Chapter
5-1
Merchandising Operations
and the Multiple-Step
Income Statement
Chapter
5-2
Accounting, Third Edition
Study Objectives
1.
Identify the differences between a service company and a
merchandising company.
2.
Explain the recording of purchases under a perpetual
inventory system.
3.
Explain the recording of sales revenues under a perpetual
inventory system.
4.
Distinguish between a single-step and a multiple-step
income statement.
5.
Determine cost of goods sold under a periodic system.
6.
Explain the factors affecting profitability.
7.
Identify a quality of earnings indicator.
Chapter
5-3
Merchandising Operations
Merchandising
Operations
Operating
cycles
Flow of costsperpetual and
periodic
inventory
systems.
Chapter
5-4
Recording
Purchases of
Merchandise
Recording
Sales of
Merchandise
Freight costs
Purchase
returns and
allowances
Purchase
discounts
Summary of
purchasing
transactions
Sales returns
and allowances
Sales discounts
Income
Statement
Presentation
Sales revenues
Gross profit
Operating
expenses
Nonoperating
activities
Determining
cost of goods
sold-periodic
system
Evaluating
Profitability
Gross profit rate
Profit margin
ratio
Merchandising Operations
Merchandising Companies
Buy and Sell Goods
Wholesaler
Retailer
Consumer
The primary source of revenues is referred to as
sales revenue or sales.
Chapter
5-5
SO 1 Identify the differences between service and merchandising companies.
Merchandising Operations
Income Measurement
Sales
Revenue
Less
Cost of
Goods Sold
Not used in a
Service business.
Equals
Gross
Profit
Cost of goods sold is the total
cost of merchandise sold
during the period.
Chapter
5-6
Illustration 5-1
Income measurement process
for a merchandising company
Less
Operating
Expenses
Equals
Net
Income
(Loss)
SO 1 Identify the differences between service and merchandising companies.
Merchandising Operations
Operating
Cycles
Illustration 5-2
The operating
cycle of a
merchandising
company ordinarily
is longer than that
of a service
company.
Chapter
5-7
SO 1 Identify the differences between service and merchandising companies.
Merchandising Operations
Flow of Costs
Illustration 5-3
Companies use either a perpetual inventory system or a periodic inventory
system to account for inventory.
Chapter
5-8
SO 1 Identify the differences between service and merchandising companies.
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.
Chapter
5-9
SO 1 Identify the differences between service and merchandising companies.
Merchandising Operations
Flow of Costs
Periodic System




Do not keep detailed records of the goods on hand.
Determine cost of goods sold only at end of accounting period.
Physical inventory count to determine cost of goods on hand.
Calculation of Cost of Goods Sold:
Beginning inventory
Add: Purchases, net
Goods available for sale
Less: Ending inventory
Cost of goods sold
Chapter
5-10
$ 100,000
800,000
900,000
125,000
$ 775,000
SO 1 Identify the differences between service and merchandising companies.
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.
Chapter
5-11
SO 1 Identify the differences between service and merchandising companies.
Chapter
5-12
Recording Purchases of Merchandise
Made using cash or credit (on account).
Normally recorded when
goods are received.
Illustration 5-5
Purchase invoice should
support each credit
purchase.
Chapter
5-13
SO 2 Explain the recording of purchases under a perpetual inventory system.
Recording Purchases of Merchandise
Illustration 5-5
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
Merchandise inventory
Accounts payable
Chapter
5-14
3,800
3,800
SO 2 Explain the recording of purchases under a perpetual inventory system.
Recording Purchases of Merchandise
Freight Costs – Terms of Sale
Illustration 5-6
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.
Chapter
5-15
Freight costs incurred by the seller are an operating expense.
Recording Purchases of Merchandise
Illustration: Assume upon delivery of the goods on May 6,
Sauk Stereo pays Haul-It Freight Company $150 for freight
charges, the entry on Sauk Stereo’s books is:
May 6
Merchandise inventory
150
Cash
150
Assume the freight terms on the invoice in Illustration 5-5
had required PW Audio Supply to pay the freight charges, the
entry by PW Audio Supply would have been:
May 4
Freight-out
Cash
Chapter
5-16
150
150
SO 2 Explain the recording of purchases under a perpetual inventory system.
