Chapter 5

Accounting for
Merchandise Operations
Chapter Outline
Learning Objectives
LO 1 Describe merchandising operations and inventory
systems.
LO 2 Record purchases under a perpetual inventory
system.
LO 3 Record sales under a perpetual inventory system.
LO 4 Apply the steps in the accounting cycle to a
merchandising company.
LO 5 Prepare financial statements for a merchandising
company.
Copyright ©2019 John Wiley & Son, Inc. 3
 Merchandising Operations and
Inventory Systems
Merchandising Companies
Buy and Sell Goods
Retailer

Wholesaler Consumer

The primary source of revenues is referred to as sales revenue or sales.

LO 1 Copyright ©2019 John Wiley & Son, Inc. 4
 Merchandising Operations and Inventory Systems
Income Measurement
Not used in a
Sales Less ILLUSTRATION 5.1
service business Income measurement process for a
Revenue merchandising company

gia von hang ban loi nhuan gop

Cost of Equals Gross Less

Goods Sold Profit

diferent withservice companies

Cost of goods sold is the total Operating Equals Net
Expenses Income
cost of merchandise sold (Loss)
during the period.

LO 1 Copyright ©2019 John Wiley & Son, Inc. 5

 Operating Cycles
Service Company

Receive Cash Perform Services

Cash

Mail

Accounts
Receivable
ILLUSTRATION 5.2
Operating cycle for a service company

LO 1 Copyright ©2019 John Wiley & Son, Inc. 6

 Operating Cycles ILLUSTRATION 5.3
Operating cycle for a
Merchandising Company merchandising company

Receive Buy
Cash Inventory
Cash
Mail

Sell Inventory

Accounts
Inventory
Receivable

not
Ordinarily is longer than that of a service company.
more steps
LO 1 Copyright ©2019 John Wiley & Son, Inc. 7
 Flow of Costs ILLUSTRATION 5.4
Flow of costs
value at begining period total value, from begin until the end

Beginning Cost of Goods

Inventory Purchased

Cost of Goods
Available for Sale
value to sold

Cost of Ending
Goods Sold Inventory

Companies use a perpetual or a periodic inventory system.

control value

LO 1 Copyright ©2019 John Wiley & Son, Inc. 8

 Flow of Costs
Perpetual System
• Maintain detailed records of cost of each inventory
purchase and sale(see Helpful Hint).
• Records continuously show inventory that should be
on hand for every item
• Company determines cost of goods sold each time a
sale occurs

LO 1 Copyright ©2019 John Wiley & Son, Inc. 9

 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
Goods available for sale 900,000
Less: Ending inventory 125,000
Cost of goods sold $ 775,000

LO 1 Copyright ©2019 John Wiley & Son, Inc. 10

 Flow of Costs
Advantages of the Perpetual System
• Traditionally used for merchandise with high unit
values
• Shows quantity and cost of inventory that should be
on hand at any time
• Provides better control over inventories than a
periodic system

LO 1 Copyright ©2019 John Wiley & Son, Inc. 11

 DO IT! 1 Merchandising Operations
and Inventory Systems
Indicate whether the following statements are true or false. If false,
indicate how to correct the statement.
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.
Solution: 1. False 2. True 3. True 4. False

LO 1 Copyright ©2019 John Wiley & Son, Inc. 12

 Recording Purchases Perpetual System
• Made using cash or credit (on account)
• Normally record when goods are received from
seller
• Purchase invoice should support each credit
purchase

LO 2 Copyright ©2019 John Wiley & Son, Inc. 13

 Purchase
invoice should
support each
credit purchase

ILLUSTRATION 5.6
Sales invoice used as purchase
invoice by Sauk Stereo

LO 2 Copyright ©2019 John Wiley & Son, Inc. 14

 ILLUSTRATION 5.6

Recording Purchases Perpetual System

Illustration: Sauk Stereo (the
buyer) uses as a purchase
invoice the sales invoice
prepared by PW Audio Supply
(the seller). Prepare the
journal entry for Sauk Stereo
for the invoice from PW Audio
Supply.
asset

May 4 Inventory hang ton kho 3,800

Accounts Payable 3,800
acc Receivable inventory
LO 2 Copyright ©2019 John Wiley & Son, Inc. 15
sale R
 Freight Costs chi phi van chuyen

Ownership of goods
passes to buyer when
public carrier accepts
goods from seller.

Ownership of goods
remains with seller until
the goods reach buyer.

ILLUSTRATION 5.7
Shipping terms
Freight costs incurred by the seller are an operating expense.

