Chapter 5

Accounting Principles, 7
th
Edition
Weygandt Kieso Kimmel
After studying this chapter, you should be able to:
1 identify the differences between a service
enterprise and a merchandising company
2 explain the entries for purchases under a
perpetual inventory system
3 explain the entries for sales revenues under a
perpetual inventory system
4 explain the steps in the accounting cycle for a
merchandising company
ACCOUNTING FOR MERCHANDISING
OPERATIONS
5 distinguish between a multiple-step and a
single-step income statement
6 explain the computation and importance of
gross profit
7 determine the cost of goods sold under a
periodic system
CHAPTER 5
ACCOUNTING FOR MERCHANDISING
OPERATIONS
After studying this chapter, you should be able to:
MERCHANDISING COMPANY
A merchandising company buys and
sells goods to earn a profit.
1) Wholesalers sell to retailers
2) Retailers sell to consumers

Primary source of revenue is Sales
Expenses for a merchandiser are divided into
two categories:
1 Cost of goods sold
The total cost of merchandise sold during the period
2 Operating expenses
Expenses incurred in the process of earning sales revenue
(Examples: sales salaries and insurance expense)

Gross profit is equal to Sales Revenue less Cost of
Goods Sold
MEASURING NET INCOME
INCOME MEASUREMENT PROCESS
FOR A MERCHANDISING COMPANY
OPERATING CYCLES FOR A SERVICE
COMPANY AND A MERCHANDISING
COMPANY
INVENTORY SYSTEMS
Merchandising entities may use either:
1) Perpetual Inventory
Detailed records of the cost of each item are
maintained, and the cost of each item sold is
determined from records when the sale
occurs.
2) Periodic Inventory
Cost of goods sold is determined only at the
end of an accounting period.
PERPETUAL VS. PERIODIC
COST OF GOODS SOLD
To determine the cost of goods sold
under a periodic inventory system:
1) Determine the cost of goods on hand at
the beginning of the accounting period,
2) Add to it the cost of goods purchased,
and
3) Subtract the cost of goods on hand at
the end of the accounting period.
Merchandise is purchased for resale to customers,
the account
Merchandise Inventory is debited for the cost
of goods.
Like sales, 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.
Each credit purchase should be supported by a
purchase invoice.
PURCHASES OF MERCHANDISE
STUDY OBJECTIVE 2
PURCHASES OF MERCHANDISE

SALES INVOICE
PURCHASES OF MERCHANDISE
For purchases on account,
Merchandise Inventory is debited
and Accounts Payable is credited.

GENERAL JOURNAL

Date Account Titles and Explanation Dr. Cr.
May 4 Merchandise Inventory
Accounts Payable
(To record goods purchased on
account, terms 2/10, n/30, from
Sellers Electronix)



3,800
3,800
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 purchasers
specifications.
The purchaser initiates the request for a reduction of
the balance due through the issuance of a debit
memorandum (purchasers debit decreases A/P!).
The debit memorandum is a document issued by a
buyer to inform a seller that the sellers account has
been debited because of unsatisfactory merchandise.
PURCHASE RETURNS AND
ALLOWANCES
PURCHASE RETURNS AND
ALLOWANCES
For purchases returns and allowances,
Accounts Payable is debited and
Merchandise Inventory is credited.

GENERAL JOURNAL

Date Account Titles and Explanation Dr. Cr.
May 8 Accounts Payable
Merchandise Inventory
(To record return of inoperable
goods received from Sellers
Electronix, DM No. 126)



300
300
A sales agreement should indicate whether the seller or the buyer is
to pay the cost of transporting the goods to the buyers place of
business.

FOB Shipping Point
1) Goods placed free on board the carrier
by seller
2) Buyer pays freight costs