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.
Chapter
5-17
Purchase Return
Purchase Allowance
Return goods for credit
if the sale was made on
credit, or for a cash
refund if the purchase
was for cash.
May choose to keep the
merchandise if the seller
will grant an allowance
(deduction) from the
purchase price.
SO 2 Explain the recording of purchases under a perpetual inventory system.
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. Merchandise Inventory
Chapter
5-18
SO 2 Explain the recording of purchases under a perpetual inventory system.
Recording Purchases of Merchandise
Illustration: Assume that on May 8 Sauk Stereo returned to
PW Audio Supply goods costing $300.
May 8
Accounts payable
Merchandise inventory
Chapter
5-19
300
300
SO 2 Explain the recording of purchases under a perpetual inventory system.
Recording Purchases of Merchandise
Purchase Discounts
Credit terms may permit buyer to claim a cash
discount for prompt payment.
Advantages:
Purchaser saves money.
Seller shortens the operating cycle.
Example: Credit terms of 2/10, n/30, is read “two-ten, net thirty.”
2% cash discount if payment is made within 10 days. Otherwise, net
amount due within 30 days.
Chapter
5-20
SO 2 Explain the recording of purchases under a perpetual inventory system.
Recording Purchases of Merchandise
Purchase Discounts - Terms
2/10, n/30
1/10 EOM
n/10 EOM
2% discount if
paid within 10
days, otherwise
net amount due
within 30 days.
1% discount if
paid within
first 10 days of
next month.
Net amount due
within the first
10 days of the
next month.
Chapter
5-21
SO 2 Explain the recording of purchases under a perpetual inventory system.
Recording Purchases of Merchandise
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 makes to
record its May 14 payment.
May 14
Accounts payable
Merchandise Inventory
Cash
3,500
70
3,430
(Discount = $3,500 x 2% = $70)
Chapter
5-22
SO 2 Explain the recording of purchases under a perpetual inventory system.
Recording Purchases of Merchandise
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
Cash
Chapter
5-23
3,500
3,500
SO 2 Explain the recording of purchases under a perpetual inventory system.
Recording Purchases of Merchandise
Purchase Discounts
Should discounts be taken when offered?
Discount of 2% on $3,500
$3,500 invested at 10% for 20 days
$ 70.00
19.18
Savings by taking the discount
$ 50.82
Passing up the discount offered equates to paying an
interest rate of 2% on the use of $3,500 for 20 days.
Example: 2% for 20 days = Annual rate of 36.5%
(365/20 = 18.25 twenty-day periods x 2% = 36.5%)
Chapter
5-24
SO 2 Explain the recording of purchases under a perpetual inventory system.
Recording Purchases of Merchandise
Summary of Purchasing Transactions
Illustration
Merchandise Inventory
Debit
4th - Purchase
6th – Freight-in
Balance
Chapter
5-25
$3,500
150
Credit
$300
70
8th - Return
14th - Discount
$3,280
SO 2 Explain the recording of purchases under a perpetual inventory system.
Recording Sales of Merchandise
Made for cash or credit (on account).
Normally recorded when
earned, usually when
goods transfer from
seller to buyer.
Illustration 5-5
Sales invoice should
support each credit
sale.
Chapter
5-26
SO 3 Explain the recording of sales revenues
under a perpetual inventory system.
Recording Sales of Merchandise
Two Journal Entries to Record a Sale
#1
#2
Chapter
5-27
Cash or Accounts receivable
Sales
XXX
Cost of goods sold
Merchandise inventory
XXX
XXX
XXX
Selling
Price
Cost
SO 3 Explain the recording of sales revenues
under a perpetual inventory system.
Recording Sales of Merchandise
Illustration: Assume PW Audio Supply records its May 4
sale of $3,800 to Sauk Stereo on account (Illustration 5-5)
as follows. Assume the merchandise cost PW Audio Supply
$2,400.