LO 2 Copyright ©2019 John Wiley & Son, Inc. 16

 Freight Costs
Illustration: If Sauk Stereo (the buyer) pays Acme Freight
€150 for freight charges on May 6, the entry on Sauk Stereo’s
books is: balance sheet

May 6 Inventory 150

Cash 150
If the freight terms on the invoice in Illustration 5.6 had
required PW Audio Supply (the seller) to pay the freight
charges, the entry by PW Audio Supply would be:
income statement
May 4 Freight-Out (Delivery Expense) 150
Cash 150
LO 2 Copyright ©2019 John Wiley & Son, Inc. 17
 tra lai phu cap

Purchase Returns and Allowances

Purchaser may be dissatisfied because goods are
damaged or defective, of inferior quality, or do not meet
specifications.
give product back to sellers no movement inventory betw buyers and sellers

Purchase Return Purchase Allowance

Return goods for credit if May choose to keep
sale was made on credit, merchandise if seller will
or for a cash refund if grant a reduction from
purchase was for cash purchase price

LO 2 Copyright ©2019 John Wiley & Son, Inc. 18

 Purchase Returns and Allowances
Illustration: Assume that Sauk Stereo returned goods
costing €300 to PW Audio Supply on May 8.
May 8 Accounts Payable 300
doi voi buyer
Inventory 300

doi voi seller

DR inventory
CR account receivable

LO 2 Copyright ©2019 John Wiley & Son, Inc. 19

 Purchase Returns and Allowances
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

LO 2 Copyright ©2019 John Wiley & Son, Inc. 20

 Purchase Discounts
Credit terms may permit buyer to claim a cash discount
for prompt payment. Example: Credit terms 2/10, n/30.
Advantages:
• Purchaser saves money
• Seller shortens operating cycle by converting
accounts receivable into cash earlier

LO 2 Copyright ©2019 John Wiley & Son, Inc. 21

 Purchase Discounts
2/10, n/30 1/10 EOM n/10 EOM
2% discount if paid 1% discount if paid Net amount due
within 10 days, within first 10 days within the first 10
otherwise net of next month days of the next
amount due within month
30 days.
pay full, no discount

LO 2 Copyright ©2019 John Wiley & Son, Inc. 22

 Purchase Discounts
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
Cash 3,430
Inventory 70
(Discount = €3,500 x 2% = €70) 3430
= 98%
3500

LO 2 Copyright ©2019 John Wiley & Son, Inc. 23

 Purchase Discounts
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

LO 2 Copyright ©2019 John Wiley & Son, Inc. 24

 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 3500 x 10% x 20/365
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

LO 2 Copyright ©2019 John Wiley & Son, Inc. 25

 Summary of Purchasing Transactions
Inventory asset

Purchase May 4 3,800 May 8 300 Purchase return

Freight-in 6 150 14 70 Purchase discount
Balance 3,580

sell product to buyer, decrease inventory

buy product, increase inventory

LO 2 Copyright ©2019 John Wiley & Son, Inc. 26

 DO IT! 2 Purchase Transactions
On September 5, Zhū Company buys merchandise on account
from Gāo Company. The purchase price of the goods paid by
Zhū is ¥15,000, and the cost to Gāo Company was ¥8,000. On
September 8, Zhū returns defective goods with a selling price
of ¥2,000. Record the transactions on the books of Zhū
Company.
Sept. 5 Inventory 15,000
Accounts Payable 15,000
8 Accounts Payable 2,000
Inventory 2,000
LO 2 Copyright ©2019 John Wiley & Son, Inc. 27
 Recording Sales Perpetual System
• Made using cash or credit (on account)
• Sales revenue, like service revenue, is recorded
when performance obligation is satisfied
• Performance obligation is satisfied when goods are
transferred from seller to buyer
• Sales invoice should support each credit sale

LO 3 Copyright ©2019 John Wiley & Son, Inc. 28

 Recording Sales Perpetual System
Journal Entries to Record a Sale

#1 Cash or Accounts receivable XXX Selling

Sales revenue XXX Price
after selling product

#2 Cost of goods sold XXX

Cost
Inventory XXX
cost

A YOU B
selling price cost

LO 3 Copyright ©2019 John Wiley & Son, Inc. 29

 Recording Sales Perpetual System
Illustration: PW Audio Supply records its May 4 sale of
€3,800 to Sauk Stereo (Illustration 5.6) as follows
(assume merchandise cost PW Audio Supply €2,400).
May 4 Accounts Receivable 3,800
Sales Revenue 3,800
more sell --> more cost of goods sold
4 Cost of Goods Sold expense 2,400
Inventory 2,400

