Chapter 5

Accounting for
Merchandise Operations
Chapter Outline
Learning Objectives
LO 1 Describe merchandising operations and inventory
systems.
LO 2 Record purchases under a perpetual inventory
system.
LO 3 Record sales under a perpetual inventory system.
LO 4 Apply the steps in the accounting cycle to a
merchandising company.
LO 5 Prepare financial statements for a merchandising
company.
Copyright ©2019 John Wiley & Son, Inc. 2
 Merchandising Operations and
Inventory Systems
Merchandising Companies
Buy and Sell Goods
Retailer

Wholesaler Consumer

The primary source of revenues is referred to as sales revenue or sales.

LO 1 Copyright ©2019 John Wiley & Son, Inc. 3
 Merchandising Operations and Inventory Systems
Income Measurement
Not used in a
Sales Less ILLUSTRATION 5.1
service business Income measurement process for a
Revenue merchandising company

Cost of Equals Gross Less

Goods Sold Profit

Cost of goods sold is the total Operating Equals Net

Expenses Income
cost of merchandise sold (Loss)
during the period.

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 Operating Cycles
Service Company

Receive Cash Perform Services

Cash

Mail

Accounts
Receivable
ILLUSTRATION 5.2
Operating cycle for a service company

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 Operating Cycles ILLUSTRATION 5.3
Operating cycle for a
merchandising company
Merchandising Company
Receive Buy
Cash Inventory
Cash
Mail

Sell Inventory

Accounts
Inventory
Receivable

Ordinarily is longer than that of a service company.

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 Flow of Costs ILLUSTRATION 5.4
Flow of costs

Beginning Cost of Goods

Inventory Purchased

Cost of Goods
Available for Sale

Cost of Ending
Goods Sold Inventory

Companies use a perpetual or a periodic inventory system.

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 Flow of Costs
Perpetual System
• Maintain detailed records of cost of each inventory
purchase and sale(see Helpful Hint).
• Records continuously show inventory that should be
on hand for every item
• Company determines cost of goods sold each time a
sale occurs

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 Flow of Costs
Periodic System
• Do not keep detailed records of the goods on hand
• Cost of goods sold determined by count at the end of
the accounting period.
• Calculation of Cost of Goods Sold:
Beginning inventory $ 100,000
Add: Purchases, net 800,000
Goods available for sale 900,000
Less: Ending inventory 125,000
Cost of goods sold $ 775,000

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 Flow of Costs
Advantages of the Perpetual System
• Traditionally used for merchandise with high unit
values
• Shows quantity and cost of inventory that should be
on hand at any time
• Provides better control over inventories than a
periodic system

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 Recording Purchases - Perpetual System
• Made using cash or credit (on account)
• Normally record when goods are received from
seller
• Purchase invoice should support each credit
purchase

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 Purchase
invoice should
support each
credit purchase

ILLUSTRATION 5.6
Sales invoice used as purchase
invoice by Sauk Stereo

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 ILLUSTRATION 5.6

Recording Purchases Perpetual System

Illustration: Sauk Stereo (the
buyer) uses as a purchase
invoice the sales invoice
prepared by PW Audio Supply
(the seller). Prepare the
journal entry for Sauk Stereo
for the invoice from PW Audio
Supply.

May 4 Inventory 3,800

Accounts Payable 3,800
LO 2 Copyright ©2019 John Wiley & Son, Inc. 13
 Freight Costs

Ownership of goods
passes to buyer when
public carrier accepts
goods from seller.

Ownership of goods
remains with seller until
the goods reach buyer.

ILLUSTRATION 5.7
Shipping terms
Freight costs incurred by the seller are an operating expense.

