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Chapter 5 Accounting for Merchandising Operations

n
PLUS

SUMMARY OF STUDY OBJECTIVES

1 Identify the differences between service and merchandising companies. Because of inventory, a merchandising company has sales revenue, cost of goods sold, and
gross profit. To account for inventory, a merchandising
company must choose between a perpetual and a periodic
inventory system.
2 Explain the recording of purchases under a perpetual
inventory system. The company debits the Merchandise
Inventory account for all purchases of merchandise and
freight-in, and credits it for purchase discounts and purchase returns and allowances.

3 Explain the recording of sales revenues under a perpetual inventory system. When a merchandising company
sells inventory, it debits Accounts Receivable (or Cash), and
credits Sales for the selling price of the merchandise. At the
same time, it debits Cost of Goods *Sold, and credits
Merchandise Inventory for the cost of the inventory items
sold.

4 Explain the steps in the accounting cycle for a merchandising company. Each of the required steps in the

accounting cycle for a service company applies to a merchandising company. A worksheet is again an optional step.
Under a perpetual inventory system, the company must adjust the Merchandise Inventory account to agree with the
physical count.
5 Prepare an income statement for a merchandiser. The
income statement usually has the following components:
sales revenue, cost of goods sold, gross profit, operating expenses, other income and expense, and interest expense.
6 Explain the computation and importance of gross
profit. Merchandising companies compute gross profit by

subtracting cost of goods sold from net sales. Gross profit

represents the merchandising profit of a company.
Managers and other interested parties closely watch the
amount and trend of gross profit and of the gross profit rate.

f-a

GLOSSARY

'PLUS

Comprehensive income An income measure that includes

gains and losses that are excluded from the determination

of net income. (p. 216).
Contra-revenue account An account that is offset against a
revenue account on the income statement. (p. 209).
Cost of goods sold The total cost of merchandise sold
during the period. (p. 200).
FOB destination Freight terms indicating that the seller
places the goods free on board to the buyer's place of business, and the seller pays the freight. (p. 205).
FOB shipping point Freight terms indicating that the seller
places goods free on board the carrier, and the buyer pays
the freight costs. (p. 205).
Gross profit The excess of net sales over the cost of goods
sold. (p. 214).
Gross profit rate Gross profit expressed as a percentage, by
dividing the amount of gross profit by net sales. (p. 215).
Net sales Sales less sales returns and allowances and less
sales discounts. (p. 214).
Operating expenses Expenses incurred in the process of
earning sales revenues. (p. 215).
Periodic inventory system An inventory system under
which the company does not keep detailed inventory
records throughout the accounting period but determines

the cost of goods sold only at the end of an accounting

period. (p. 202).
Perpetual inventory system An inventory system under
which the company keeps detailed records of the cost of each
inventory purchase and sale,with the result that the records continuously show the inventory that should be on hand. (p. 201).
Purchase allowance A deduction made to the selling price
of merchandise, granted by the seller so that the buyer will
keep the merchandise. (p. 206).
Purchase discount A cash discount claimed by a buyer for
prompt payment of a balance due. (p. 206).
Purchase invoice A document that supports each credit
purchase. (p. 203).
Purchase return A return of goods from the buyer to the
seller for a cash or credit refund. (p. 206).
Sales discount A reduction given by a seller for prompt
payment of a credit sale. (p. 210).
Sales invoice A document that supports each credit sale.
( p 208).
Sales returns and allowances Purchase returns and allowances from the seller's perspective. See Purchase return
and Purchase
(P. 209).
Sales revenue (Sales) The primary source of revenue in a
merchandising company. (p. 200).

APPENDIX 5A Periodic Inventory System

As described in this chapter, companies may use one of two basic systems of
accounting for inventories: (1)the perpetual inventory system or (2) the periodic inventory system. In the chapter, we focused on the characteristics of
the perpetual inventory system. In this appendix, we discuss and illustrate