LO 3 Copyright ©2019 John Wiley & Son, Inc. 30

 Sales Returns and Allowances
• “Flip side” of purchase returns and allowances
DR balance
• 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
sale revenue (cross); doanh thu gop
sale returns and allowances
sale discount

net sales: doanh thu thuan

LO 3 Copyright ©2019 John Wiley & Son, Inc. 31

 2 entry 1 entry

Sales Returns and Allowances

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
connected selling price

8 Inventory 140
Cost of Goods Sold 140

LO 3 Copyright ©2019 John Wiley & Son, Inc. 32

 loi nhuan ban hang va phu cap

Sales Returns and Allowances

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
connected selling price

8 Inventory 50
Cost of Goods Sold 50

LO 3 Copyright ©2019 John Wiley & Son, Inc. 33

 Sales Returns and Allowances
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.

LO 3 Copyright ©2019 John Wiley & Son, Inc. 34

 Sales Discounts
• Offered to customers to promote prompt payment
of balance due
• Contra-revenue account (debit) to Sales Revenue
contra revenue account
Sales Returns and
Sales Revenue Allowances Sales Discounts
3,800 300 70

Net Sales
€3,430
LO 3 Copyright ©2019 John Wiley & Son, Inc. 35
 Sales Discounts
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.
Cash 3,430
Sales Discounts 70
Accounts Receivable 3,500
[(€3,800 – €300) X 2%]

neu là buyer thi nguoc lai

LO 3 Copyright ©2019 John Wiley & Son, Inc. 36

 DO IT! 3 Sales Transactions
On September 5, Zhū Company buys merchandise on account
from Gāo Company. The selling price of the goods is ¥15,000,
and the cost to Gāo Company was ¥8,000. On September 8,
Zhū returns defective goods with a selling price of ¥2,000 and
a fair value of ¥300. Record the transactions on the books of
Gāo Company.
Sept. 5 Accounts Receivable 15,000
Sales Revenue 15,000
5 Cost of Goods Sold 8,000
Inventory 8,000
LO 3 Copyright ©2019 John Wiley & Son, Inc. 37
 DO IT! 3 Sales Transactions
On September 5, Zhū Company buys merchandise on account
from Gāo Company. The selling price of the goods is ¥15,000,
and the cost to Gāo Company was ¥8,000. On September 8,
Zhū returns defective goods with a selling price of ¥2,000 and
a fair value of ¥300. Record the transactions on the books of
Gāo Company.
Sept. 8 Sales Returns and Allowances 2,000
Accounts Receivable 2,000
8 Inventory 300
Cost of Goods Sold 300
LO 3 Copyright ©2019 John Wiley & Son, Inc. 38
 The Accounting Cycle for a
Merchandising Company
Adjusting Entries
• Generally same as a service company
• One additional adjustment to make records agree
with actual inventory on hand
• Involves adjusting Inventory and Cost of Goods Sold

LO 4 Copyright ©2019 John Wiley & Son, Inc. 39

 Adjusting Entries
Illustration: Suppose that PW Audio Supply has an
unadjusted balance of €40,500 in Inventory. Through a
physical count, PW Audio Supply determines that its
actual merchandise inventory at December 31 is €40,000.
The company would make an adjusting entry as follows.
Cost of Goods Sold 500
Inventory (€40,500 – €40,000) 500

LO 4 Copyright ©2019 John Wiley & Son, Inc. 40

 Closing Entries
SALE
Dec. 31 Service Revenue 480,000
Income Summary 480,000
(Close credit balance accounts)
31 Income Summary 450,000
Sales Returns and Allowances contra revenue account
NOT expense
12,000
Sales Discounts 8,000
Cost of Goods Sold 316,000
Salaries and Wages Expense 64,000
Freight-Out dilivery expense 7,000
Advertising Expense 16,000
Utilities Expense 17,000
Depreciation Expense 8,000
Insurance Expense 2,000
(Close debit balance accounts)
LO 4 Copyright ©2019 John Wiley & Son, Inc. 41
 Closing Entries

Dec. 31 Income Summary 30,000

Owner’s Capital 30,000
(To close net income to owner’s
capital)
31 Owner’s Capital 15,000
Owner’s Drawings 15,000
(To close owner’s drawings to
owner’s capital)

LO 4 Copyright ©2019 John Wiley & Son, Inc. 42

 DO IT! 4 Sales Transactions
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