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 Freight Costs
Illustration: If Sauk Stereo (the buyer) pays Acme Freight
€150 for freight charges on May 6, the entry on Sauk Stereo’s
books is:
May 6 Inventory 150
Cash 150
If the freight terms on the invoice in Illustration 5.6 had
required PW Audio Supply (the seller) to pay the freight
charges, the entry by PW Audio Supply would be:
May 4 Freight-Out (Delivery Expense)150
Cash 150
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 Purchase Returns and Allowances
Purchaser may be dissatisfied because goods are
damaged or defective, of inferior quality, or do not
meet specifications.
Purchase Return Purchase Allowance
Return goods for credit if May choose to keep
sale was made on credit, merchandise if seller will
or for a cash refund if grant a reduction from
purchase was for cash purchase price

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 Purchase Returns and Allowances
Illustration: Assume that Sauk Stereo returned goods
costing €300 to PW Audio Supply on May 8.
May 8 Accounts Payable 300
Inventory 300

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 Purchase Discounts
Credit terms may permit buyer to claim a cash discount
for prompt payment. Example: Credit terms 2/10, n/30.
Advantages:
• Purchaser saves money
• Seller shortens operating cycle by converting
accounts receivable into cash earlier

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 Purchase Discounts
2/10, n/30 1/10 EOM n/10 EOM
2% discount if paid 1% discount if paid Net amount due
within 10 days, within first 10 days within the first 10
otherwise net of next month days of the next
amount due within month
30 days.

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 Purchase Discounts
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 Stereo makes on May 14 to record
the payment.
May 14 Accounts Payable 3,500
Cash 3,430
Inventory 70
(Discount = €3,500 x 2% = €70)
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 Purchase Discounts
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 3,500
Cash 3,500

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 Purchase Discounts
Should discounts be taken when offered?
Discount of 2% on €3,500 €70.00
€3,500 invested at 10% for 20 days 19.18
Savings by taking the discount €50.82

Example: 2% for 20 days = Annual rate of 36.5%

€3,500 x 36.5% x 20 ÷ 365 = €70

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 Summary of Purchasing Transactions
Inventory
Purchase May 4 3,800 May 8 300 Purchase return
Freight-in 6 150 14 70 Purchase discount
Balance 3,580

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 Recording Sales - Perpetual System
• Made using cash or credit (on account)
• Sales revenue, like service revenue, is recorded
when performance obligation is satisfied
• Performance obligation is satisfied when goods are
transferred from seller to buyer
• Sales invoice should support each credit sale

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 Recording Sales - Perpetual System
Journal Entries to Record a Sale

#1 Cash or Accounts receivable XXX Selling

Sales revenue Price
XXX

#2 Cost of goods sold XXX

Cost
Inventory
XXX

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 Recording Sales - Perpetual System
Illustration: PW Audio Supply records its May 4 sale
of €3,800 to Sauk Stereo (Illustration 5.6) as follows
(assume merchandise cost PW Audio Supply €2,400).
May 4 Accounts Receivable 3,800
Sales Revenue 3,800
4 Cost of Goods Sold 2,400
Inventory 2,400

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 Sales Returns and Allowances
• “Flip side” of purchase returns and allowances
• Contra-revenue account to Sales Revenue (debit)
• Sales not reduced (debited) because:
 Would obscure importance of sales returns and
allowances as a percentage of sales
 Could distort comparisons

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 Sales Returns and Allowances
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 Allowances300
Accounts Receivable 300
8 Inventory 140
Cost of Goods Sold 140

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 Sales Returns and Allowances
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 Allowances300
Accounts Receivable 300
8 Inventory 50
Cost of Goods Sold 50

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 Sales Discounts
• Offered to customers to promote prompt payment
of balance due
• Contra-revenue account (debit) to Sales Revenue

Sales Returns and

Sales Revenue Allowances Sales Discounts
3,800 300 70

Net Sales
€3,430

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 Sales Discounts
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.
Cash 3,430
Sales Discounts 70
Accounts Receivable 3,500
[(€3,800 – €300) X 2%]
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 The Accounting Cycle for a
Merchandising Company
Adjusting Entries
• Generally same as a service company
• One additional adjustment to make records agree
with actual inventory on hand
• Involves adjusting Inventory and Cost of Goods Sold

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 Adjusting Entries
Illustration: Suppose that PW Audio Supply has an
unadjusted balance of €40,500 in Inventory. Through a
physical count, PW Audio Supply determines that its
actual merchandise inventory at December 31 is
€40,000. The company would make an adjusting entry
as follows.
Cost of Goods Sold 500
Inventory (€40,500 – €40,000) 500

