Chapter 5
ACCOUNTING FOR MERCHANDISING OPERATIONS
True /False Questions
1. Merchandise inventory consists of products that a company acquires to resell to customers.
2. A service company earns net income by buying and selling merchandise.
3. Gross profit is also called gross margin.
4. Cost of goods sold is also called cost of sales.
5. A wholesaler is an intermediary that buys products from manufacturers or other
wholesalers and sells them to consumers.
6. A retailer is an intermediary that buys products from manufacturers and sells them to
wholesalers.
7. Cost of goods sold represents the cost of buying and preparing merchandise for sale.
8. A company had sales and cost of goods sold of $350,000 and $200,000, respectively. Its
gross profit equals $150,000.
9. A company had net sales and cost of goods of $545,000 and $345,000, respectively. Its
gross margin equals $890,000.
10. A company had a gross profit of $300,000 based on sales of $400,000. Its cost of goods
sold equals $700,000.
11. A merchandising company’s operating cycle begins with the sale of merchandise and ends
with the collection of cash from the sale.
12. Merchandise inventory is reported in the long-term assets section of the balance sheet.
13. Cash sales shorten the operating cycle for a merchandiser; credit sales lengthen operating
cycles.
14. Assets tied up in inventory are not productive assets.
15. A perpetual inventory system requires updating of the inventory account only at the
beginning of an accounting period.
16. A perpetual inventory system continually updates accounting records for inventory
transactions.
17. Beginning merchandise inventory plus the net cost of purchases is the merchandise
available for sale.
18. The acid-test ratio is also called the quick ratio.
19. Quick assets include cash, inventory, and current receivables.
20. The acid-test ratio is defined as current assets divided by current liabilities.
21. A common rule of thumb is that a company’s acid-test ratio should be at least 2 or a
company may face near-term liquidity problems.
22. Successful use of a just-in-time inventory system can narrow the gap between the acid-test
and the current ratio.
23. A company’s quick assets are $147,000 and its current liabilities are $143,000. This
company’s acid-test ratio is 1.03.
24. A company’s current ratio is 1.2 and its quick ratio is 0.25. This company is probably an
excellent credit risk because the ratios reveal no indication of liquidity problems.
25. The gross margin ratio is defined as gross margin divided by net sales.
26. The profit margin ratio is gross margin divided by total assets.
27. A company had net sales of $340,500, its cost of goods sold was $257,000, and its net
income was $13,750. The company’s gross margin ratio equals 24.5%.
28. The Merchandise Inventory account balance at the end of the current period is equal to the
amount of beginning merchandise inventory for the next period.
29. Credit terms for a purchase include the amounts and timing of payments from a buyer to a
seller.
30. Purchase returns refer to merchandise a buyer acquires but then returns to the seller.
31. Purchase allowances refer to merchandise a buyer acquires but then returns to the seller.
32. Under the perpetual inventory system, the cost of merchandise purchased is recorded in
the Merchandise Inventory account.
33. Credit terms of 2/10, n/30 imply that the seller offers the purchaser a 2% cash discount if
the amount is paid within 10 days of the invoice date. Otherwise, the full amount is due in 30
days.
34. Sellers always offer a discount to buyers for prompt payment toward purchases made on
credit.
35. Purchase discounts are the same as trade discounts.
36. If a company sells merchandise with credit terms 2/10 n/60, the credit period is 10 days
and the discount period is 60 days.
37. The seller is responsible for paying shipping charges and bears the risk of damage or loss
in transit if goods are shipped FOB destination.
38. If goods are shipped FOB shipping point, the seller does not record revenue from the sale
until the goods arrive at their destination because the transaction is not complete until that
point.
39. A buyer records the costs of shipping goods in a Delivery Expense, or transportation-out
account when the buyer is responsible for these costs.
40. A buyer did not take advantage of a supplier’s credit terms of 2/10, n/30, and instead paid
the invoice in full at the end of 30 days. By not taking the discount the buyer lost the
equivalent of 18% annual interest on the amount of the purchase.
