Accounting Principles
ACCOUNTING FOR
MERCHANDISING
OPERATIONS
MERCHANDISING COMPANY
• A merchandising company is an enterprise
that buys and sells goods to earn a profit.
1. Wholesalers sell to retailers.
2. Retailers sell to consumers.
• A merchandiser’s primary source of revenue
is sales, whereas a service company’s
primary source of revenue is service
revenue.
OPERATING CYCLES FOR A SERVICE
COMPANY AND A MERCHANDISING
COMPANY
Service Company
Receive
Cash
Cash
Perform
Services
Accounts
Receivable
Merchandising Company
Receive
Cash
Cash
Buy
Inventory
Sell Inventory
Accounts
Receivable
Merchandise
Inventory
Accounting for Merchandising Operations
Power Notes
Accounting Principles
INCOME MEASUREMENT PROCESS
FOR A MERCHANDISING COMPANY
Sales
Revenue
Less
Equals
Cost of
Goods Sold
You should recognize this process
already, but without the middle
two boxes.
Less
Gross
Profit
Equals
Operating
Expenses
Net
Income
(Loss)
INVENTORY SYSTEMS
Merchandising entities may use either (or both)
of the following inventory systems:
1. Perpetual – where detailed records of each
inventory purchase and sale are maintained.
Cost of goods sold is calculated at the time of
each sale.
2. Periodic – detailed records are not
maintained. Cost of goods sold is calculated
only at the end of the accounting period.
We will look mainly at the perpetual method.
RECORDING COST OF GOODS
PURCHASED
• When merchandise is purchased for
resale to customers, the account,
Merchandise Inventory, is debited for the
cost of the goods.
• Purchases may be made for cash or on
account (credit).
• The purchase is normally recorded
by the purchaser when the goods
are received from the seller.
Accounting for Merchandising Operations
Power Notes
Accounting Principles
PURCHASES OF MERCHANDISE
General Journal
Date Account Title and Explanation Ref
May 4 Merchandise Inventory
Accounts Payable
To record goods purchased on
account, terms n/30.
Debit
3,800
J1
Credit
3,800
For purchases on account, Merchandise
Inventory is debited and Accounts Payable is
credited. For cash purchases, Merchandise
Inventory is debited and Cash is credited.
FREIGHT COSTS
• The sales agreement should indicate whether
the seller or the buyer is to pay the cost of
transporting the goods to the buyer’s place of
business.
• FOB Shipping Point
1. Goods delivered to shipping point by seller
2. Buyer pays freight costs from shipping
point to destination
• FOB Destination
1. Goods delivered to destination by seller
2. Seller pays freight costs
ACCOUNTING FOR FREIGHT
COSTS
• Merchandise Inventory is debited by the
buyer, if the buyer pays the freight bill
(FOB shipping point).
• Freight Out (or Delivery Expense) is
debited by the seller, if the seller pays the
freight bill (FOB destination).
Accounting for Merchandising Operations
Power Notes
Accounting Principles
ACCOUNTING FOR
FREIGHT COSTS
General Journal
Date Account Title and Explanation
May 4 Merchandise Inventory
Cash
To record payment of freight.
Ref
Debit
150
J1
Credit
150
When the purchaser directly incurs the
freight costs, the account Merchandise
Inventory is debited and Cash is
credited.
PURCHASE RETURNS
AND ALLOWANCES
• A purchaser may be dissatisfied with
merchandise received because the goods
1. are damaged or defective,
2. are of inferior quality, or
3. are not in accord with the purchaser’s
specifications.
PURCHASE RETURNS
AND ALLOWANCES
General Journal
Date Account Title and Explanation
May 8 Accounts Payable
Merchandise Inventory
To record return of goods.
Ref
Debit
300
J1
Credit
300
For purchase returns and allowances that were
originally made on account, Accounts Payable
is debited and Merchandise Inventory is
credited. For cash returns and allowances, Cash
is debited and Merchandise Inventory is
credited.