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 Closing Entries
Dec. 31 Service Revenue 480,000
Income Summary 480,000
(Close credit balance accounts)
31 Income Summary 450,000
Sales Returns and Allowances 12,000
Sales Discounts 8,000
Cost of Goods Sold 316,000
Salaries and Wages Expense 64,000
Freight-Out 7,000
Advertising Expense 16,000
Utilities Expense 17,000
Depreciation Expense 8,000
Insurance Expense 2,000
(Close debit balance accounts)

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 Closing Entries
Dec. 31 Income Summary 30,000
Owner’s Capital 30,000
(To close net income to owner’s
capital)
31 Owner’s Capital 15,000
Owner’s Drawings 15,000
(To close owner’s drawings to
owner’s capital)

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 Income and Comprehensive Income
Statements
• Shows several steps in determining net income
• Two steps relate to principal operating activities
• Distinguishes between operating and non-operating
activities

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 PW Audio Supply
Income Statement
For the Year Ended December 31, 2020

Income Sales
Sales revenue €480,000
Less: Sales returns and allowances €12,000
Statement Sales discounts
Net sales
8,000 20,000
460,000
Cost of goods sold 316,000
Key Items: Gross profit 144,000
Operating expenses
• Net sales Salaries and wages expense 64,000
Utilities expense 17,000
• Gross profit Advertising expense
Depreciation expense
16,000
8,000
Freight-out 7,000
• Operating Insurance expense 2,000
Total operating expenses 114,000
expenses Income from operations 30,000
Other revenues and gains
• Nonoperating Interest revenue 3,000
Gain on disposal of plant assets 600 3,600
activities Other expenses and losses
Interest expense 1,800
• Net income Casualty loss from vandalism 200 2,000
Net income € 31,600

LO 5 Copyright ©2019 John Wiley & Son, Inc. ILLUSTRATION 5.14 37

 PW Audio Supply
Income Statement
For the Year Ended December 31, 2020

Income Sales
Sales revenue €480,000
Less: Sales returns and allowances €12,000
Statement Sales discounts
Net sales
8,000 20,000
460,000
Cost of goods sold 316,000
Key Items: Gross profit 144,000
Operating expenses
• Net sales Salaries and wages expense 64,000
Utilities expense 17,000
• Gross profit Advertising expense
Depreciation expense
16,000
8,000
Freight-out 7,000
• Operating Insurance expense 2,000
Total operating expenses 114,000
expenses Income from operations 30,000
Other revenues and gains
• Nonoperating Interest revenue 3,000
Gain on disposal of plant assets 600 3,600
activities Other expenses and losses
Interest expense 1,800
• Net income Casualty loss from vandalism 200 2,000
Net income € 31,600

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 Nonoperating Activities
Various revenues and expenses and gains and losses that are
unrelated to company’s main line of operations.
ILLUSTRATION 5.13
Other Revenues and Gains
Interest revenue from notes receivable and marketable securities.
Dividend revenue from investments in common stock.
Rent revenue from subleasing a portion of the store.
Gain from the sale of property, plant, and equipment.
Other Expenses and Losses
Interest expense on notes and loans payable.
Casualty losses from recurring causes, such as vandalism and accidents.
Loss from the sale or abandonment of property, plant, and equipment.
Loss from strikes by employees and suppliers.

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 Comprehensive Income Statement
ILLUSTRATION 5.15
PW Audio Supply
Comprehensive Income Statement
For the Year Ended December 31, 2020
Net income €31,600
Other comprehensive income
Unrealized holding gain on investment securities 2,300
Comprehensive income €33,900

Items excluded from net income but included in comprehensive

income are either reported in either:
• Combined statement of net income and comprehensive
income
• Separate comprehensive income statement

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 Classified Statement of Financial Position
ILLUSTRATION 5.16
PW Audio Supply
Statement of Financial Position (Partial)
December 31, 2020
Assets
Current assets
Cash € 9,500
Accounts receivable 2,300
Inventory 40,000
Prepaid insurance 1,800
Total current assets 67,400
Property, plant, and equipment
Equipment €80,000
Less: Accumulated depreciation 24,000 56,000
Total assets €123,400

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Copyright
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