41. FOB shipping point (or FOB factory) implies that ownership of goods transfers to the
buyer at the buyer’s place of business.
42. Each sales transaction for a seller that uses a perpetual inventory system involves
recognizing both revenue and cost of merchandise sold.
43. Sales discounts on credit sales can benefit a seller by decreasing the delay in receiving
cash and reducing future collections efforts.
44. Sales Discounts is a contra revenue account, meaning that the Sales Discounts account is
added to the Sales account when computing a company’s net sales.
45. A credit memorandum from a seller informs a buyer of the seller’s credit to its Accounts
Payable account arising from a sales return or allowance.
46. When a credit customer returns merchandise to the seller, under a perpetual inventory
system, the seller would debit Sales Returns and Allowances and credit Accounts Receivable
and also debit Merchandise Inventory and credit Cost of Goods Sold.
47. Because sellers assume that their customers will pay within the discount period, the seller
usually records the discount at the time of the sale.
48. A journal entry with a debit to cash of $980, a debit to Sales Discounts of $20, and a credit
to Accounts Receivable of $1,000 means that a customer has taken a 10% cash discount for
early payment.
49. Sales of $350,000 and net sales of $323,000 could reflect sales discounts of $27,000.
50. A perpetual inventory system is able to directly measure and monitor inventory shrinkage
and there is no need for a physical count of inventory.
51. Sales Discounts and Sales Returns and Allowances are credited to close the accounts
during the closing process.
52. Cost of Goods Sold is debited to close the account during the closing process.
53. In a perpetual inventory system, the merchandise inventory account must be closed at the
end of the accounting period.
54. The adjusting entry to reflect inventory shrinkage is a debit to Income Summary and a
credit to Inventory Shrinkage Expense.
55. A multiple-step income statement format shows detailed computations of net sales and
other costs and expenses, and reports subtotals for various classes of items.
56. Operating expenses are classified into two categories: selling expenses and cost of goods
sold.
57. A merchandiser’s classified balance sheet reports merchandise inventory as a current asset.
58. Selling expenses support a company’s overall operations and include expenses related to
accounting, human resource management, and financial management.
59. When a company has no reportable non-operating activities, its income from operations is
simply labeled net income.
60. A single-step income statement includes cost of goods sold as another expense, and shows
only one subtotal for total expenses.
61. Under a periodic inventory system, purchases, purchases returns and allowances, purchase
discounts, and transportation in transactions are recorded in separate temporary accounts.
62. The periodic inventory system requires updating the inventory account only at the end of
the period to reflect the quantity and cost of both the goods available and the goods sold.
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63. In a periodic inventory system, cost of goods sold is recorded as each sale occurs.
64. Under both the periodic and perpetual inventory systems, the temporary account
Purchases Returns and Allowances is used to accumulate the cost of all returns and
allowances for a period.
65. Delivery expense is reported as part of general and administrative expense in the seller’s
income statement.
66. A merchandising company:
A. Earns net income by buying and selling merchandise.
B. Receives fees only in exchange for services.
C. Earns profit from commissions only.
D. Earns profit from fares only.
E. Buys products from consumers.
67. Cost of goods sold:
A. Is another term for merchandise sales.
B. Is the term used for the cost of buying and preparing merchandise for sale.
C. Is another term for revenue.
D. Is also called gross margin.
E. Is a term only used by service firms.
68. A company had sales of $695,000 and cost of goods sold of $278,000. Its gross margin
equals:
A. $(417,000).
B. $695,000.
C. $278,000.
D. $417,000.
E. $973,000.
69. A company had sales of $375,000 and its gross profit was $157,500. Its cost of goods sold
equals:
A. $(217,000).
B. $375,000.
C. $157,500.
D. $217,500.
E. $532,500.
70. The following statements regarding gross profit are true except:
A. Gross profit is also called gross margin.
B. Gross profit less other operating expenses equals income from operations.
C. Gross profit is not calculated on the multiple-step income statement.
D. Gross profit must cover all operating expenses to yield a return for the owner of the
business.
E. Gross profit equals net sales less cost of goods sold.