Accounting and Financial
Reporting
Master of Business Administration
(MBA)
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Lecture Week 14
Accounting for Merchandising Operations
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Learning Objectives
1. Describe merchandising operations and inventory systems.
2. Prepare financial statements for a merchandising company.
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Types of Company Operations
There are 3 basic types of company operations:
1. Services Companies : providing customer services for profit.
2. Merchandisers : buying products and re-selling them for
profit.
3. Manufacturers: creating products and selling them for
profit.
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Service Companies
Service organizations sell time to earn revenue.
Examples: Accounting firms and law firms
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Merchandising Companies
• Merchandising Companies buy Products for resale (Goods or products
purchased for resale are called “merchandise inventory”, examples include;
sporting goods, clothing, and auto parts stores).
Manufacturer Wholesaler Retailer Consumers
• The usual accounting term for revenues from selling merchandise is sales
• The term used for the expense of buying and preparing the merchandise is cost of
goods sold (COGS)
• Some service companies use the term sales instead of revenues; and cost of goods
sold is also called cost of sales. 6
Operating Cycles for Service and Merchandising Businesses
Service Business Merchandising Business
Receive Buy
Receive Cash Perform Cash Inventory
Cash Services Cash
Sell Inventory
Accounts Accounts
Receivable Inventory
Receivable
• Ordinarily the operating cycle for a merchandiser is longer than that of a service company.
• The operating cycle of a business that sells inventory on credit is typically longer than that of a
business that sells only on a cash basis. This additional time is due to time between when the
customer buys the inventory and the time the customer pays off the account receivable.
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Flow of Costs in Inventory Systems
COGS = Beg. Inventory + Net Purchases - End. Inventory 8
Inventory Systems
Two alternative inventory accounting systems can be used to collect
information about cost of goods sold and cost of inventory:
Perpetual systems Periodic systems
continually update accounting accounting records for
records for merchandising merchandise transactions are
transactions updated only at the end of the
accounting period
Most companies use a hybrid system that includes a perpetual update in
addition to a periodic check.
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Inventory Systems
Perpetual System
• Maintain detailed records of cost of each inventory purchase and
sale.
• Records continuously show inventory that should be on hand for
every item
• Traditionally used for merchandise with high unit values
• Company determines cost of goods sold each time a sale occurs
• Provides better control over inventories than a periodic system
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Inventory Systems
Periodic System
• Do not keep detailed running records of the goods on hand
• Ending inventory determined by physical count
• Cost of goods sold not determined until end of 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
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Quick Test; 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
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Calculating Gross Profit for Merchandising Businesses
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Sales Discounts
• Sales discounts on credit sales can benefit a seller by decreasing the delay
in receiving cash and reducing future collection efforts.
• Contra-revenue account (debit) to Sales Revenue
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Sales Returns and Allowances
Sales returns refer Sales allowances
to merchandise that refer to reductions in
customers return to the selling price of
the seller after a merchandise sold to
sale. customers.
• Sales returns and allowances usually involve dissatisfied customers and the possibility
of lost future sales.
• 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
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Classified Statement of Financial Position for
Merchandising Businesses
• The merchandiser’s classified balance sheet reports merchandise inventory as a current
asset, usually after accounts receivable according to an asset’s nearness to liquidity.
• Inventory is usually less liquid than accounts receivable because inventory must first be sold
before cash can be received; but it is more liquid than supplies and prepaid expenses.
PW Audio Supply
Statement of Financial Position (Partial)
December 31, 2020
Assets
Current assets
Cash € 9,500 Highly
Accounts receivable 2,300 Liquid
Inventory 40,000
Prepaid insurance 1,800
Total current assets 67,400
Property, plant, and equipment
Equipment €80,000 Less
Liquid
Less: Accumulated depreciation 24,000 56,000
Total assets €123,400 16
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
activities Gain on disposal of plant assets
Other expenses and losses
600 3,600
Interest expense 1,800
• Net income Casualty loss from vandalism 200 2,000
Net income € 31,600
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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
activities Gain on disposal of plant assets
Other expenses and losses
600 3,600
Interest expense 1,800
• Net income Casualty loss from vandalism 200 2,000
Net income € 31,600
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Income Statement
Nonoperating Activities
Various revenues and expenses and gains and losses that are unrelated to
company’s main line of operations.
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.
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Quick Test; Income and Comprehensive Income Statements
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
Prepare a multiple-step income statement for Art Center.
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Quick Test; Income and Comprehensive Income Statements
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
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References
• Wild, J., Shaw, K., Chiappetta, B. and Samaha, K., 2017. Fundamental
Accounting Principles. 2nd ed. McGraw-Hill Education.
• Weygandt, J., Kimmel, P. and Kieso, D., 2019. Accounting Principles
IFRS Version. Global Edition. Wiley.
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