Accounting For Merchandising Operations

Review Materials
Prepared by:
Junior Philippine Institute of
Accountants UC-Banilad Chapter
F.Y. 2019-2020
Accounting for
Merchandising
KEY TERMS AND CONCEPTS TO REMEMBER:
THE OPERATING CYCLE OF A MERCHANDISING BUSINESS
CASH
COLLECTION OF PURCHASE OF
RECEIVABLES MERCHANDISE
ACCOUNTS
SALE OF
RECEIVABLE (if
MERCHANDISE
on account)
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Merchandising – a business engaged in the buying and selling of final goods.
Merchandise Inventory:
 Merchandise Inventory (Inventory or MI) refers to the goods the company has
purchased and intends to sell to others.
 Inventory is a current asset since the company intends to sell it within one year.
Cost of Goods Sold:

 Inventory that has been sold becomes an expense, Cost of Goods Sold, in the
period of sale.
Inventory Systems:
 Perpetual Inventory System
 records all inventory transactions as they occur in the Merchandise Inventory account.
 records all purchase-related inventory transactions as they occur in separate accounts and
records the cost of goods sold only at the end of the period.
 Periodic Inventory System

 the inventory account is updated at the end of an accounting period rather than after every
sale and purchase.
 Shrinkage is the cost of inventory not on hand and not sold. It is part of cost of goods sold under
either inventory system
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Purchasing Transactions:
 Inventory account is increased for the cost of the merchandise purchased plus the freight cost
necessary to transport the inventory to the buyer’s place of business (FOB shipping point).
 Inventory is always recorded at the final cost to the buyer, purchase price less allowances received
from the seller and any cash discounts taken
 Trade discounts are deducted as part of the initial purchase transaction; they are not a purchase
discount.
Purchase returns:
 Inventory account is decreased for the cost of the merchandise returned to the seller less any
allowances or discounts already recorded in the ledger.
Sales Transactions:
 Inventory account is decreased and cost of goods sold is increased for the cost of the merchandise
sold.
 The freight cost necessary to transport the inventory to the buyer’s place of business is an expense
in the period of sale (FOB Destination). Transportation Out or Freight Out are typical accounts
used to record the expense.
 The selling price of the merchandise sold represents revenue to the seller and is recorded in a
separate transaction.
 Trade discounts are deducted as part of the initial sale transaction; they are not a sales discount
nor a contra-revenue.
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Sales Returns:
 Inventory account is increased and cost of goods sold is decreased for the cost of the merchandise
returned by the buyer.
 Sales returns and allowances is increased and cash or A/R is decreased for the selling price of the
merchandise returned by the buyer.
ALWAYS KNOW WHETHER YOU ARE THE BUYER OR THE SELLER IN THE
TRANSACTION. SOME OF THE ACCOUNTS USED AND SOME OF THE DOLLAR
AMOUNTS RECORDED WILL DIFFER DEPENDING ON WHETHER YOU ARE THE
BUYER OR SELLER IN THE TRANSACTION.
Transportation (Freight) Costs:

 FOB Shipping Point – Purchaser is responsible for paying the shipping charges. They are usually
prepaid by the seller and added to the invoice. Buyer adds the shipping costs to inventory. If seller
prepays, seller has a receivable from buyer.
 FOB Destination – Seller is responsible for paying the shipping charges and they are recorded as
the expense Transportation Out. Buyer does not make an entry.
 Transportation (freight) costs are not subject to a cash discount.
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Credit Terms:
 Generally take the form of 2/10, n/30 where
• 2 is the discount %
• 10 is the discount period in days
• n is the net (total) amount to pay
• 30 is the number of days after the invoice date that the net amount is due
 Only purchases are subject to the discount; transportation or freight costs paid by the seller on
behalf of the buyer are not subject to a discount.
 Cash discounts reduce the cost of inventory for the buyer (credit merchandise inventory)
 Cash discounts reduce revenue for the seller (debit sales discounts, a contra revenue account)
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KEY TOPICS:
1. Purchase Transactions
 When companies purchase goods they intend to sell to customers, the transaction is recorded in
the Merchandise Inventory account, a current asset.
 Inventory is recorded at cost, which includes the price paid for the goods plus all necessary costs
of getting the inventory to the company’s place of business and ready to sell.
 The rules of FOB determine whether freight costs are included in the cost of inventory.
2. Sales Transactions
 When companies sell merchandise inventory, the transaction requires two journal entries: the
first entry records the revenue from the sale at the selling price and the second entry decreases
the inventory account and records the expense of the sale at cost.
 Revenue (sales) is recorded at the time the transaction occurs, regardless of whether payment is
received from the buyer.
 Inventory is decreased for the cost of the inventory sold.
 The rules of FOB determine whether freight costs are recorded as transportation out, a selling
expense.
EXAMPLE: Inventory is sold for $800 cash (FOB shipping point. In a separate transaction, the
purchaser pays $100 of shipping charges to the shipping company. Note that the seller has a 20%
gross margin ratio. The total cost of the inventory when purchased was $640 (800 –( 20% * 800)):
Cash 800
Sales 800
8 Cost of Goods Sold 640
Merchandise Inventory 640
KEY TOPICS:
3. Inventory Shrinkage
 Inventory could have been stolen or damaged, disposed of and not reported as such
 Inventory losses or shrinkage, under the matching principle, are recorded as expenses in the
period in which they occur to match them against the revenue earned.
 Although texts suggest that they should be recorded as cost of goods sold, in practice they may be
recorded in a separate inventory shrinkage expense account reported within cost of goods sold.
EXAMPLE: The balance in the Merchandise Inventory account in the general ledger was $300,000
before adjustment. A Physical Inventory was taken and the value of the merchandise on hand was
$294,000.
Adjusting entry required:
Cost of Merchandise Sold 6,000

Merchandise Inventory 6,000
4. Multi-Step Income Statement

 Provides a substantial amount of additional significant information to the user of the financial
statements.
 It also incorporates revenues and expenses unique to the merchandising company versus a
service provider.
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KEY TOPICS:
Key characteristics of a multi-step income statement include:
 Gross-to-Net Sales to account for contra-revenue accounts

 Gross Profit to report the margin or profit remaining after covering the cost of merchandise sold
that is available to cover operating expenses
 Separating Operating Expenses into selling expenses and administrative expenses to provide an
additional level detail
 Income from Operations to report the profitability of the company’s reason for being in business
 Other Income and Other Expense to identify the revenues and expenses not
 related to the company’s reason for being in business
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End of Topic
Please see complementary test bank for
practice problems and theories.
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Dear, you.
Always be in pursuit for
the one you have not yet
become. Keep going!
Love,
Your UCB-JPIA family
12
Reference:
Harper College (2012). Accounting for merchandising
operations. Retrieved on July 21, 2020 from
https://www.harpercollege.edu/academic-
support/tutoring/subjects/pdf/ACC101-Chapter4new.pdf
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Review Materials

Cost of Goods Sold:

 Periodic Inventory System

Transportation (Freight) Costs:

Cost of Merchandise Sold 6,000

4. Multi-Step Income Statement

 Gross-to-Net Sales to account for contra-revenue accounts

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