Accounting Accounting PrinciplesPrinciplesSecond Canadian EditionSecond Canadian Edition

Prepared by: Carole Bowman, Sheridan College

Weygandt · Kieso · Kimmel · Trenholm

ACCOUNTING FOR ACCOUNTING FOR MERCHANDISING MERCHANDISING

OPERATIONSOPERATIONS

CHAPTERCHAPTER

55

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.

MERCHANDISING COMPANYMERCHANDISING COMPANY

OPERATING CYCLES FOR A OPERATING CYCLES FOR A SERVICE COMPANY AND A SERVICE COMPANY AND A

MERCHANDISING COMPANYMERCHANDISING COMPANY

Accounts Receivable

Cash

Service Company

Cash

Merchandising Company

Receive Cash

Perform Services

Sell Inventory

Accounts Receivable

Receive Cash

Buy Inventory

Merchandise Inventory

Sales Revenue

Cost ofGoods Sold

Less

ILLUSTRATION ILLUSTRATION 5-15-1 INCOME MEASUREMENT PROCESS INCOME MEASUREMENT PROCESS FOR A MERCHANDISING COMPANYFOR A MERCHANDISING COMPANY

Gross Profit

Equals

Operating Expenses

Less

Net Income(Loss)

Equals

INVENTORY SYSTEMSINVENTORY SYSTEMSMerchandising 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.

This chapter covers the perpetual method.

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.

RECORDING COST OF RECORDING COST OF GOODS PURCHASEDGOODS PURCHASED

PURCHASES OF PURCHASES OF MERCHANDISEMERCHANDISE

For purchases on account, Merchandise Inventory is debited and Accounts Payable is credited. For cash purchases, Merchandise Inventory is debited and Cash is credited.

J1Date Account Title and Explanation Ref Debit CreditMay 4 Merchandise Inventory 3,800

Accounts Payable 3,800 To record goods purchased on account, terms n/30.

General Journal

FREIGHT COSTSFREIGHT 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 Point1. Goods delivered to shipping point by seller2. Buyer pays freight costs from shipping point to destination

FOB Destination 1. Goods delivered to destination

by seller2. Seller pays 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 ACCOUNTING FOR FREIGHT COSTSFREIGHT COSTS

J1Date Account Title and Explanation Ref Debit CreditMay 4 Merchandise Inventory 150

Cash 150 To record payment of freight.

General Journal

When the purchaser directly incurs the freight costs, the account Merchandise Inventory is debited and Cash is credited.

ACCOUNTING FOR ACCOUNTING FOR FREIGHT COSTSFREIGHT COSTS

A purchaser may be dissatisfied with merchandise received because the goods1. are damaged or defective,2. are of inferior quality, or3. are not in accord with the

purchaser’s specifications.

PURCHASE RETURNS AND PURCHASE RETURNS AND ALLOWANCESALLOWANCES

J1Date Account Title and Explanation Ref Debit CreditMay 8 Accounts Payable 300

Merchandise Inventory 300 To record return of goods.

General Journal

PURCHASE RETURNS AND PURCHASE RETURNS AND ALLOWANCESALLOWANCES

For purchases 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.

QUANTITY DISCOUNTSQUANTITY DISCOUNTS

• Volume purchase terms may permit the buyer to claim a quantity discount.

• The merchandise inventory is simply recorded at the discounted cost.

PURCHASE DISCOUNTSPURCHASE DISCOUNTS

Credit terms may permit the buyer to claim a cash discount for the prompt payment of a balance due.

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.

SALES TRANSACTIONSSALES TRANSACTIONS

SALES TRANSACTIONSSALES TRANSACTIONS

J1Date Account Title and Explanation Ref Debit CreditMay 4 Accounts Receivable 3,800

Sales 3,800 To record credit sale.

May 4 Cost of Goods Sold 2,400 Merchandise Inventory 2,400

To record cost of merchandise sold.

General Journal

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 TAXESSALES 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 some Atlantic Provinces.

SALES TAXES ON REVENUESSALES 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.

