Chapter 5

Merchandising
Accounting
Sep 4, 2014
Sem 1, AY 2014 15
Merchandising Companies
Buy and Sell Goods
Manufacturer
Wholesaler
Retailer Consumer
The primary source of revenues is referred to as
sales revenue or sales.
Merchandising Operations
2
Income Measurement
Cost of goods sold (COGS) is the
total cost of merchandise sold
during the period.
Not used in a
service business.
Merchandising Operations
3
Direct costs incurred to have the goods ready for sale.
Indirect
expenses
Also called Cash Conversion Cycle. It measures the average
period of time required for a business to make an initial outlay
of cash to produce goods, sell the goods, and receive cash
from customers in exchange for the goods.
Operating Cycle
Merchandising Operations
4
Companies use either a perpetual inventory system or a periodic inventory
system to account for inventory.
Illustration 5-4
Merchandising Operations
Flow of Costs
5
Perpetual System
Maintain detailed records of the cost of each inventory
purchase and sale.
Records continuously show inventory that should be on
hand.
Company determines cost of goods sold each time a
sale occurs.
Much better method of inventory control because
missing items arent included in COGS.
Traditionally used for merchandise with high unit values.
Flow of Costs
6
Periodic System
Beginning inventory
+ Purchases, NET
Goods available for sale
- Ending inventory
Cost of goods sold
Flow of Costs
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:
7
Periodic System
Flow of Costs
Calculation of Net Purchases
Purchases
- Purchase returns/discounts
+ Transportation-in (Freight-in)
+ Insurance in transit
+ Taxes
+ Storage costs, etc.
= Net Purchases (cost of goods purchased)
8
Illustration: Best Denki (the buyer) opens its store on May 1.
On May 4, it purchases 10 TV sets at the price $1,500/unit
from Sony Electronics, Inc. (the seller). Prepare the journal
entry for Best Denki.
May 4
Recording Purchases of Merchandise
Perpetual Periodic
Inventory 15,000
Accounts Payable 15,000
Purchases 15,000
Accounts Payable 15,000
9
Seller places goods Free On
Board the carrier, and buyer pays
freight costs.
Seller places goods Free On
Board to the buyers place of
business, and seller pays freight
costs.
Freight Costs Terms of Sale
Freight costs incurred by the seller are an operating expense.
Recording Purchases of Merchandise
10
Illustration: Upon delivery of the goods on May 6, Best Denki (the
buyer) pays Maersk Logistic $400 for freight charges, the entry on
Best Denkis books is:
In contrast, if the freight terms on the invoice had required Sony
Electronics (the seller) to pay the freight charges, the entry by Sony
Electronics would have been:
Freight-out (Delivery expense) 400 May 4
Cash 400
Recording Purchases of Merchandise
Perpetual Periodic
Inventory 400
Cash 400
Freight-in 400
Cash 400
11
Freight-in adds to cost of inventory/COGS.
Freight-out are an operating expense.
Purchaser may be dissatisfied because goods are damaged
or defective, of inferior quality, or do not meet specifications.
Purchase Returns and Allowances
Return goods for credit if the sale
was made on credit, or for a cash
refund if the purchase was for
cash.
May choose to keep the
merchandise if the seller will
grant an allowance (deduction)
from the purchase price.
Purchase Return Purchase Allowance
Recording Purchases of Merchandise
12
Illustration: Assume that on May 8 Best Denki returned to
Sony 2 defective TVs.
May 8
Recording Purchases of Merchandise
Perpetual Periodic
Accounts payable 3,000*
Inventory 3,000
Accounts payable 3,000
Purchase Return/Allowance 3,000
Contra
Purchase
account
13
2 TVs $1,500/TV = $3,000
Credit terms may permit buyer to claim a cash discount for
prompt payment.
Advantages:
Purchaser saves money.
