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CHAPTER FOUR
Accounting For Merchandising
Operation
(AcFn 2011)

AAU School of Commerce Acfn 2011

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 Learning Objectives
After studying this chapter, you should be able to:
 Identify the differences between service and merchandising companies.
 Explain the recording of purchases under a perpetual inventory system.
 Explain the recording of sales revenues under a perpetual inventory
system.
 Explain the steps in the accounting cycle for a merchandising company.
 Prepare an income statement for a merchandiser.

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 Preview of Chapter 4

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 Merchandising Operations

Merchandising Companies
Buy and Sell Goods

Wholesaler Retailer Consumer

The primary source of revenues is referred to as

sales revenue or sales.

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 Merchandising Operations

Income Measurement

Cost of goods sold is the total

cost of merchandise sold during
the period.

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 Merchandising Operations

Operating
Cycles

The operating cycle

of a merchandising
company ordinarily
is longer than that of
a service
company.

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 Merchandising Operations

Flow of Costs

Companies use either a perpetual inventory system or a periodic inventory

system to account for inventory.

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 Merchandising Operations

Flow of Costs
Perpetual System
 Maintain detailed records of the cost of each inventory
purchase and sale.
 Records continuously show inventory that should be on
hand.
 Company determines cost of goods sold each time a
sale occurs.

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 Merchandising Operations

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 Birr XXX

Add: Purchases, net XXX
Goods available for sale XXX
Less: Ending inventory XXX
Cost of goods sold Birr XXX
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 Merchandising Operations

Flow of Costs
Additional Consideration
Perpetual System:
 Traditionally used for merchandise with high unit
values.
 Provides better control over inventories.
 Requires additional clerical work and additional cost to
maintain inventory records.

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 Recording Purchases of Merchandise

 Made using cash or credit (on account).

 Normally recorded when

goods are received.
 Purchase invoice should
support each credit
purchase.

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 Recording Purchases of Merchandise –
Perpetual System

Example: AB Company (the

buyer) uses as a purchase invoice
the sales invoice prepared by PW
Audio Supply company (the seller).
Prepare the journal entry for AB
company Stereo for the invoice
from PW Audio Supply.

May 4 Inventory 3,800

Accounts payable
3,800
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 Recording Purchases of Merchandise

Freight Costs – Terms of Sale

Seller places goods Free On

Board the carrier, and buyer
pays freight costs.

Seller places goods Free On

Board to the buyer’s place of
business, and seller pays
freight costs.

Freight costs incurred by the seller are an operating expense.

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LO 2
 Recording Purchases of Merchandise

Example: Upon delivery of the goods on May 6, AB Company(the

buyer) pays ABC Freight Company €150 for freight charges, the
entry on AB company’s books is:

May 6 Inventory 150

Cash 150

In contrast, if the freight terms on the invoice had required PW Audio

Supply (the seller) to pay the freight charges, the entry by PW
Audio Supply would have been:

May 4 Freight-out (Delivery expense) 150

Cash 150
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 Recording Purchases of Merchandise

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 will
for a cash refund if the grant an allowance
purchase was for cash. (deduction) from the purchase
price.

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 Recording Purchases of Merchandise

Question
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

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 Recording Purchases of Merchandise

Purchase Discounts
Credit terms may permit buyer to claim a cash discount for
prompt payment.

Advantages: Example: Credit

terms may read 2/10,
 Purchaser saves money. n/30.

 Seller shortens the operating cycle.

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 Recording Purchases of Merchandise

Purchase Discounts

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

2% discount if 1% discount if Net amount due

paid within 10 paid within first 10 within the first 10
days, otherwise days of next days of the next
net amount due month. month.
within 30 days.

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 Recording Purchases of Merchandise

Example: Assume that on May 8 AB company returned to

PW Audio Supply goods costing €300.

May 8 Accounts payable 300

Inventory 300

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 Recording Purchases of Merchandise

Example: Assume AB company 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 AB company
makes to record its May 14 payment.

May 14 Accounts payable 3,500

Cash 3,430
Inventory 70
(Discount = €3,500 x 2% = €70)

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 Recording Purchases of Merchandise

Example: If AB company 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

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 Recording Purchases of Merchandise

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
Savings by taking the discount € 50.82

Example: 2% for 20 days = Annual rate of 36.5%

(365/20 = 18.25 twenty-day periods x 2% = 36.5%)

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 Recording Purchases of Merchandise

Summary of Purchasing Transactions

Inventory
Debit Credit
May 4th - Purchase May 8th - Return
€3,800 €300
May 6th – Freight-in May 14th - Discount
150 70

Balance €3,580

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 Recording Sales of Merchandise

 Made using cash or credit (on account).

 Normally recorded when

earned, usually when
goods transfer from seller
to buyer.
 Sales invoice should
support each credit sale.