LO 4 Copyright ©2019 John Wiley & Son, Inc. 43

 The trial balance 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
LO 4 Copyright ©2019 John Wiley & Son, Inc. 44
 Income and Comprehensive Income
Statements
• Shows several steps in determining net income
• Two steps relate to principal operating activities
• Distinguishes between operating and non-operating
activities

LO 5 Copyright ©2019 John Wiley & Son, Inc. 45

 PW Audio Supply
Income Statement
For the Year Ended December 31, 2020

Income Sales
Sales revenue €480,000

Statement Less: Sales returns and allowances

Sales discounts
Net sales
€12,000
8,000 20,000
460,000
Cost of goods sold 316,000
Key Items: Gross profit 144,000
Operating expenses
• Net sales Salaries and wages expense 64,000
Utilities expense 17,000
• Gross profit Advertising expense
Depreciation expense
16,000
8,000
Freight-out 7,000
• Operating Insurance expense 2,000
expenses Total operating expenses
Income from operations
114,000
30,000
Other revenues and gains
• Nonoperating Interest revenue 3,000
Gain on disposal of plant assets 600 3,600
activities Other expenses and losses
Interest expense 1,800
• Net income Casualty loss from vandalism 200 2,000
Net income € 31,600

LO 5 Copyright ©2019 John Wiley & Son, Inc. ILLUSTRATION 5.14 46

 PW Audio Supply
Income Statement
For the Year Ended December 31, 2020

Income Sales
Sales revenue €480,000

Statement Less: Sales returns and allowances

Sales discounts
Net sales
€12,000
8,000 20,000
460,000
Cost of goods sold 316,000
Key Items: Gross profit 144,000
Operating expenses
• Net sales Salaries and wages expense 64,000
Utilities expense 17,000
• Gross profit Advertising expense
Depreciation expense
16,000
8,000
Freight-out 7,000
• Operating Insurance expense 2,000
expenses Total operating expenses
Income from operations
114,000
30,000
Other revenues and gains
• Nonoperating Interest revenue 3,000
Gain on disposal of plant assets 600 3,600
activities Other expenses and losses
Interest expense 1,800
• Net income Casualty loss from vandalism 200 2,000
Net income € 31,600

LO 5 Copyright ©2019 John Wiley & Son, Inc. ILLUSTRATION 5.14 47

 Nonoperating Activities
Various revenues and expenses and gains and losses that are
unrelated to company’s main line of operations.
ILLUSTRATION 5.13
Other Revenues and Gains
Interest revenue from notes receivable and marketable securities.
Dividend revenue from investments in common stock.
Rent revenue from subleasing a portion of the store.
Gain from the sale of property, plant, and equipment.
Other Expenses and Losses
Interest expense on notes and loans payable.
Casualty losses from recurring causes, such as vandalism and accidents.
Loss from the sale or abandonment of property, plant, and equipment.
Loss from strikes by employees and suppliers.

LO 5 Copyright ©2019 John Wiley & Son, Inc. 48

 Income Statement
The 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.

LO 5 Copyright ©2019 John Wiley & Son, Inc. 49

 Comprehensive Income Statement
PW Audio Supply ILLUSTRATION 5.15

Comprehensive Income Statement

For the Year Ended December 31, 2020
Net income €31,600
Other comprehensive income
Unrealized holding gain on investment securities 2,300
Comprehensive income €33,900

Items excluded from net income but included in comprehensive

income are either reported in either:
• Combined statement of net income and comprehensive
income
• Separate comprehensive income statement

LO 5 Copyright ©2019 John Wiley & Son, Inc. 50

 Classified Statement of Financial Position
PW Audio Supply ILLUSTRATION 5.16

Statement of Financial Position (Partial)

December 31, 2020
Assets
Current assets
Cash € 9,500
Accounts receivable 2,300
Inventory 40,000
Prepaid insurance 1,800
Total current assets 67,400
Property, plant, and equipment
Equipment €80,000
Less: Accumulated depreciation 24,000 56,000
Total assets €123,400

LO 5 Copyright ©2019 John Wiley & Son, Inc. 51

 DO IT! 5 Financial Statement Classifications

The following information is available for Art Center for the year
ended December 31, 2020.
Other revenues and gains $ 8,000 Sales revenue $462,000
Other expenses and losses 3,000 Operating expenses 187,000
Cost of goods sold 147,000 Sales discounts 20,000
Other comprehensive loss 10,000
Prepare a multiple-step income statement and comprehensive
income statement for Art Center.