Seller shortens the operating cycle.
Purchase Discounts
Example: Credit
terms may read 2/10, n/30.
Recording Purchases of Merchandise
14
2% discount if
paid within 10
days, otherwise
net amount due
within 30 days.
1% discount if
paid within first 10
days of next
month.
2/10, n/30 1/10 EOM
Net amount due
within the first 10
days of the next
month.
n/10 EOM
Purchase Discounts
Recording Purchases of Merchandise
15
May 14
(Discount = $12,000 x 2% = $240)
Illustration: Assume Best Denki pays the balance due of
$12,000 (gross invoice price of $15,000 less purchase returns
and allowances of $3,000) on May 14, the last day of the
discount period (terms 2/10, n/30). Prepare the journal entry
Best Denki makes to record its May 14 payment.
Recording Purchases of Merchandise
16
Perpetual Periodic
Accounts payable 12,000
Cash 11,760
Inventory 240
Accounts payable 12,000
Cash 11,760
Purchase Discount 240
Contra
Purchase
account
June 3
Illustration: If Best Denki failed to take the discount, and
instead made full payment of $12,000 on June 3, the journal
entry would be:
Recording Purchases of Merchandise
17
Perpetual Periodic
Accounts payable 12,000
Cash 12,000
Accounts payable 12,000
Cash 12,000
Should discounts be taken when offered?
Example: 2% for 20 days = Annual rate of 36.5%
(365/20 = 18.25 twenty-day periods x 2% = 36.5%)
Recording Purchases of Merchandise
Purchase Discounts
18
Discount of 2% on $12,000 $240
Minus: Alternative earning from
depositing $12,000 to a bank at
10% interest for 20 days (Best
Denki can hold the money for
20 more days) 65.75
Net savings by taking the
discount
$174.25
Inventory
Debit Credit
$15,000 8
th
- Return $3,000
Balance
4
th
- Purchase
$12,160
240 14
th
- Discount
Summary of Purchasing Transactions
(perpetual system)
400 6
th
Freight-in
Recording Purchases of Merchandise
19
Journal Entries to Record a Sale (Perpetual System)
Cash or Accounts receivable XXX
Sales revenue XXX
#1
Cost of goods sold XXX
Inventory XXX
#2
Selling
Price
Cost
Recording Sales of Merchandise
20
Journal Entries to Record a Sale (Periodic System)
Cash or Accounts receivable XXX
Sales revenue XXX
Selling
Price
Recording Sales of Merchandise
21
May 15
Illustration: Assume Best Denki sold 5 TV sets to
customers on account at the price $3,000/set on May 15,
terms 1/10, n/30. The unit cost for Best Denki is $1,520/set
(total cost $12,160 for 8 TV sets).
Recording Sales of Merchandise
22
Perpetual Periodic
Accounts receivable 15,000
Sales revenue 15,000
Accounts receivable 15,000
Sales revenue 15,000
COGS 7,600
Inventory 7,600
Flipside of purchase returns and allowances.
Contra-revenue account (debit).
Sales not reduced (debited) because:
Would obscure importance of sales returns and
allowances as a percentage of sales.
Could distort comparisons.
Sales Returns and Allowances
Recording Sales of Merchandise
23
Illustration: Customers returned 1 TV set to Best Denki on
May 20. Assume the goods were not defective.
May 20
Recording Sales of Merchandise
24
Perpetual Periodic
Sales returns and allowances 3,000
Accounts receivable 3,000
Sales returns and allowances 3,000
Accounts receivable 3,000
Inventory 1,520
COGS 1,520
Offered to customers to promote prompt payment.
Flipside of purchase discount.
Contra-revenue account (debit).
Sales Discount
Recording Sales of Merchandise
25
Cash 11,880
May 25
Accounts receivable 12,000
Sales discounts 120
* [($15,000-3,000) X 1%]
*
Illustration: Assume customers pay the balance due of
$12,000 on May 25, the last day of the discount period.
Recording Sales of Merchandise
26
Generally the same as a service company.
One additional adjustment to make the records agree
with the actual inventory on hand.
Involves adjusting Inventory and Cost of Goods
Sold.

