Chapter 5

Accounting for Merchandising

Operations

ACCT 100
Objectives:
1. To distinguish a service company from
a merchandising company.
2. To learn how to account for inventory
purchase and inventory sale under a
perpetual inventory system.
3. To learn how to account for inventory
purchase, inventory sale under a
periodic inventory system.

Accounting for Merchandising operations 2

Defining Inventory
1. Assets held for resale purpose in a normal
course of business.
2. Assets used to produce products for resale
purpose.
Examples of Inventory:
Merchandising Firms: merchandise or
goods
Manufacturing Firms: raw materials
work-in-process
finished Goods
Accounting for Merchandise Inventory, Cost of Goods Sold and the Gross Profit 3
Service Companies
Providing services (i.e., transportation
companies, banks, etc.)
Main Revenues: service revenues.
Income measurement:
Service Revenues
- Operating Expenses
Operating Income
Operating cycle: Cash Providing Service
Accounts receivables Cash
Accounting for Merchandise Inventory, Cost of Goods Sold and the Gross Profit 4
Merchandising Companies
Buy and sell goods (i.e., retail companies
such as Wal-Mart, Macys, etc.).
Main revenues: Sales revenues.
Income measurement:
Sales Revenues
- Cost of Goods Sold (cost of total merchandise sold during the period)
Gross Profit
- Operating Expenses
Operating Income
Operating cycle: Cash Buy Inventory Sell
Inventory Accounts Receivable Cash
Accounting for Merchandise Inventory, Cost of Goods Sold and the Gross Profit 5
Perpetual Inventory System- An
Example
On February 10, inventory Costing
$1,000 was purchased on credit, terms,
2/10 and n/30.
On March 2, Inventory costing $250
was sold for $500 on credit.

Accounting for Merchandising Operations 6

 Accounting for Inventory Purchase A
Perpetual Inventory System
At Purchase:
Inventory 1,000
Accounts Payable 1,000
(to record goods purchased on account, terms
2/10, n/30)
At Sale:
Accounts Receivable 500
Sales Revenue 500
(to record credit sale, terms 2/10,n/30)

Cost of Goods Sold 250

Inventory 250
(to record cost of merchandise sold)Operations
Accounting for Merchandising 7
T-Accounts of Inventory and CGS
Inventory CGS
1,000 250 250
750

Accounts Rec. Sales

500 500

Accounting for Merchandising Operations 8

Perpetual Inventory System
The inventory account is used for the
purchase and sale of inventory.
The balances of inventory is available at
all time.
A physical count of inventory is needed
at the end of a period.
Any discrepancy of inventory book
balance with physical count should be
adjusted to a loss or gain account.

Accounting for Merchandise Inventory, Cost of Goods Sold and the Gross Profit 9
Perpetual Inventory System (contd.)
The cost of goods sold (CGS) account
is used to record the CGS of a sale.
Therefore, the CGS is known at all
time.
The CGS is determined by selecting a
cost flow assumption (will be discussed
in Chapter 6).

Accounting for Merchandise Inventory, Cost of Goods Sold and the Gross Profit 10
 Purchase, Purchase Returns and
Allowance and Purchase Discounts
On Feb. 10, $1,000 inventory was purchased on credit.
$200 inv. was returned on Feb. 15. The payment was
made on Feb, 17.
Feb. 10 Inventory 1,000
Accounts Payable 1,000
(To record goods purchased, terms 2/10, n/30)
Feb. 15 Accounts Payable 200
Inventory 200
(To record return of goods purchased)
Feb. 17 Accounts Payable 800
Cash 784
Inventory 16
(To record payment with discount taken)
Accounting for Merchandising Operations 11
Purchase Discount Not Taken
March 3 Accounts Payable 800
Cash 800
(To record payment on account without discount
taken)

Accounting for Merchandising Operations 12

Purchase of Inventory Freight
Costs
Freight Terms: FOB Shipping PointBuyers
are responsible for freight charges.
Feb. 10 Inventory 100
Cash 100
(To record freight charges of $100, terms FOB
shipping point)
Note: If freight terms were FOB destination, the
seller will be responsible for the payment of the
freights.

Accounting for Merchandising Operations 13

Purchase Invoice/Sales Invoice (see
Illustration 5-4 of textbook for an example)
Any purchase should be supported by a
purchase invoice.
Companies usually record purchases when
receiving goods from the seller.
A purchaser uses the sales invoice of the
seller as its purchase invoice.
In addition to the names of the seller and the
buyer, the goods sold and the total amount,
credit terms and freight terms are also
included in the sales invoice.
Accounting for Merchandising Operations 14
 Sales, Sales Returns and Allowances,
Sales Discounts
On March 2, Inventory costing $250 was sold for $500 on
credit. On March 5, $50 of inventory sold was returned:
Mar. 2 A/R 500
Sales 500
(To record credit sale, terms 2/10,n/30)
CGS 250
Inventory 250
(To record cost of merchandise sold)
Mar. 5 Sales Return and Allowance 50
A/R 50
Inventory 25
CGS 25
(To record sales return)
15
Collection of A/R and Sales
Discounts
Collection of A/R on Mar. 7:
Cash 441
Sales Discount 9
A/R 450
(To record collection of A/R within discount period)
If the discount is not taken (i.e., collection after
discount period:
Cash 450
A/R 450
Accounting for Merchandising Operations 16
Net Sales
Net Sales = Sales Sales Returns and
Allowances Sales Discount