FOB Destination
1) Goods placed free on board at
buyers business
2) Seller pays freight costs
FREE ON BOARD
Merchandise Inventory is debited if
buyer pays freight.
Freight-out (or Delivery Expense) is
debited if seller pays freight.
ACCOUNTING FOR FREIGHT
COSTS
ACCOUNTING FOR FREIGHT
COSTS
When the purchaser directly incurs the freight costs, the account
Merchandise Inventory is debited and Cash is credited.
GENERAL JOURNAL
Date Account Titles and Explanation Dr. Cr.
May 6 Merchandise Inventory
Cash
(To record payment of freight,
terms FOB shipping point)
150
150
ACCOUNTING FOR FREIGHT
COSTS
Freight costs incurred by the seller on outgoing
merchandise are debited to Freight-out (or
Delivery Expense) and Cash is credited.
GENERAL JOURNAL
Date Account Titles and Explanation Dr. Cr.
May 4 Freight-out (Delivery Expense)
Cash
(To record payment of freight on
goods sold FOB destination)
150
150
PURCHASE 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.
Like a sales discount, a
purchase discount is based on
the invoice cost less returns
and allowances, if any.
PURCHASE DISCOUNTS
If payment is made within the discount period, Accounts
Payable is debited, Cash is credited, and Merchandise
inventory is credited for the discount taken.
GENERAL JOURNAL
Date Account Titles and Explanation Dr. Cr.
May 14 Accounts Payable
Cash
Merchandise Inventory
(To record payment within
discount period)
3,500
3,430
70
If payment is made after the discount
period, Accounts Payable is debited and
Cash is credited for the full amount.
GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
June 3 Accounts Payable
Cash
(To record payment with no
discount taken)
3,500
3,500
SAVINGS OBTAINED BY TAKING
PURCHASE DISCOUNT
Discount of 2% on $3,500 $ 70.00
Interest received on $3,500 (for 20 days at 10%) ( 19.44)
Savings by taking the discount $ 50.56


A buyer should usually take all available discounts.
If Beyer Video takes the discount, it pays $70 less in cash.
If it forgoes the discount and invests the $3,500 for 20 days
at 10% interest, it will earn only $19.44 in interest.
The savings obtained by taking the discount is calculated as
follows:
Revenues (Revenue recognition
principle)
Earned when the goods are transferred
from seller to buyer

All sales should be supported by a document
such as a cash register tape or sales
invoice.
SALES TRANSACTIONS
STUDY OBJECTIVE 3
RECORDING CASH SALES
For cash sales, Cash is debited and Sales is credited.
For the cost of goods sold for cash, Cost of Goods
Sold is debited and Merchandise Inventory is credited.
GENERAL JOURNAL
Date Account Titles and Explanation Dr. Cr.
May 4 Cash
Sales
(To record daily cash sales)
4 Cost of Goods Sold
Merchandise Inventory
(To record cost of merchandise
sold for cash)
2,200
2,200

1,400
1,400
RECORDING CREDIT SALES
For credit sales, Accounts Receivable is debited and Sales is credited.
For the cost of goods sold on account, Cost of Goods Sold is debited
and Merchandise Inventory is credited.

GENERAL JOURNAL

Date Account Titles and Explanation Dr. Cr.
May 4 Accounts Receivable
Sales
(To record credit sales to Beyer
Video per invoice #731)

4 Cost of Goods Sold
Merchandise Inventory
(To record cost of merchandise
sold on invoice #731 to Beyer
Video)



3,800
3,800


2,400
2,400
Sales Returns
Customers dissatisfied with merchandise
and are allowed to return the goods to the
seller for credit or a refund.
Sales Allowances
Result when customers are dissatisfied and
the seller allows a deduction from the
selling price.
SALES RETURNS AND
ALLOWANCES
Credit memorandum
the seller prepares a form to inform the
customer that a credit has been made to the
customers account receivable
Sales Returns and Allowances
Contra revenue account to the Sales
account
The normal balance of Sales Returns
and Allowances is a debit
SALES RETURNS AND
ALLOWANCES
RECORDING SALES RETURNS
AND ALLOWANCES
The sellers entry to record a credit memorandum involves a debit to the
Sales Returns and Allowances account and a credit to Accounts
Receivable. The entry to record the cost of the returned goods involves
a debit to Merchandise Inventory and a credit to Cost Goods Sold.

GENERAL JOURNAL

Date Account Titles and Explanation Dr. Cr.
May 8 Sales Returns and Allowances
Accounts Receivable
(To record return of inoperable
goods delivered to Beyer Video,
per credit memorandum)

8 Merchandise Inventory
Cost of Goods Sold
(To record cost of goods returned
per credit memorandum)



300
300



140
140
Sales discount
Offer of a cash discount to a customer for the
prompt payment of a balance due
Is a contra revenue account with a normal debit
balance
Example: Credit sale has the terms 3/10, n/30, a 3%
discount is allowed if payment is made within 10
days. After 10 days there is no discount, and the
balance is due in 30 days.

SALES DISCOUNTS
T E R M S E X P L A N A T I O N









CREDIT TERMS
Credit terms specify the amount and time
period for the cash discount
Indicates the length of time in which the purchaser is
expected to pay the full invoice price

2/10, n/30 A 2% discount may be taken if payment is made
within 10 days of the invoice date.

1/10 EOM A 1% discount is available if payment is made
by the 10
th
of the next month.
RECORDING
SALES DISCOUNTS
When cash discounts are taken by
customers, the seller debits Sales Discounts.

