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Accounting for Merchandising Activities

CHAPTER 6

2007 McGraw-Hill Ryerson Ltd.

Learning Objectives
1.

2.
3.

Describe merchandising and identify and explain the important income statement and balance sheet components for a merchandising company. Describe both periodic and perpetual inventory systems. Analyze and record transactions for merchandise purchases and sales using a perpetual system.
2007 McGraw-Hill Ryerson Ltd.

Learning Objectives
4.

5.

6.

Prepare adjustments for a merchandising company. Define, prepare, and use merchandising income statements. Prepare closing entries for a merchandising company.

2007 McGraw-Hill Ryerson Ltd.

Learning Objectives
7.

8.

Record and compare merchandising transactions using both periodic and perpetual inventory systems. (Appendix 6A) Explain and record Provincial Sales Tax (PST) and Goods and Services Tax (GST). (Appendix 6B)

2007 McGraw-Hill Ryerson Ltd.

Merchandising Activities
Merchandiser: A company that earns net income by buying and selling merchandise. Examples: The Bay, Canadian Tire, The Gap Wholesaler: A company that buys products from manufacturers or other wholesalers and sells them to retailers or other wholesalers. Examples: Provigo, Westfair Foods
2007 McGraw-Hill Ryerson Ltd.

Computing Net Income

Merchandiser
Net Sales

Service Company
Revenue

Cost of Goods Sold

Gross Profit

Operating Expenses

Operating Expenses

Net Income

Net Income
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Inventory
Products a company owns for the purpose of selling to customers. It is:
Often

referred to as Merchandise Inventory. Classified as a current asset.

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Inventory
Cost of inventory includes:
Costs

incurred to purchase the goods. Shipping costs. Other costs required to make goods ready for sale.

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Inventory Systems
Perpetual Provides a continuous record of: The amount of inventory on hand. Cost of goods sold to date. Periodic Requires a physical count of goods to determine: The amount of inventory on hand. Cost of goods sold.
2007 McGraw-Hill Ryerson Ltd.

Perpetual System-Example
Purchases
Oct. 1 Inventory 5,000 Accounts Payable 5,000 Purchased inventory on account

Purchase Returns and Allowances

Oct. 4 Accounts Payable Inventory 1,000 1,000

Defective merchandise returned to supplier.

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Purchase/Sales Discounts
A deduction from the invoice price granted to induce early payment of the amount due. Example 2/10, n30
Terms Time
Oct.1
Discount Period = 10 days Credit Period = 30 days

Oct.11
(Full amount minus 2% discount) due between Oct.1 and Oct.11 Full amount due anytime between Oct.12 and Oct.31

Oct.31

Due

Purchase or Sale
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Perpetual System Example

Purchase Discounts- Assume the purchase of inventory on October 1 was on the terms 2/10,n30. Case 1-Discount taken
Oct.11 Accounts Payable 4,000 Inventory 80 Cash 3,920 2% x (5,000 - 1,000) = 80
This amount decreases the cost of merchandise inventory

Case 2-Discount not taken

Oct.31 Accounts Payable Cash 4,000 4,000

2007 McGraw-Hill Ryerson Ltd.

Mini-Quiz
Prepare journal entries for each of the following transactions. Assume a perpetual inventory system. October 6: Purchased 650 units of inventory at $5 per unit. The seller offered a cash discount of 2/10, n/30. October 8: Returned 25 defective units and received full credit. October 10:Paid the amount in full, less the returned items.

2007 McGraw-Hill Ryerson Ltd.

Mini-Quiz
Prepare journal entries for each of the following transactions. Assume a perpetual inventory system. October 6: Purchased 650 units of inventory at $5 per unit. The seller offered a cash discount of 2/10, n/30. Oct.6 Inventory 3,250 A/P to record purchase (650 x 5)

3,250

2007 McGraw-Hill Ryerson Ltd.

Mini-Quiz
Prepare journal entries for each of the following transactions. Assume a perpetual inventory system. October 6: Purchased 650 units of inventory at $5 per unit. The seller offered a cash discount of 2/10, n/30. October 8: Returned 25 defective units and received full credit.

2007 McGraw-Hill Ryerson Ltd.

Mini-Quiz
Prepare journal entries for each of the following transactions. Assume a perpetual inventory system. October 6: Purchased 650 units of inventory at $5 per unit. The seller offered a cash discount of 2/10, n/30. October 8: Returned 25 defective units and received full credit. 8 A/P 125 Inventory 125 to record return of inventory (25 x 5)
2007 McGraw-Hill Ryerson Ltd.

Mini-Quiz
Prepare journal entries for each of the following transactions. Assume a perpetual inventory system. October 6: Purchased 650 units of inventory at $5 per unit. The seller offered a cash discount of 2/10, n/30. October 8: Returned 25 defective units and received full credit. October 10:Paid the amount in full, less the returned items.

2007 McGraw-Hill Ryerson Ltd.

Mini-Quiz
Prepare journal entries for each of the following transactions. Assume a perpetual inventory system.