LO 5 Copyright ©2019 John Wiley & Son, Inc. 52

 DO IT! 5 Financial Statement Classifications
Art Center
Income Statement
For the Year Ended December 31, 2020
Sales
Sales revenue $462,000
Sales discounts 20,000
Net sales 442,000
Cost of goods sold 147,000
Gross profit 295,000
Operating expenses 187,000
Income from operations 108,000
Other revenues and gains $8,000
Other expenses and losses 3,000 5,000
Net income $113,000
LO 5 Copyright ©2019 John Wiley & Son, Inc. 53
 DO IT! 5 Financial Statement Classifications
Art Center
Comprehensive Income Statement
For the Year Ended December 31, 2020
Net income $113,000
Other comprehensive loss 10,000
Comprehensive income $103,000

LO 5 Copyright ©2019 John Wiley & Son, Inc. 54

 Worksheet for a
Appendix 5A
Merchandising Company
As indicated in Chapter 4, a worksheet enables
companies to prepare financial statements 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
nonoperating items). The unique accounts for a
merchandiser using a perpetual inventory system are in
red.

LO 6 Copyright ©2019 John Wiley & Son, Inc. 55

 PW Audio Supply
ILLUSTRATION 5A.1
Worksheet
Worksheet perpetual system
For the Month Ended December 31, 2020
Adjusted Income Statement of
Trial Balance Adjustments Trial Balance Statement Financial Position
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 9,500 9,500 9,500
Accounts Receivable 16,000 1,6100 1,6100
Inventory 40,500 (a) 500 40,000 40,000
Prepaid Insurance 3,800 (b) 2,000 1,800 1,800
Equipment 80,000 80,000 80,000
Accumulated Depreciation 16,000 (c) 8,000 24,000 24,000
Accounts Payable 20,400 20,400 20,400
Owner's Capital 83,000 83,000 83,000
Owner's Drawings 15,000 15,000 15,000
Service Revenue 480,000 480,000 480,000
Sales Returns and Allow. 12,000 12,000 12,000
Sales Discounts 8,000 8,000 8,000
Cost of Goods Sold 315,500 (a) 500 316,000 316,000
Freight-Out 7,000 7,000 7,000
Advertising Expense 16,000 16,000 16,000
Salaries and Wages Expense 59,000 (d) 5,000 64,000 64,000
Utilities Expense 17,000 17,000 17,000
Totals 599,400 599,400
Insurance Expense (b) 2,000 2,000 2,000
Depreciation Expense (c) 8,000 8,000 8,000
Salaries and Wages Payable (d) 5,000 5,000 5,000
Totals 15,500 15,500 612,400 612,400 450,000 450,000 162,400 132,400
Net Income 30,000 30,000
Totals 480,000 480,000 162,400 162,400

LO 6 Copyright ©2019 John Wiley & Son, Inc. 56

 Appendix 5B Periodic Inventory System
Determining Cost of Goods Sold Under a
Periodic System
• No running account of changes in inventory
• Ending inventory determined by physical count
• Cost of goods sold not determined until end of
period.

LO 7 Copyright ©2019 John Wiley & Son, Inc. 57

 Appendix 5B Periodic Inventory System
PW Audio Supply ILLUSTRATION 5B.2

Cost of Goods Sold

For the Year Ended December 31, 2020
Cost of goods sold
Inventory, January 1 € 36,000
Purchases €325,000
Less: Purchase returns and allowances €10,400
Purchase discounts 6,800 17,200
Net purchases 307,800
Add: Freight-in 12,200
Cost of goods purchased 320,000
Cost of goods available for sale 356,000
Less: Inventory, December 31 40,000
Cost of goods sold €316,000
LO 7 Copyright ©2019 John Wiley & Son, Inc. 58
 Recording Merchandise Transactions
• Record revenues when sales are made
• Do not record cost of merchandise sold on 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
LO 7 Copyright ©2019 John Wiley & Son, Inc. 59
 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
(see Helpful Hint).