Accounting for Merchandising Operations 17

Sale of Inventory Freight Costs
FOB Shipping Point:
Buyers are responsible for the freight.
FOB Destination:
Seller are responsible for the freight.
The seller paid $30 for the shipping:
Freight-out 30
Cash 30
(Note: Freight-out is an expense account)

Accounting for Merchandising Operations 18

Closing Entries
Sale Revenue 500
Income Summary 500
Income Summary 314
Cost of Goods Sold 225
Sales ret. and Allow. 50
Sales Discount 9
Freight-out 30

Accounting for Merchandising Operations 19

Income Statement Formats
Multiple -Step Income Statement (see
illustration 5-11 of textbook for an Example) :
Net sales revenue $150,000
Cost of good sold (80,000)
Gross margin 70,000
Operating expenses
Selling, Administration and Depreciation (40,000)
Income form operations 30,000
Other icome (expense):
Interest revenue $2,000
Interest expense (9,000)
Gain on sale of equipment 3,000 (4,000)
Income before income tax 26,000
Income tax expense (10,000)
Net income $16,000
Accrual Accounting and the Financial Statements 20
20
Income Statement Formats (contd.)
Single-Step Income Statement (See Illus.5-12 of
textbook)
Revenues:
Net sales $150,000
Interest revenue 2,000
Gain on sale of equipment 3,000
Total revenue $155,000
Expenses:
Cost of goods sold 80.000
Selling, administrative and depr. 40,000
Interest expense 9,000
Income tax expense 10,000
Total expenses 139,000
Net Income $ 16,000
Accounting for Merchandising Operations 21
Income Statement Formats (Contd.)
Selling expenses include: salaries
expense (sales related), advertising
expense, freight-out.
Administrative expenses include:
salaries expense (administration
related), utility expense, insurance
expense.

Accounting for Merchandising Operations 22

Periodic Inventory System (using
the example on page 6)
At Purchase:
Purchases 1,000
Accounts Payable 1,000
(to record goods purchased on account, terms
2/10, n/30)
At Sale:
Accounts Receivable 500
Sales Revenue 500
(to record credit sale, terms 2/10,n/30)

Accounting for Merchandise Inventory, Cost of Goods Sold and the Gross Profit 23
Periodic Inv. System: Purchase, Purchase
Returns and Allowance and Purchase Discounts
On Feb. 10, $1,000 inventory was purchased on credit.
$200 inv. was returned on Feb. 15. The payment was made
on Feb, 17. The buyer paid freight charge $100 on 2/10.
2/10 Purchases 1,000
Accounts Payable 1,000
2/10 Freight-in 100
Cash 100
2/15 A/P 200
Purchase R&A 200
2/17 A/P 800
Cash 784
Purchase Discounts 16
Accounting for Merchandising Operations 24
Net Purchases of a Periodic
Inventory System
Net purchases = Purchases Purchases
Returns and Allowances Purchases
Returns + Freight-in

Accounting for Merchandising Operations 25

Periodic Inv. System: Sales, Sales Returns
and Allowances and Sales Discounts
On March 2, Inventory costing $250 was sold for $500 on
credit with terms, 2/10, n/30 and FOB destination. Shipping
cost is $30. On March 5, $50 of inventory sold was returned
and the remaining bal. of A/R was collected on March 7.
3/2 A/R 500
Sales 500
Freight-out 30
Cash 30
3/5 Sales Ret. and Allow. 50
A/R 50
3/7 Cash 441
Sales Discount 9
A/R Accounting for Merchandising Operations
450 26
Comparison of Perpetual vs. Periodic
Inventory System
Perpetual Inventory Sys. Periodic Inventory Sys.
Pur. Inventory 1,000 Purchases 1,000
A/P 1,000 A/P 1,000
Freight Inventory 100 Freight-in 100
Cash 100 Cash 100
Pur. R&A A/P 200 A/P 200
Inventory 200 Pur. R&A 200
Pur. Dis. A/P 800 A/P 800
Cash 784 Cash 784
Inventory 16 Pur. Dis. 16

Accounting for Merchandise Inventory, Cost of Goods Sold and the Gross Profit 27
 Comparison of Perpetual vs. Periodic
Inventory System (Contd.)
Perpetual Inventory Sys. Periodic Inventory Sys.
Sales A/R 500 A/R 500
Sales 500 Sales 500
CGS 250 None
Inventory 250
Sales R&A 50
S. Ret. Sales R&A 50
A/R 50
A/R 50
None
Inventory 25
CGS 25
S. Dis. Cash 441 Cash 441
Sales Dis. 9 Sales Dis. 9
A/R 450 A/R 450
Freight Freight-out 30 Freight-out 30
Cash 30 Cash 30
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