GENERAL JOURNAL

Date Account Titles and Explanation Dr. Cr.
May 14 Cash
Sales Discounts
Accounts Receivable
(To record collection within 2/10,
n/30 discount period from Beyer
Video)


3,430
70
3,500
CLOSING ENTRIES
STUDY OBJECTIVE 4

Adjusting entries are journalized from the adjustment
columns of the work sheet.
All accounts that affect the determination of net income are
closed to Income Summary.
Data for the preparation of closing entries may be obtained
from the income statement columns of the work sheet.

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit
2005 (1)
Dec. 31 Sales
Income Summary
(To close income statement
accounts with credit balances)


480,000
480,000
CLOSING ENTRIES
Cost of Goods Sold is a new account that must be closed to
Income Summary.

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit
2005 (2)
Dec. 31 Income Summary 140,000
Sales Returns and Allowances 12,000
Sales Discounts 8,000
Cost of goods sold 316,000
Store Salaries Expense 45,000
Rent Expense 19,000
Freight-out 7,000
Advertising Expense 16,000
Utilities Expense 17,000
Depreciation Expense 8,000
Insurance Expense 2,000
(To close income statement
accounts with debit balances)


CLOSING ENTRIES
After the closing entries are posted, all temporary accounts
have zero balances
It addition, R. A. Lamb, Capital has a credit balance of
$98,000 ($83,000 + $30,000 - $15,000).

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit
2005 (3)
Dec. 31 Income Summary 30,000
R. A. Lamb, Capital 30,000
(To close net income to capital)

(4)
31 R. A. Lamb, Capital 15,000
R. A. Lamb, Drawing 15,000
(To close drawings to capital)


Chapter5

Under a perpetual inventory system,
acquisition of merchandise for resale is
debited to the

a. purchases account
b. supplies account
c. merchandise inventory account
d. cost of goods sold account
Chapter5

Under a perpetual inventory system,
acquisition of merchandise for resale is
debited to the

a. purchases account
b. supplies account
c. merchandise inventory account
d. cost of goods sold account
Includes sales revenue, cost of goods
sold, and gross profit sections
Additional nonoperating sections may
be added for:
1) revenues and expenses resulting
from secondary or auxiliary operations
2) gains and losses unrelated to
operations
MULTIPLE-STEP INCOME
STATEMENT
STUDY OBJECTIVE 5

Operating expenses may be subdivided
into:
a) Selling expenses
b) Administrative expenses
Nonoperating sections are reported after
income from operations and are classified as:
a) Other revenues and gains
b) Other expenses and losses

MULTIPLE-STEP
INCOME STATEMENT

SELLERS ELECTRONIX


Income Statement


For the Year Ended December 31, 2005


Revenues
Net sales $ 460,000
Interest revenue 3,000
Gain on sale of equipment 600
Total revenues 463,600
Expenses
Cost of goods sold $ 316,000
Selling expenses 76,000
Administrative expenses 38,000
Interest expense 1,800
Casualty loss from vandalism 200
Total expenses 432,000
Net income $ 31,600


SINGLE-STEP INCOME
STATEMENT
All data are classified under
two categories:
1 Revenues
2 Expenses
Only one step is required in
determining net income or net
loss.
Gross profit is determined as follows:

Net sales $ 460,000
Cost of goods sold 316,000
Gross profit $ 144,000
COMPUTATION OF GROSS
PROFIT
STUDY OBJECTIVE 6

OPERATING EXPENSES IN
COMPUTING NET INCOME
Net income is determined as follows:

Gross profit $ 144,000
Operating expenses 114,000
Net income $ 30,000
Chapter5

Gross profit for a merchandiser is net sales
minus

a. operating expenses
b. cost of goods sold
c. sales discounts
d. cost of goods available for sale

Chapter5

Gross profit for a merchandiser is net sales
minus

a. operating expenses
b. cost of goods sold
c. sales discounts
d. cost of goods available for sale

PERIODIC INVENTORY
SYSTEMS
Appendix 5A
Revenues from the sale of merchandise are
recorded when sales are made in the same way as
in a perpetual system
No attempt is made on the date of sale to record
the cost of merchandise sold
Physical inventories are taken at end of period to
determine:
The cost of merchandise on hand
The cost of the goods sold during the period
Determining Cost of Goods Sold
Periodic
STUDY OBJECTIVE 7

