Accounting Principles

Second Canadian Edition

Weygandt Kieso Kimmel Trenholm

Carole Bowman, Sheridan College

Prepared by:

CHAPTER

5
ACCOUNTING FOR MERCHANDISING OPERATIONS

MERCHANDISING COMPANY

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 merchandisers primary source of revenue is sales, whereas a service companys primary source of revenue is service revenue.

OPERATING CYCLES FOR A SERVICE COMPANY AND A MERCHANDISING COMPANY

Service Company
Receive Cash

Cash

Perform Services

Accounts Receivable
Merchandising Company
Receive Cash

Cash
Sell Inventory

Buy Inventory

Accounts Receivable

Merchandise Inventory

ILLUSTRATION 5-1

INCOME MEASUREMENT PROCESS FOR A MERCHANDISING COMPANY

Sales Revenue
Less

Equals

Cost of Goods Sold

Gross Profit

Less

Equals

Operating Expenses

Net Income (Loss)

INVENTORY SYSTEMS
Merchandising 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.

RECORDING COST OF GOODS PURCHASED

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.

PURCHASES OF MERCHANDISE
General Journal Date Account Title and Explanation Ref May 4 Merchandise Inventory Accounts Payable To record goods purchased on account, terms n/30. J1 Credit 3,800

Debit 3,800

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

FREIGHT COSTS

The 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 delivered to shipping point by seller 2. Buyer pays freight costs from shipping point to destination FOB Destination 1. Goods delivered to destination by seller 2. Seller pays freight costs

ACCOUNTING FOR 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 FREIGHT COSTS

General Journal Date Account Title and Explanation May 4 Merchandise Inventory Cash To record payment of freight.

Ref

Debit 150

J1 Credit 150

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

PURCHASE RETURNS AND ALLOWANCES

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.

PURCHASE RETURNS AND ALLOWANCES

General Journal Date Account Title and Explanation May 8 Accounts Payable Merchandise Inventory To record return of goods.

Ref

Debit 300

J1 Credit 300

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 DISCOUNTS
Volume purchase terms may permit the buyer to claim a quantity discount. The merchandise inventory is simply recorded at the discounted cost.

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. A purchase discount is based on the invoice cost less any returns and allowances granted.

SALES TRANSACTIONS

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 TRANSACTIONS
General Journal Date Account Title and Explanation May 4 Accounts Receivable Sales To record credit sale. May 4 Cost of Goods Sold Merchandise Inventory To record cost of merchandise sold. Ref Debit 3,800 J1 Credit 3,800

2,400 2,400

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 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 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 AND ALLOWANCES

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 ALLOWANCES

The normal balance of Sales Returns and Allowances is a debit. Sales Returns and Allowances is a contra revenue account to the Sales account.

RECORDING SALES RETURNS AND ALLOWANCES

General Journal Date Account Title and Explanation May 8 Sales Returns and Allowances Accounts Receivable To record returned goods. May 8 Merchandise Inventory Cost of Goods Sold To record cost of goods returned. Ref Debit 300 J1 Credit 300

140 140

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.

QUANTITY DISCOUNTS
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.

SALES 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.

COMPLETING THE ACCOUNTING 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 ACCOUNTING 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 5-9

STATEMENT PRESENTATION OF SALES REVENUE SECTION

As 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.
HIGHPOINT ELECTRONIC Income Statement (Partial) For the Year Ended December 31, 2002 Sales revenue Sales $ 480,000 Less: Sales returns and allowances 20,000 Net sales $ 460,000

ILLUSTRATION 5-10

CALCULATION OF GROSS PROFIT

Gross profit is calculated by deducting cost of goods sold from net sales as follows:
Net Net sales sales Cost Cost of of goods goods sold sold Gross Gross profit profit $ $ 460,000 460,000 316,000 $ 144,000

100% 69% 31%

Gross profit is often expressed as a percentage of sales.

ILLUSTRATION 5-12

CALCULATION OF NET INCOME

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

Gross profit Operating expenses Net income

$ 144,000 114,000 $ 30,000

Net income is the bottom line of a companys income statement.

ILLUSTRATION 5-14

HIGHPOINT ELECTRONIC Income Statement For the Year Ended December 31, 2002 Sales revenue Sales Less: Sales returns and allowances Net sales Cost of goods sold Gross profit Operating expenses Selling expenses Salaries expense $ Advertising expense Amortization expense Freight out Total selling expenses Administrative expenses Rent expense $ Utilities expense Insurance expense Total administrative expenses Total operating expenses Income from operations Other revenue and gains Interest revenue $ Gain on sale of equipment Total non-operating revenue and gain Other expenses and losses Interest on expense $ Casualty loss from vandalism Total non-operating expense and loss Net non-operating revenue Net income $ 480,000 20,000 460,000 316,000 144,000

This is the format of a multi-step income statement that has both operating and nonoperating activities.
As shown, the nonoperating activities are reported immediately after the companys primary operating activities.

45,000 16,000 8,000 7,000 $ 76,000 19,000 17,000 2,000 38,000 114,000 30,000 3,000 600 $ 1,800 200 2,000 $ 1,600 31,600 3,600

CLASSIFIED BALANCE SHEET

HIGHPOINT ELECTRONIC Balance Sheet (partial) December 31, 2002 Assets On the balance sheet, Current assets merchandise inventory is Cash reported as a current asset Accounts receivable and appears immediately Merchandise inventory below accounts receivable. Prepaid insurance This is because current assets are listed in the Total current assets order of their liquidity. Capital assets Store equipment $ 80,000 Less: Accumulated amortization 24,000 Total assets

9,500 16,100 40,000 1,800 67,400

56,000 $ 123,400

USING THE INFORMATION IN THE FINANCIAL STATEMENTS

Inventory is particularly important because:
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

USING THE INFORMATION IN THE FINANCIAL 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 TURNOVER

Inventory turnover = Cost of goods sold Average inventory

DAYS SALES IN INVENTORY

Days sales in inventory = 365 days Inventory turnover

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