Adjusting Entries
27
Taking a Physical Inventory Count for two reasons:
Perpetual System
1. Check accuracy of inventory records.
2. Determine amount of inventory lost (wasted raw materials,
shoplifting, or employee theft).
Periodic System
1. Determine the inventory on hand.
2. Determine the cost of goods sold for the period.
Adjusting Entries
28
Involves counting, weighing, or measuring each kind of
inventory on hand.
Taken,
when the business is closed or business is slow.
at end of the accounting period.
Adjusting Entries
29
Taking a Physical Inventory Count
Illustration: On book, Best Denki has 4 TV sets in stock on
May 31. Through a physical count, Best Denki determines that
its actual inventory is 3 TV sets. The company would make an
adjusting entry as follows.
30
Adjusting Entries
Perpetual Periodic
COGS (inventory shrinkage) 1,520
Inventory 1,520
Inventory (ending balance) 4,560
COGS 7,600
Purchase discounts 240
Purchase returns 3,000
Inventory (beginning balance) 0
Purchases 15,000
Freight-in 400
Multiple-column form used in preparing financial
statements.
Not a permanent accounting record.
Five step process.
Use of worksheet is optional.
Preparing a Worksheet
Prepare Financial Statements -- Using a
Worksheet
31
Illustration 4-1
Steps in Preparing a Worksheet
32
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 15,200
Supplies 2,500
Prepaid Insurance 600
Equipment 5,000
Notes Payable 5,000
Accounts Payable 2,500
Unearned Revenue 1,200
Share Capital-Ordinary 10,000
Dividends 500
Service Revenue 10,000
Salaries and Wages Exp. 4,000
Rent Expense 900
Totals 28,700 28,700
Financial Position
Adjusted Income
Trial Balance Adjustments Trial Balance Statement
Statement of
1. Prepare a Trial Balance on the Worksheet
Trial balance amounts come
directly from ledger accounts.
Include all accounts
with balances.
Steps in Preparing a Worksheet
Illustration 4-2
33
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 15,200
Supplies 2,500 1,500
Prepaid Insurance 600 50
Equipment 5,000
Notes Payable 5,000
Accounts Payable 2,500
Unearned Revenue 1,200 400
Share Capital-Ordinary 10,000
Dividends 500
Service Revenue 10,000 400
200
Salaries and Wages Exp. 4,000 1,200
Rent Expense 900
Totals 28,700 28,700
Supplies Expense 1,500
Insurance Expense 50
Accumulated Depreciation 40
Depreciation Expense 40
Accounts Receivable 200
Interest Expense 50
Interest Payable 50
Salaries and Wages Payable 1,200
Totals 3,440 3,440
Financial Position
Adjusted Income
Trial Balance Adjustments Trial Balance Statement
Statement of
2. Enter the Adjustments in the Adjustments Columns
(a)
(b)
(a)
(g)
(c)
(d)
(d)
(e)
(b)
(e)
(f)
(f)
(g)
(c)
Enter adjustment amounts, total
adjustments columns,
and check for equality.
Add additional accounts as needed.
Adjustments Key:
(a) Supplies Used.
(b) Insurance Expired.
(c) Depreciation Expensed.
(d) Service Revenue Earned.
(e) Service Revenue Accrued.
(f) Interest Accrued.
(g) Salaries Accrued.
Steps in Preparing a Worksheet
34
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 15,200 15,200
Supplies 2,500 1,500 1,000
Prepaid Insurance 600 50 550
Equipment 5,000 5,000
Notes Payable 5,000 5,000
Accounts Payable 2,500 2,500
Unearned Revenue 1,200 400 800
Share Capital-Ordinary 10,000 10,000
Dividends 500 500
Service Revenue 10,000 400 10,600
200
Salaries and Wages Exp. 4,000 1,200 5,200
Rent Expense 900 900
Totals 28,700 28,700
Supplies Expense 1,500 1,500
Insurance Expense 50 50
Accumulated Depreciation 40 40
Depreciation Expense 40 40