May 4
Accounts receivable
3,800
Sales
4
3,800
Cost of goods sold
Merchandise inventory
Chapter
5-28
2,400
2,400
SO 3 Explain the recording of sales revenues
under a perpetual inventory system.
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 between total sales
in different accounting periods.
Chapter
5-29
SO 3 Explain the recording of sales revenues
under a perpetual inventory system.
Recording Sales of Merchandise
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
8
Merchandise inventory
Cost of goods sold
Chapter
5-30
300
140
140
SO 3 Explain the recording of sales revenues
under a perpetual inventory system.
Recording Sales of Merchandise
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
8
Merchandise inventory
Cost of goods sold
Chapter
5-31
300
50
50
SO 3 Explain the recording of sales revenues
under a perpetual inventory system.
Recording Sales of Merchandise
Review 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.
Chapter
5-32
SO 3 Explain the recording of sales revenues
under a perpetual inventory system.
Chapter
5-33
Recording Sales of Merchandise
Sales Discount
Offered to customers to promote prompt payment.
“Flipside” of purchase discount.
Contra-revenue account (debit).
Chapter
5-34
SO 3 Explain the recording of sales revenues
under a perpetual inventory system.
Recording Sales of Merchandise
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
Accounts receivable
70
*
3,500
* [($3,800 – $300) X 2%]
Chapter
5-35
SO 3 Explain the recording of sales revenues
under a perpetual inventory system.
Income Statement Presentation
Single-Step Income Statement
Subtract total expenses from total revenues
Two reasons for using the single-step format:
1) Company does not realize any type of profit
until total revenues exceed total expenses.
2) Format is simpler and easier to read.
Chapter
5-36
SO 4 Distinguish between a single-step and a multiple-step income statement.
Income Statement Presentation
SingleStep
Chapter
5-37
Illustration 5-7
SO 4 Distinguish between a single-step and a multiple-step income statement.
Income Statement Presentation
Multiple-Step Income Statement
Considered more useful because it highlights the
components of net income.
Three important line items:
 gross profit,
 income from operations, and
 net income.
Chapter
5-38
SO 4 Distinguish between a single-step and a multiple-step income statement.
Income Statement Presentation
MultipleStep
Illustration 5-8
Key Line
Items
Chapter
5-39
SO 4 Distinguish between a single-step and a multiple-step income statement.
Income Statement Presentation
Review Question
The multiple-step 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.
Chapter
5-40
SO 4 Distinguish between a single-step and a multiple-step income statement.
Income Statement Presentation
Sales Revenues
Illustration 5-9
Chapter
5-41
SO 4 Distinguish between a single-step and a multiple-step income statement.
Income Statement Presentation
Gross Profit
Illustration 5-11
Comparisons with past amounts and rates and with those in the industry
indicate the effectiveness of a company’s purchasing and pricing policies.
Chapter
5-42
SO 4 Distinguish between a single-step and a multiple-step income statement.
Income Statement Presentation
Operating Expenses
Illustration 5-11
Chapter
5-43
Income Statement Presentation
Nonoperating Activities
Various revenues and expenses and gains and losses that
are unrelated to the company’s main line of operations.
Illustration 5-10
Chapter
5-44
SO 4 Distinguish between a single-step and a multiple-step income statement.
Illustration 5-11
Income
Statement
Presentation
Chapter
5-45
Chapter
5-46
Income Statement Presentation
Determining Cost of Goods Sold Under a
Periodic System
No running account of changes in inventory.
Ending inventory determined by physical count.
Directly adjust Merchandise Inventory account
for any transaction that affects inventory.
Chapter
5-47
SO 5 Determine cost of goods sold under a periodic system.
Income Statement Presentation
Determining Cost of Goods Sold Under a
Periodic System
Illustration 5-13
Cost of goods sold for a
merchandiser using a
periodic inventory system
Chapter
5-48
SO 5 Determine cost of goods sold under a periodic system.
Evaluating Profitability
Gross Profit Rate
A company’s gross profit may be expressed as a percentage
by dividing the amount of gross profit by net sales.