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.

SALES RETURNS AND SALES RETURNS AND ALLOWANCESALLOWANCES

The normal balance of Sales Returns and Allowances is a debit.

Sales Returns and Allowances is a contra revenue account to the Sales account.

SALES RETURNS AND SALES RETURNS AND ALLOWANCESALLOWANCES

RECORDING SALES RETURNS RECORDING SALES RETURNS AND ALLOWANCESAND ALLOWANCES

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.

J1Date Account Title and Explanation Ref Debit CreditMay 8 Sales Returns and Allowances 300

Accounts Receivable 300 To record returned goods.

May 8 Merchandise Inventory 140 Cost of Goods Sold 140

To record cost of goods returned.

General Journal

• 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.

QUANTITY DISCOUNTSQUANTITY 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.

SALES DISCOUNTSSALES DISCOUNTS

COMPLETING THE COMPLETING THE ACCOUNTING CYCLEACCOUNTING CYCLE

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.

COMPLETING THE COMPLETING THE ACCOUNTING CYCLEACCOUNTING 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 account 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.

ILLUSTRATION ILLUSTRATION 5-95-9 STATEMENT PRESENTATION OF STATEMENT PRESENTATION OF

SALES REVENUE SECTIONSALES REVENUE SECTIONAs 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.

Sales revenueSales 480,000$ Less: Sales returns and allowances 20,000 Net sales 460,000$

HIGHPOINT ELECTRONIC

For the Year Ended December 31, 2002Income Statement (Partial)

ILLUSTRATION ILLUSTRATION 5-105-10 CALCULATION OF GROSS PROFITCALCULATION OF GROSS PROFIT

Gross profit is often expressed as a percentage of sales.

Net sales 460,000$ Cost of goods sold 316,000 Gross profit 144,000$

Gross profit is calculated by deducting cost of goods sold from net sales as follows:

Net sales 460,000$ 100%Cost of goods sold 316,000 69%Gross profit 144,000$ 31%

ILLUSTRATION ILLUSTRATION 5-125-12 CALCULATION OF NET INCOMECALCULATION OF NET INCOME

Net income is the “bottom line” of a company’s income statement.

Gross profit 144,000$ Operating expenses 114,000 Net income 30,000$

Net income is calculated by deducting operating expenses from gross profit as follows:

Sales revenueSales 480,000$ Less: Sales returns and allowances 20,000

Net sales 460,000 Cost of goods sold 316,000 Gross profit 144,000 Operating expenses

Selling expensesSalaries 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 114,000

Income from operations 30,000 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 1,600

Net income 31,600$

HIGHPOINT ELECTRONICIncome Statement

For the Year Ended December 31, 2002ILLUSTRATION 5-14

This is the format of a multi-step

income statement that has both

operating and non-operating activities.

As shown, the non-operating activities

are reported immediately after

the company’s primary operating

activities.

CLASSIFIED BALANCE SHEETCLASSIFIED BALANCE SHEET

Current assetsCash 9,500$ Accounts receivable 16,100 Merchandise inventory 40,000 Prepaid insurance 1,800

Total current assets 67,400 Capital assets

Store equipment 80,000$ Less: Accumulated amortization 24,000 56,000

Total assets 123,400$

HIGHPOINT ELECTRONICBalance Sheet (partial)

December 31, 2002Assets

On the balance sheet, merchandise inventory is

reported as a current asset and appears immediately

below accounts receivable. This is because current assets are listed in the

order of their liquidity.

USING THE INFORMATION IN THE USING THE INFORMATION IN THE FINANCIAL STATEMENTSFINANCIAL STATEMENTS

• 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

Inventory is particularly important because:

USING THE INFORMATION IN THE USING THE INFORMATION IN THE FINANCIAL STATEMENTSFINANCIAL 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 TURNOVERINVENTORY TURNOVER

Inventory turnover =Cost of goods soldAverage inventory

DAYS SALES IN INVENTORYDAYS SALES IN INVENTORY

Days sales in inventory =

365 daysInventory turnover

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