Accounts Receivable 200 200
Interest Expense 50 50
Interest Payable 50 50
Salaries and Wages Payable 1,200 1,200
Totals 3,440 3,440 30,190 30,190
Financial Position
Adjusted Income
Trial Balance Adjustments Trial Balance Statement
Statement of
3. Complete the Adjusted Trial Balance Columns
(a)
(b)
(a)
(g)
(c)
(d)
(d)
(e)
(b)
(e)
(f)
(f)
(g)
(c)
Total the adjusted trial balance
columns and check for equality.
Steps in Preparing a Worksheet
35
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 15,200 15,200
Supplies 2,500 1,500 1,000
Prepaid Insurance 600 50 550
Equipment 5,000 5,000
Notes Payable 5,000 5,000
Accounts Payable 2,500 2,500
Unearned Revenue 1,200 400 800
Share Capital-Ordinary 10,000 10,000
Dividends 500 500
Service Revenue 10,000 400 10,600 10,600
200
Salaries and Wages Exp. 4,000 1,200 5,200 5,200
Rent Expense 900 900 900
Totals 28,700 28,700
Supplies Expense 1,500 1,500 1,500
Insurance Expense 50 50 50
Accumulated Depreciation 40 40
Depreciation Expense 40 40 40
Accounts Receivable 200 200
Interest Expense 50 50 50
Interest Payable 50 50
Salaries and Wages Payable 1,200 1,200
Totals 3,440 3,440 30,190 30,190 7,740 10,600
Financial Position
Adjusted Income
Trial Balance Adjustments Trial Balance Statement
Statement of
4. Extend Amounts to Financial Statement Columns
(a)
(b)
(a)
(g)
(c)
(d)
(d)
(e)
(b)
(e)
(f)
(f)
(g)
(c)
Extend all revenue and expense account
balances to the income statement columns.
Steps in Preparing a Worksheet
36
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 15,200 15,200 15,200
Supplies 2,500 1,500 1,000 1,000
Prepaid Insurance 600 50 550 550
Equipment 5,000 5,000 5,000
Notes Payable 5,000 5,000 5,000
Accounts Payable 2,500 2,500 2,500
Unearned Revenue 1,200 400 800 800
Share Capital-Ordinary 10,000 10,000 10,000
Dividends 500 500 500
Service Revenue 10,000 400 10,600 10,600
200
Salaries and Wages Exp. 4,000 1,200 5,200 5,200
Rent Expense 900 900 900
Totals 28,700 28,700
Supplies Expense 1,500 1,500 1,500
Insurance Expense 50 50 50
Accumulated Depreciation 40 40 40
Depreciation Expense 40 40 40
Accounts Receivable 200 200 200
Interest Expense 50 50 50
Interest Payable 50 50 50
Salaries and Wages Payable 1,200 1,200 1,200
Totals 3,440 3,440 30,190 30,190 7,740 10,600 22,450 19,590
Net Income 2,860 2,860
Totals 10,600 10,600 22,450 22,450
Financial Position
Adjusted Income
Trial Balance Adjustments Trial Balance Statement
Statement of
(a)
(b)
(a)
(g)
(c)
(d)
(d)
(e)
(b)
(e)
(f)
(f)
(g)
(c)
Steps in Preparing a Worksheet
Compute Net Income or Net Loss.
5. Total Columns, Compute Net Income (Loss)
37
Income statement is prepared from the income
statement columns.
Statement of financial position and retained earnings
statement are prepared from the statement of financial
position columns.
Companies journalize and post adjusting entries.
Preparing Statements from a Worksheet
Using a Worksheet
38
Identifying characteristics: Gross Profit, Income from
Operations.
Highlights components of income based on operating vs.
non-operating activities
Multi-step Income Statement
39
Net Sales
Sales Revenues
- Sales Returns and Allowances / Discounts
- Cost of Goods Sold (COGS)
= Gross Profit
- Operating Expenses
Selling Expense
General & Administrative Expense
Etc.
= Income from Operations
Other Income and Expenses
= Income before Income Taxes
- Income Tax Expense
= Net Income
Multi-step Income Statement
40
Revenues:
amounts of assets received or liabilities settled during the period from
delivering goods or providing services to customers.