October 10:Paid the amount in full, less the returned items. 11 A/P Inventory Cash 3,125 62.50 3,062.50

to record payment on account within discount period (3,250-125) x 2%

2007 McGraw-Hill Ryerson Ltd.

Mini-Quiz
Oct.6 Inventory A/P (650 x 5) Inventory (25 x 5) Inventory Cash 3,250 3,250

8 A/P

125

125

11 A/P

3,125

(3,250-125) x 2%

62.50 3,062.50

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Transportation Charges Perpetual System

Seller
FOB Shipping Point (Buyer pays shipping charges)

Goods
Carrier

Buyer
FOB Destination (Seller pays for shipping charges)

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Perpetual System Example

Transportation Charges
Oct. 2 Inventory Accounts Payable 100 100

Transportation charges on goods purchased FOB shipping point.

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Perpetual System Example

Sales of Merchandise
Oct.15 Accounts Receivable 4,000 Sales 4,000 Sale of merchandise, terms 1/10, n30 Cost of goods sold 3,000 Inventory 3,000 To record cost of merchandise sold

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Perpetual System Example

Sales Returns and Allowances
Oct.17 Sales Returns & Allowance 400 Accounts Receivable 400 Defective merchandise returned Inventory Cost of Goods Sold To record return of inventory 300 300

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Perpetual System Example

Sales Discounts Case 1- Discount taken
Oct.25 Cash Sales Discounts Accounts Receivable 1% X (4,000 - 400) = 36 3,564 36 3,600

Case 2- Discount not taken

Oct.25 Cash Accounts Receivable (4,000- 400) 3,600 3,600

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Adjustments Perpetual Inventory

Perpetual

inventory systems keep a running total of inventory levels by recording sales and purchase transactions. Periodic adjustments must be made to account for shrinkage (loss due to theft or deterioration of inventory).
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Perpetual System Example

Inventory per accounting records: $198,000 Inventory per physical count: $194,200 Difference (shrinkage) $3,800 Adjustment required:
Oct.31 Cost of Goods Sold Inventory 3,800
3,800

To record inventory shrinkage revealed by physical count.

2007 McGraw-Hill Ryerson Ltd.

Income Statement Formats

Income statements may be formatted in a variety of ways. Typical formats are:
Classified,

Multiple-Step Multiple-Step Single-Step

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Z-Mart Income Statement For Year Ended December 31, 2011

Classified Sales Sales discounts Less: Sales Multi-step Net sales returns and allowances goods Format Cost ofprofit sold Gross
Operating expenses: Selling expenses: Amortization expense, store Sales salaries expense Rent expense Store supplies expense Advertising expense General and administrative expenses: Amortization expense, office Office salaries expense Insurance expense Rent expense Office supplies Total operating expenses Income from operations Other revenues and expenses: Rent revenue Interest expense Net income $ 3,000 18,500 8,100 1,200 11,300 700 25,300 600 900 1,800

$ 321,000 $ 4,300 2,000 6,300 314,700 230,400 84,300

42,100

29,300 71,400 12,900 2,800 (360)

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2,440 $ 15,340

Multi-step Format

Z-Mart Income Statement For Year Ended December 31, 2011 Sales, net Cost of goods sold Gross profit Operating expenses: Amortization expense Salaries expense Rent expense Insurance expense Supplies expense Advertising expense Income from operations Other revenues and expenses: Rent revenue Interest expense Net income $ 314,700 230,400 84,300 $ 3,700 43,800 9,000 600 3,000 11,300

71,400 12,900

2,800 (360)

2,440 $ 15,340

2007 McGraw-Hill Ryerson Ltd.

Singlestep Format

Z-Mart Income Statement For Year Ended December 31, 2011 Revenues: Sales, net Rent revenue Total revenues Expenses: Cost of goods sold Selling expense General and administrative expense Interest expense Total expenses Net income $ 314,700 2,800 317,500 $ 230,400 42,100 29,300 360 302,160 $ 15,340

2007 McGraw-Hill Ryerson Ltd.

Gross Profit Ratio

The amount of gross profit expressed as a percentage of net sales. May be tracked over time and/or compared to similar businesses. May be calculated for whole business, departments, products.

Gross profit ratio

Gross profit from sales Net sales

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X 100

Closing Entries-Perpetual System

The closing process is similar for merchandising and service companies. Merchandising companies have additional temporary accounts that must be closed.

These include: Sales Sales Returns & Allowances Sales Discounts Cost of Goods Sold
2007 McGraw-Hill Ryerson Ltd.

Review
Q Identify and explain the components of income A
for a merchandising company. The basic components of income start with net sales. From net sales is subtracted the cost of goods sold. The resulting amount is called gross profit or gross margin. Selling and administrative expenses are subtracted from gross margin to determine income from operations.