May 4 Purchases 3,800

Accounts Payable 3,800

LO 7 Copyright ©2019 John Wiley & Son, Inc. 60

 Recording Purchases of Merchandise
Freight Costs
Illustration: If Sauk Stereo pays Acme Freight Company €150
for freight charges on its purchase from PW Audio Supply on
May 6, the entry on Sauk Stereo’s books is as follows.
May 6 Freight-In (Transportation-In) 150
Cash 150

LO 7 Copyright ©2019 John Wiley & Son, Inc. 61

 Recording Purchases of Merchandise
Purchase Returns and Allowances
Illustration: Sauk Stereo returns goods costing €300 to PW
Audio Supply and prepares the following entry to recognize
the return.
May 8 Accounts Payable 300
Purchase Returns and Allowances 300

LO 7 Copyright ©2019 John Wiley & Son, Inc. 62

 Recording Purchases of Merchandise
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 Supply for payment within 10 days. Sauk
Stereo records the payment and discount as follows.
May 14 Accounts Payable (€3,800 – €300) 3,500
Purchase Discounts (€3,500 × .02) 70
Cash 3,430

LO 7 Copyright ©2019 John Wiley & Son, Inc. 63

 Recording Sales of Merchandise
Illustration: The seller, 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 time of sale under a periodic system.

LO 7 Copyright ©2019 John Wiley & Son, Inc. 64

 Recording Sales of Merchandise
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 Allowance 300
Accounts Receivable 300

LO 7 Copyright ©2019 John Wiley & Son, Inc. 65

 Recording Sales of Merchandise
Sales Discounts
Illustration: On May 14, PW Audio Supply receives payment of
€3,430 on account from Sauk Stereo. PW Audio Supply honors
the 2% cash discount and records the payment of Sauk
Stereo’s account receivable in full as follows.
May 14 Cash 3,430
Sales Discounts ($3,500 × .02) 70
Accounts Receivable ($3,800 – $300) 3,500

LO 7 Copyright ©2019 John Wiley & Son, Inc. 66

 Closing Entries
• All accounts that affect the determination of net
income are closed to Income Summary
• In journalizing, all debit column amounts are
credited, and all credit columns amounts are
debited
• Beginning inventory balance is debited to Income
Summary and credited to Inventory
• Ending inventory balance is debited to Inventory and
credited to Income Summary

LO 7 Copyright ©2019 John Wiley & Son, Inc. 67

 PW Audio Supply
ILLUSTRATION 5B.5
Worksheet
Worksheet periodic system
For the Month Ended December 31, 2020
Adjusted Income Statement of
Trial Balance Adjustments Trial Balance Statement Financial Position
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 9,500 9,500 9,500
Accounts Receivable 16,000 1,6100 1,6100
Inventory 36,000 36,000 36,000 40,000 40,000
Prepaid Insurance 3,800 (a) 2,000 1,800 1,800
Equipment 80,000 80,000 80,000
Accumulated Depreciation 16,000 (b) 8,000 24,000 24,000
Accounts Payable 20,400 20,400 20,400
Owner's Capital 83,000 83,000 83,000
Owner's Drawings 15,000 15,000 15,000
Service Revenue 480,000 480,000 480,000
Sales Returns and Allow. 12,000 12,000 12,000
Sales Discounts 8,000 8,000 8,000
Purchases 325,000 325,000 325,000
Purchase Returns and Allow 10,400 10,400 10,400
Purchase Discounts 6,800 6,800 6,800
Freight-In 12,200 12,200 12,200
Freight-Out 7,000 7,000 7,000
Advertising Expense 16,000 16,000 16,000
Salaries and Wages Expense 59,000 (c) 5,000 64,000 64,000
Utilities Expense 17,000 17,000 17,000
Totals 616,600 616,600
Insurance Expense (a) 2,000 2,000 2,000
Depreciation Expense (b) 8,000 8,000 8,000
Salaries and Wages Payable (d) 5,000 5,000 5,000
Totals 15,500 15,500 629,600 629,600 507,200 537,200 162,400 132,400
Net Income 30,000 30,000
Totals 537,200 537,200 162,400 162,400

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 A Look at U.S. GAAP
Key Points
Similarities
• Under both GAAP and IFRS, a company can choose to use either a
perpetual or periodic inventory systems.
• 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 performing of services. The definition under GAAP is essentially the
same.
• Similar to GAAP, comprehensive income under IFRS includes unrealized
gains and losses (such as those on non-trading securities) that are not
included in the calculation of net income.

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 A Look at U.S. GAAP
Key Points
Differences
• Under GAAP companies generally classify income statement items by
function. Classification by function leads to descriptions like
administration, distribution (selling), and manufacturing. Under IFRS,
companies must classify expenses either by nature or by 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.

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 A Look at U.S. GAAP
Key Points
Differences
• 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.
• 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.

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 A Look at U.S. GAAP
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 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
liabilities used to generate the income. 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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Copyright
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Copyright ©2019 John Wiley & Son, Inc. 73