Other Revenues (non-operating):
revenues from other sources than sales, such as interest revenue, rent
revenue, etc.

Gains:
increases in assets due to peripheral or incidental transactions, such as
selling equipment.
Multi-step Income Statement
41
Multi-step Income Statement
COGS:
(Direct) cost of products or services provided to customers

Operating Expense:
Costs of operating a business, other than COGS, such as
R&D Expense
Selling, General and Administrative Expense (SG&A)
Depreciation Expense

Other Expenses:
Non-operating expenses, such as Interest Expense, Casualty
Loss, etc.

Loss:
Non-operating decreases in net assets that arise from peripheral
or incidental transactions, such as casualty loss from fires
42
Gross Profit Ratio:

Gross Profit Net Sales

Example: Sales $175,000
(COGS) (125,000)
Gross Profit 50,000

GP Ratio =
Gross Profit
Sales
=
50,000
175,000
= 0.29 or 29%

For every $1 of sales, 29 cents is available to cover other expenses (other than COGS)
and to earn a profit.
Multi-step Income Statement
43
Presents a snapshot at a point in time.
To improve understanding, companies group similar
assets and similar liabilities together.
Standard Classifications under IFRS
The Classified Statement of Financial Position
44
Illustration
4-18
The Classified Statement of Financial Position
45
The Classified Statement of Financial Position
Illustration
4-18
46
Assets that do not have physical substance.
Trademarks, copyrights, patents, goodwill
Intangible Assets
The Classified Statement of Financial Position
47
Long useful lives.
Currently used in operations.
Depreciation - allocating the cost of assets to a number
of years. (Land does not depreciate)
Accumulated depreciation - total amount of
depreciation expensed thus far in the assets life.
Property, Plant, and Equipment
The Classified Statement of Financial Position
48
Property, Plant, and Equipment
Illustration 4-20
The Classified Statement of Financial Position
49
Investments in ordinary shares and bonds of other
companies.
Investments in non-current assets such as land or buildings
that a company is not using in its operating activities.
Long-Term Investments
Illustration 4-21
The Classified Statement of Financial Position
50
Assets that a company expects to convert to cash or
use up within one year or the operating cycle, whichever
is longer.
Operating cycle is the average time it takes from the
purchase of inventory to the collection of cash from
customers.
Current Assets
The Classified Statement of Financial Position
51
Usually listed in the reverse order that they are expected to convert into
cash.
Current Assets
Illustration 4-22
The Classified Statement of Financial Position
52
Proprietorship - one capital account.
Partnership - capital account for each partner.
Corporation Share Capital and Retained Earnings.
Equity
Illustration 4-23
The Classified Statement of Financial Position
53
Obligations a company expects to pay after one year.
Non-Current Liabilities
Illustration 4-24
The Classified Statement of Financial Position
54
Obligations company has to pay within the coming year
or its operating cycle, whichever is longer.
Usually list notes payable first, followed by accounts
payable. Other items follow in order of magnitude.
Liquidity - ability to pay obligations expected to be due
within the next year.
Current Liabilities
The Classified Statement of Financial Position
55
Illustration 4-25
Current Liabilities
The Classified Statement of Financial Position
56
Under U.S. GAAP, list in the order that they are expected to
convert into cash
The Classified Statement of Financial Position
Assets Liabilities and Equity
Current assets
Cash
Short-term investments
A/R
Inventories
Current liabilities
Accounts Payable
Notes Payable
Long-term investments Non-current liabilities
Property, plant, and equipment Equity
Intangible assets
57
Uses of Statement of Financial Position
Measure a companys ability to pay its debts as they
come due
Working Capital = Current Assets Current Liabilities
Current Ratio = Current Assets Current Liabilities
Liquidity Measures
58
At the end of the accounting period, the company makes
the accounts ready for the next period.
Illustration 4-5
Closing the Books
59
Closing entries formally recognize, in the general ledger, the
transfer of
net income (or net loss) and
dividends
to retained earnings.
Closing entries are only made at the end of the annual
accounting period.
Closing the Books
Preparing Closing Entries
60
Illustration 4-6
Retained earnings is a
permanent account; all
other accounts are
temporary accounts.
Dividends are closed directly
to retained earnings and not
to Income Summary because
dividends are not an
expense.
Note:
Closing the Books
61
Closing
Entries
Illustrated
Illustration 4-7
Closing entries
journalized
Closing the Books
62
Posting
Closing
Entries
Closing the Books
Illustration 4-8
63
Purpose is to prove the equality of the permanent account
balances after journalizing and posting of closing entries.
Preparing a Post-Closing Trial Balance
Illustration 4-9
64
1. Analyze business transactions
2. Journalize the
transactions
6. Prepare an adjusted trial
balance
7. Prepare financial
statements
8. Journalize and post
closing entries
9. Prepare a post-closing
trial balance
4. Prepare a trial balance
3. Post to ledger accounts
5. Journalize and post
adjusting entries
Illustration 4-12
Summary of the Accounting Cycle
65
Practice Question
These financial statement items are for Batra Corporation at year-end,
December 31, 2013:












Required:
a. Prepare a multi-step income statement, assuming income tax rate is
30%.
b. Prepare a classified balance sheet at December 31, 2013.
Salaries expense $20,000 Utilities expense $14,900
Equipment 15,900 Accounts Payable 6,220
Sales Revenue 89,600 Accounts receivable 10,765
Unearned rent revenue 1,800 Dividends 14,000
Share capital -- ordinary 20,000 Depreciation expense 4,000
Cost of Goods Sold (COGS) 38,700 Retained earnings (Jan. 1, 2013) 25,200
Cash 20,440 Prepaid Expenses 3,500
Interest revenue 200 Loss on sale of equipment 850
Accumulated depreciation 5,400 Sales Discounts 2,800
66