A decline in the gross profit rate might have several causes.

The company may have begun to sell products with a lower
“markup.”

Increased competition may result in a lower selling price.

Company may be forced to pay higher prices to its suppliers
without being able to pass these costs on to its customers.
Chapter
5-49
SO 6 Explain the factors affecting profitability.
Evaluating Profitability
Gross Profit Rate
Illustration 5-15
Why does Wal-Mart have a lower gross profit rate than
Target and the industry average?
Chapter
5-50
SO 6 Explain the factors affecting profitability.
Evaluating Profitability
Profit Margin Ratio
Measures the percentage of each dollar of sales that results
in net income.
How do the gross profit rate and profit margin ratio
differ?

Gross profit rate - measures the margin by which selling
price exceeds cost of goods sold.

Profit margin ratio - measures the extent by which selling
price covers all expenses (including cost of goods sold).
Chapter
5-51
SO 6 Explain the factors affecting profitability.
Evaluating Profitability
Profit Margin Ratio
Illustration 5-17
How does Wal-Mart compare to its competitors?
Keep in mind that an increasing percentage of Wal-Mart’s sales is
from low-margin groceries.
Chapter
5-52
SO 6 Explain the factors affecting profitability.
Chapter
5-53
Evaluating Profitability
Earnings have high quality if they
provide a full and transparent
depiction of how a company performed.
 In general, a measure significantly less than 1 suggests that a
company may be using more aggressive accounting techniques in
order to accelerate income recognition.
 A measure significantly greater than 1 suggests that a company
is using conservative accounting techniques which cause it to
delay the recognition of income.
Chapter
5-54
SO 7 Identify a quality of earnings indicator.
Periodic Inventory System
Recording Merchandise Transactions
 Record revenues when sales are made.
 Do not record cost of merchandise sold on the date of sale.
 Physical inventory count at the end of the period to
determine:
1.
cost of merchandise on hand and
2. cost of goods sold during the period.
 Record purchases of merchandise in Purchases account.
 Purchase returns and allowances, Purchase discounts, and
Freight costs are recorded in separate accounts.
Chapter
5-55
SO 8 Explain the recording of purchases and sales of
inventory under a periodic inventory system.
Periodic Inventory System
Recording Purchases of Merchandise
Illustration: On the basis of the sales invoice (Illustration 5-5)
and receipt of the merchandise ordered from PW Audio
Supply, Sauk Stereo records the $3,800 purchase as follows.
May 4
Purchases
Accounts payable
Chapter
5-56
3,800
3,800
SO 8 Explain the recording of purchases and sales of
inventory under a periodic inventory system.
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)
Cash
Chapter
5-57
150
150
SO 8 Explain the recording of purchases and sales of
inventory under a periodic inventory system.
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
Chapter
5-58
300
SO 8 Explain the recording of purchases and sales of
inventory under a periodic inventory system.
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
Purchase discounts
Cash
Chapter
5-59
3,500
70
3,430
SO 8 Explain the recording of purchases and sales of
inventory under a periodic inventory system.
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 (sales invoice No. 731,
Illustration 5-5) as follows.
May 4
Accounts receivable
Sales
3,800
3,800
No entry is recorded for cost of goods sold at the time of
the sale under a periodic system.
Chapter
5-60
SO 8 Explain the recording of purchases and sales of
inventory under a periodic inventory system.
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 4
Sales returns and allowances
Accounts receivable
Chapter
5-61
300
300
SO 8 Explain the recording of purchases and sales of
inventory under a periodic inventory system.
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
Accounts receivable
Chapter
5-62
70
3,500
SO 8 Explain the recording of purchases and sales of
inventory under a periodic inventory system.
Comparison of Entries—Perpetual Vs. Periodic
Chapter
5-63
SO 8 Explain the recording of purchases and sales of
inventory under a periodic inventory system.
Comparison of Entries—Perpetual Vs. Periodic
Chapter
5-64
SO 8 Explain the recording of purchases and sales of
inventory under a periodic inventory system.
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Chapter
5-65