Accounting for Merchandising Operations
Power Notes
Accounting Principles
QUANTITY DISCOUNTS
• Volume purchase terms may permit the
buyer to claim a quantity discount.
• The merchandise inventory is simply
recorded at the discounted cost.
PURCHASE DISCOUNTS
• Credit terms may permit the buyer to
claim a cash discount for the prompt
payment of a balance due. E.g. 2/15 n30
• The buyer calls this discount a purchase
discount.
• A purchase discount is based on the
invoice cost less any returns and
allowances granted.
• Revenues are reported when earned in
accordance with the revenue recognition
principle.
• In a merchandising company, revenues are
earned when the goods are transferred from
seller to buyer.
Accounting for Merchandising Operations
Power Notes
Accounting Principles
SALES TRANSACTIONS
General Journal
Date Account Title and Explanation
May 4 Accounts Receivable
Sales
To record credit sale.
Ref
Debit
3,800
J1
Credit
3,800
May 4 Cost of Goods Sold
Merchandise Inventory
To record cost of merchandise
sold.
2,400
2,400
1. The first entry records the sale of goods to a
customer at the retail (selling) price.
2. The second entry releases the goods from
inventory at cost and charges the goods to
Cost of Goods Sold.
SALES TAXES
•
•
Sales tax is expressed as a percentage of the
sales price on selected goods sold to customers
by a retailer. They are collected on most
revenues, and paid on many costs.
Sales taxes may include the federal goods and
services tax (GST) and the provincial sales tax
(PST), if any. These two taxes have been
combined into one harmonized sales tax (HST)
in most Provinces.
SALES TAXES ON REVENUES
• The retailer collects the tax from the
customer when the sale occurs, and
periodically (usually monthly) remits the
collections to the Receiver General.
• Sales taxes are not revenue but are a
current liability until remitted.
Accounting for Merchandising Operations
Power Notes
Accounting Principles
• Sales Returns occur when customers are
dissatisfied with merchandise and are
allowed to return the goods to the seller for
credit or a refund.
• Sales Allowances occur when customers
are dissatisfied, and the seller allows
a deduction from the selling price.
• The normal balance of Sales Returns and
Allowances is a debit.
• Sales Returns and Allowances is a contra
revenue account to the Sales account.
General Journal
Date Account Title and Explanation
May 8 Sales Returns and Allowances
Accounts Receivable
To record returned goods.
May 8 Merchandise Inventory
Cost of Goods Sold
To record cost of goods
returned.
Ref
Debit
300
J1
Credit
300
140
140
1. The first entry reduces the balance owed by the
customer and records the goods returned at retail
price.
2. The second entry records the physical return of
goods to inventory at cost and removes the goods
from the Cost of Goods Sold account.
Accounting for Merchandising Operations
Power Notes
Accounting Principles
QUANTITY DISCOUNTS
• A quantity discount is the offer of a cash
discount to a customer in return for a
volume sale.
• Quantity discounts result in a sales price
reduction. They are not separately
journalized. Instead the sale is recorded at
the reduced price.
SALES DISCOUNTS
• A sales discount is the offer of a cash
discount to a customer in exchange for the
prompt payment of a balance due.
• Similar to Sales Returns and Allowances,
Sales Discounts is also a contra revenue
account with a normal debit balance.
• A merchandising company requires the same
types of adjusting entries as a service
company, with one additional adjustment for
inventory to ensure the recorded inventory
amount agrees with the actual quantity on
hand.
• A physical count is an important control
feature since a perpetual system indicates
what should be there but a count will
determine what is actually there.
Accounting for Merchandising Operations
Power Notes
Accounting Principles
COMPLETING THE
ACCOUNTING CYCLE
• A merchandising company also requires the
same types of closing entries as a service
company.
• The additional accounts that need to be closed
out in a merchandising company include Sales,
Sales Returns and Allowances, Cost of Goods
Sold, and Freight Out.