Purchases
Merchandise purchased for resale to
customers
May be made for cash or on account
(credit)
Normally recorded by the purchaser when
the goods are received from the seller
Credit purchase should be
supported by a purchase invoice
RECORDING MERCHANDISE
TRANSACTIONS UNDER A
PERIODIC INVENTORY SYSTEM
RECORDING PURCHASES
OF MERCHANDISE
To illustrate the recording of merchandise
transactions under a periodic system, we will
use the purchase/sale transactions between
Seller and Buyer. For purchases on account,
Purchases is debited and Accounts Payable is
credited for merchandise ordered from Seller.
Date Account Titles Debit Credit
General Journal
May 4 Purchases 3,800
Accounts Payable 3,800
A sales return and allowance on the sellers books is
recorded as a purchase return and allowance on the
books of the purchaser.
Purchase Returns and Allowances
contra account to Purchases
Normal credit balance
Debit memorandum
Purchaser initiates the request for a reduction of the
balance due through the issuance of a debit memorandum
A document issued by a buyer to inform a seller that the
sellers account has been debited because of
unsatisfactory merchandise
PURCHASE RETURNS
AND ALLOWANCES
RECORDING PURCHASE
RETURNS AND
ALLOWANCES
For purchases returns and allowances, Accounts
Payable is debited and Purchase Returns and
Allowances is credited. Because $300 of
merchandise received from Seller is inoperable,
Buyer returns the goods and issues a debit
memo.
Date Account Titles Debit Credit
General Journal
May 8 Accounts Payable 300
Purchase Returns and Allowances 300
Freight-in is debited if buyer pays
freight
Freight-out (or Delivery Expense) is
debited if seller pays freight
ACCOUNTING FOR FREIGHT
COSTS
ACCOUNTING FOR FREIGHT
COSTS
When the purchaser directly incurs the freight
costs, the account Freight-in (or Transportation-in)
is debited and Cash is credited. In this example,
Buyer pays Acme Freight Company $150 for
freight charges on its purchase from Seller.
Date Account Titles Debit Credit
General Journal
May 9 Freight-in 150
Cash 150
PURCHASE 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.
Like a sales discount, a purchase discount
is based on the invoice cost less returns
and allowances, if any.
PURCHASE DISCOUNTS
If payment is made within the discount period,
Accounts Payable is debited, Purchase
Discounts is credited for the discount taken,
and Cash is credited. On May 14 Buyer pays
the balance due on account to Seller taking
the 2% cash discount allowed by Seller for
payment within 10 days.
Date Account Titles Debit Credit
General Journal
May 14 Accounts Payable 3,500
Purchase Discounts 70
Cash 3,430
For credit sales, Accounts
Receivable is debited and Sales is
credited. In this illustration, the
sale of $3,800 of merchandise to
Buyer on May 4 is recorded by the
Seller.
RECORDING SALES OF
MERCHANDISE
Date Account Titles Debit Credit
General Journal
May 4 Accounts Receivable 3,800
Sales 3,800
RECORDING SALES RETURNS
AND ALLOWANCES
The sellers entry to record a credit memorandum
involves a debit to the Sales Returns and Allowances
account and a credit to Accounts Receivable. Based
on the debit memo received from Buyer on May 8 for
returned goods, Seller records the $300 sales returns
above.
Date Account Titles Debit Credit
General Journal
May 8 Sales Returns and Allowances 300
Accounts Receivable 300
RECORDING
SALES DISCOUNTS
When cash discounts are taken by customers, the
seller debits Sales Discounts. On May 15, Seller
receives payment of $3,430 on account from
Buyer. Seller honors the 2% discount and records
the payment of Buyers accounts receivable.
Date Account Titles Debit Credit
General Journal
May 15 Cash 3,430
Sales Discounts 70
Accounts Receivable 3,500
WORK SHEET FOR A MERCHANDISING
COMPANY
USING A WORK SHEET
Appendix 5B
Trial Balance Columns
1 Data from the trial balance are obtained from
the ledger balances of Sellers Electronix at
December 31
2 The amount shown for Merchandise
Inventory, $40,500, is the year-end inventory
amount which results from the application of
a perpetual inventory system
USING A WORK SHEET
Adjustments Columns
1 A merchandising company usually has the
same types of adjustments as a service
company
2 Work sheet adjustments b, c, and d are for
insurance, depreciation, and salaries
Adjusted Trial Balance - The adjusted trial
balance shows the balance of all accounts after
adjustment at the end of the accounting period
USING A WORK SHEET
Income Statement Columns
1 The accounts and balances that affect the
income statement are transferred from the
adjusted trial balance columns to the income
statement columns for Sellers Electronix at
December 31
2 All of the amounts in the income statement
credit column should be totaled and compared
to the total of the amounts in the income
statement debit column
USING A WORK SHEET
Balance Sheet Columns
1 The major difference between the balance
sheets of a service company and a
merchandising company is inventory
2 For Sellers Electronix, the ending
Merchandise Inventory amount of $40,000 is
shown in the balance sheet debit column
3 The information to prepare the owners equity
statement is also found in these columns