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 Recording Sales of Merchandise

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

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 Recording Sales of Merchandise

Example: Assume PW Audio Supply records its May 4 sale

of €3,800 to AB company on account as follows. Assume the
merchandise cost PW Audio Supply €2,400.

May 4 Accounts receivable 3,800

Sales revenue 3,800

May 4 Cost of goods sold 2,400

Inventory 2,400

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 Recording Sales of Merchandise

Sales Returns and Allowances

 “Flipside” of purchase returns and allowances.
 Contra-revenue account (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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 Recording Sales of Merchandise

Example: 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

May 8 Inventory 140

Cost of goods sold 140

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 Recording Sales of Merchandise

Example: 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

May 8 Inventory 50
Cost of goods sold 50

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 Recording Sales of Merchandise

Question
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.

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 Recording Sales of Merchandise

Sales Discount
 Offered to customers to promote prompt payment.
 “Flipside” of purchase discount.
 Contra-revenue account (debit).

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 Recording Sales of Merchandise

Example: Assume AB company 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%]

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 Completing the Accounting Cycle

Adjusting Entries
 Generally the same as a service company.
 One additional adjustment to make the records agree
with the actual inventory on hand.
 Involves adjusting Inventory and Cost of Goods
Sold.

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 Completing the Accounting Cycle

Example: PW Audio Supply has an unadjusted balance of

€40,500 in Inventory. Through a physical count, PW Audio
determines that its actual inventory at year-end is €40,000. The
company would make an adjusting entry as follows.

Cost of goods sold 500

Inventory
500

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 Completing the Accounting Cycle

Closing Entries

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 Completing the Accounting Cycle

Closing Entries

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 The trial balance of ABC’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.

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 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.

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 Forms of Financial Statements

Income
Statement
Presentation
of Sales

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 Forms of Financial Statements

Income
Statement
Key Items:
 Net sales

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 Forms of Financial Statements

Income
Statement
Key Items:
 Net sales
 Gross profit

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 Forms of Financial Statements

Income
Statement
Key Items:
 Net sales
 Gross profit
 Gross profit rate

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 Forms of Financial Statements

Income
Statement
Key Items:
 Net sales
 Gross profit
 Operating
expenses

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 Illustration 5-13
Forms of Financial Statements

Income
Statement
Key Items:
 Net sales
 Gross profit
 Operating
expenses
 Other income
and expense

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 Forms of Financial Statements

Income
Statement
Key Items:
 Net sales
 Gross profit
 Operating
expenses
 Other income
and expense

5-45
 Forms of Financial Statements

Income
Statement
Key Items:
 Net sales
 Gross profit
 Operating
expenses
 Other income and
expense
 Interest expense

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 Forms of Financial Statements Illustration 5-14

Income
Statement
Key Items:
 Net sales
 Gross profit
 Operating
expenses
 Other income and
expense
 Interest expense
 Net income
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 Forms of Financial Statements

Question
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.

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 Forms of Financial Statements

Classified Statement of Financial Position

Illustration 5-16

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 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
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 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 SFP Non-current liabilities
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 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 Non-current liabilities
Salaries and Wages Expense IS Operating expenses
Salaries and Wages Payable SFP Current liabilities
Sales Returns and Allowances IS Sales revenue
Sales Revenue IS Sales revenue
Share Capital - Ordinary SFP Equity
Utilities Expense IS Operating expenses

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 PERIODIC INVENTORY SYSTEM

Periodic Inventory System

 Record revenues when sales are made.
 Do not record cost of goods sold on the date of sale.
 Physical inventory count determines:
► Cost of merchandise on hand and
► Cost of goods sold during the period.
 Record purchases in Purchases account.
 Purchase returns and allowances, Purchase discounts,
and Freight costs are recorded in separate accounts.

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 PERIODIC INVENTORY SYSTEM

Determining Cost of Goods Sold

Illustration 5A-2

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 PERIODIC INVENTORY SYSTEM

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

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 PERIODIC INVENTORY SYSTEM

Freight Costs
Illustration: If Sauk pays Haul-It 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

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 PERIODIC INVENTORY SYSTEM

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

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 PERIODIC INVENTORY SYSTEM

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

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 PERIODIC INVENTORY SYSTEM

Recording Sales of Merchandise

Illustration: PW Audio Supply records the sale of €3,800 of
merchandise to Sauk Stereo on May 4 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.

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 PERIODIC INVENTORY SYSTEM

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

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 PERIODIC INVENTORY SYSTEM

Sales Discounts
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

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 PERIODIC INVENTORY SYSTEM

Comparison of Entries—Perpetual Vs. Periodic

Illustration 5A-3

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 PERIODIC INVENTORY SYSTEM

Comparison of Entries—Perpetual Vs. Periodic

Illustration 5A-3

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