• Merchandise Inventory is an asset account and
is not closed at the end of the period.
STATEMENT PRESENTATION
OF SALES REVENUE SECTION
As contra revenue accounts, Sales returns and
allowances (and sales discounts, if any) are
deducted from Sales in the income statement to
arrive at Net Sales.
HIGHPOINT ELECTRONIC
Income Statement (Partial)
For the Year Ended December 31, 2002
Sales revenue
Sales
$ 480,000
Less: Sales returns and allowances
20,000
Net sales
$ 460,000
CALCULATION OF GROSS PROFIT
Gross profit is calculated by deducting cost
of goods sold from net sales as follows:
Net
sales
Net
sales
Cost
of of
goods
sold
Cost
goods
sold
Gross
profit
Gross
profit
$ 460,000
$ 460,000 100%
316,000
316,000 69%
$ 144,000
$ 144,000 31%
Gross profit is often expressed as a
percentage of sales.
Accounting for Merchandising Operations
Power Notes
Accounting Principles
CALCULATION OF NET INCOME
Net income is calculated by deducting operating
expenses from gross profit as follows:
Gross profit
Operating expenses
Net income
$ 144,000
114,000
$ 30,000
Net income is the “bottom line” of a
company’s income statement.
This is the format
of a multi-step
income statement
that has both
operating and nonoperating
activities.
As shown, the nonoperating activities
are reported
immediately after
the company’s
primary operating
activities.
HIGHPOINT ELECTRONIC
Income Statement
For the Year Ended December 31, 2002
Sales revenue
Sales
Less: Sales returns and allowances
Net sales
Cost of goods sold
Gross profit
Operating expenses
Selling expenses
Salaries expense
$ 45,000
Advertising expense
16,000
Amortization expense
8,000
Freight out
7,000
Total selling expenses
$ 76,000
Administrative expenses
Rent expense
$ 19,000
Utilities expense
17,000
Insurance expense
2,000
Total administrative expenses
38,000
Total operating expenses
Income from operations
Other revenue and gains
Interest revenue
$ 3,000
Gain on sale of equipment
600
Total non-operating revenue and gain
$ 3,600
Other expenses and losses
Interest on expense
$ 1,800
Casualty loss from vandalism
200
Total non-operating expense and loss
2,000
Net non-operating revenue
Net income
$ 480,000
20,000
460,000
316,000
144,000
114,000
30,000
$
1,600
31,600
CLASSIFIED BALANCE SHEET
HIGHPOINT ELECTRONIC
Balance Sheet (partial)
December 31, 2002
Assets
On the balance sheet,
Current assets
merchandise inventory is
Cash
9,500
reported as a current asset and $
Accounts receivable
16,100
appears immediately below
accounts receivable. This is
Merchandise inventory
40,000
because current assets are listed
Prepaid insurance
1,800
in the order of their liquidity.
Total current assets
67,400
Capital assets
Store equipment
$ 80,000
Less: Accumulated amortization
24,000
56,000
Total assets
$ 123,400
Accounting for Merchandising Operations
Power Notes
Accounting Principles
USING THE INFORMATION IN THE
FINANCIAL STATEMENTS
Inventory is particularly important because:
• It is a large current
asset on the balance
sheet
• It becomes a large
expense on the income
statement
• It is vulnerable to theft
or misuse
USING THE INFORMATION IN
THE FINANCIAL STATEMENTS
• A balancing act is needed to ensure that a
sufficient, but not excessive, quantity of
inventory is on hand.
• Two ratios help evaluate the management
of inventory:
• Inventory turnover
• Days sales in inventory
INVENTORY TURNOVER
Inventory turnover =
Cost of goods sold
Average inventory
Accounting for Merchandising Operations
Power Notes
Accounting Principles
DAYS SALES IN INVENTORY
Days sales in inventory =
365 days
Inventory turnover
Accounting for Merchandising Operations
Power Notes