
 > DO IT!
You are presented with the following list of accounts from the adjusted trial
balance for merchandiser Gorman Company. Indicate in which financial
statement and under what classification each of the following would be
reported.
Financial
Account Statement Classification
Accounts payable SFP Current liabilities
Accounts receivable SFP Current assets
Accumulated Depreciation-Buildings SFP Property, plant, and equipment
Accumulated Depreciation-Equipment SFP Property, plant, and equipment
Advertising Expense IS Operating expenses
Buildings SFP Property, plant, and equipment
Cash SFP Current assets
Depreciation Expense IS Operating expenses
Dividends RES Deduction section
 > DO IT!
You are presented with the following list of accounts from the adjusted trial
balance for merchandiser Gorman Company. Indicate in which financial
statement and under what classification each of the following would be
reported.
Financial
Account Statement Classification
Equipment SFP Property, plant, and equipment
Freight-Out IS Operating expenses
Gain on Disposal of Plant Assets IS Other income and expense
Insurance Expense IS Operating expenses
Interest Expense IS Interest expense
Interest Payable SFP Current liabilities
Inventory SFP Current assets
Land SFP Property, plant, and equipment
Notes Payable (due in 3 years) SFP Non-current liabilities
 > DO IT!
You are presented with the following list of accounts from the adjusted trial
balance for merchandiser Gorman Company. Indicate in which financial
statement and under what classification each of the following would be
reported.
Financial
Account Statement Classification
Property Taxes Payable SFP Current liabilities
Salaries and Wages Expense IS Operating expenses
Salaries and Wages Payable SFP Current liabilities
Sales Returns and Allowances IS Sales
Sales Revenue IS Sales
Share Capital—Ordinary SFP Equity
Utilities Expense IS Operating expenses
 3.6. Periodic Inventory System
Determining CoGS Under a Periodic System

 No running account of changes in inventory.

 Ending inventory determined by physical count.

 Cost of goods sold not determined until the

end of the period.
Determining CoGS Under a Periodic System
Illustration 5B-2: CoGS for a Merchandiser Using a Periodic Inventory System

Illustration 5B-2
Recording Merchandise Transactions
 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.
Recording Purchases of Merchandise
Illustration: On the basis of the sales invoice (Illustration
5-6) 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
 Cont’d
Freight Costs
Illustration: If Sauk pays Public 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
 Cont’d
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
 Cont’d
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
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 5-6) 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.
 Cont’d
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 8 Sales Returns and Allowances 300

Accounts Receivable 300

 Cont’d
Sales Discount
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
 Cont’d
Comparison of Entries
Illustration 5B-3: Comparison of Entries for Perpetual Vs Periodic Inventory Systems
 Cont’d
Comparison of Entries
Illustration 5B-3: Comparison of Entries for Perpetual Vs Periodic Inventory Systems
 3.7. Worksheet for Merchandising Co.
Using a Worksheet
 As indicated in Chapter 2, a worksheet enables companies
to prepare FS’s before they journalize and post adjusting
entries.

 The steps in preparing a worksheet for a merchandising

company are the same as for a service company.

 Illustration 5A-1 shows the worksheet for PW Audio

Supply (excluding non-operating items).

 The unique accounts for a merchandiser using a perpetual

inventory system are in boldface letters & red.
Illustration 5A-1
Worksheet for
Merchandising Company
The End of Chapter 3
Thank You!!!