2007 McGraw-Hill Ryerson Ltd.

Review
Q Explain the difference between single-step and
multiple-step income statements. A A single-step income statement format includes cost of goods sold as an operating expense, and shows only one subtotal for total expenses. Operating expenses are highly summarized. A multiple-step income statement shows intermediate totals between sales and net income. It also includes detailed computations of net sales and cost of goods sold.
2007 McGraw-Hill Ryerson Ltd.

Appendix 6A- Periodic and Perpetual Inventory Systems Compared

Periodic systems Inventory is updated at the end of the period based on a physical count. Perpetual systems Inventory is updated after each sale or purchase.

2007 McGraw-Hill Ryerson Ltd.

Appendix 6A Example
Periodic System
Purchase of Merchandise
Purchases Accounts Payable 5,000 5,000 Inventory Accounts Payable 5,000 5,000

Perpetual System

Return of Merchandise
Accounts Payable Purchase Returns 1,000 1,000 Accounts Payable Inventory 1,000 1,000

2007 McGraw-Hill Ryerson Ltd.

Appendix 6A Example
Periodic System
Accounts Payable Purchase Discounts Cash 4,000 80 3,920

Perpetual System
Accounts Payable Inventory Cash 4,000 80 3,920

Purchase Discount Taken (2/10, n30)

Transportation Charges
Transportation-in Accounts Payable 100 100 Inventory Accounts Payable 100 100

2007 McGraw-Hill Ryerson Ltd.

Appendix 6A Example
Periodic System
Sale of merchandise
Accounts Receivable Sales 4,000 4,000 Accounts Receivable Sales Cost of Goods Sold Inventory 3,000 3,000 4,000 4,000

Perpetual System

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Appendix 6A Example
Periodic System
Sales Return
Sales Returns Accounts Receivable 400 400 Sales Returns Accounts Receivable Inventory Cost of Goods Sold 300 300 400 400

Perpetual System

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Appendix 6A Example
Periodic System: Calculation of Net Purchases and Cost of Goods Purchased
Purchases Less: Purchase discounts Purchase returns and allowances $4,200 1,500 5,700 $235,800

Net Purchases
Add: Transportation in Cost of Goods Purchased

$230,100
2,300 232,400

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Appendix 6A Example
Periodic System: Calculation of Cost of Goods Sold
Beginning Merchandise Inventory Plus: Net cost of purchases Less: Ending merchandise inventory $19,000 232,400 21,000

Equals: Cost of Goods Sold

$230,400

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Appendix 6A Example
Periodic System: Closing Entries; (1) Close all credit temporary accounts to Income Summary
Rent Revenue Sales Merchandise Inventory 2,800 321,000 21,000

Purchase Discounts
Purchase Returns and Allowances Income Summary

42,000
1,500 350,500

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Appendix 6A Example
Periodic System: Closing Entries; (2) Close all debit temporary accounts to Income Summary
Income Summary Sales Discounts Sales Returns and Allowances Merchandise Inventory 335,160 4,300 2,000 19,000

Purchases
Transportation in Amortization expense, store equipment

235,800
2,300 3,000

..etc..
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Appendix 6A Summary
The periodic system transfers cost of goods sold to the Income Summary account but does not use a Cost of Goods Sold account.

The periodic system does not measure shrinkage. Instead it calculates cost of goods available for sale, subtracts the cost of ending inventory, and defines the difference as cost of goods sold, which includes shrinkage.
2007 McGraw-Hill Ryerson Ltd.

Appendix 6B Sales Tax

Provincial Sales Tax (PST)
A consumption tax applied on sales to the final consumers of products or services.
Is

not applicable to all sales. from province to province. collected is a liability.

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Varies

Amount 7%

in BC

Appendix 6B Sales Tax

Goods and Services Tax (GST)

A 5% tax on almost all goods and services provided in Canada.

Is ultimately paid by the final consumer. Is uniform from province to province. Amount collected by a business is a liability. Amount paid by a business offsets the GST owing.
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Appendix 6B Example
Purchase of Merchandise
Assume: Perpetual system and 5% GST.
Inventory 5,000 GST Receivable 250 Accounts Payable 5,250

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Appendix 6B Example
Sale of Merchandise
Assume: Perpetual system, 7% PST and 5% GST.
Accounts Receivable Sales PST Payable GST Payable 4,480

4,000 280 200

Cost of goods sold 3,000 Inventory 3,000 To record cost of merchandise sold

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Appendix 6B Example
GST Remittance; General Journal Entry
GST Payable Cash 550 200

GST Receivable

350

to record payment of GST to Receiver General for Canada

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Appendix 6B Example
PST Remittance; General Journal Entry
PST Payable Cash 490 490

to record payment of PST to provincial government authority.

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Appendix 6B Summary

GST and PST Payable accounts hold funds that will be transferred to the appropriate governing body The liability accounts are closed when the business remits the money to the government GST may be remitted monthly, quarterly or annually depending upon the size of the business
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End of Chapter

2007 McGraw-Hill Ryerson Ltd.