Chapter 06 – Merchandising Activities
6 MERCHANDISING ACTIVITIES
Chapter Summary
The introduction of merchandising provides a rich set of challenges for the student. These
range from the problem of how to best account for the acquisition and sale of inventory to the
development of accounting information to support the operating decisions of owners and
managers.
The chapter opens with an introduction to the nature of a merchandising business. This
discussion centers on the operating cycle of the merchandising business, and introduces the new
concepts found on the income statement of a merchandiser. The nature and use of subsidiary
ledgers is next introduced. Our intent is to demonstrate to the student that a single information
system can be designed to serve multiple objectives. In this case, the accounting system provides
the information required to meet financial reporting obligations, and through the use of subsidiary
ledgers, produces the information required to serve the needs of company personnel in conducting
daily business operations.
The core of the chapter explains the use of the perpetual and periodic inventory systems.
Emphasis is placed on three topics: recording the acquisition of merchandise inventory, recording
the sale of merchandise, and the determination of the cost of goods sold for presentation on the
income statement. The relative merits of the two inventory systems are discussed in closing the
section.
Numerous modifications to the accounting system designed to improve its efficiency are
covered in some detail. We begin with a brief introduction to the nature of special journals. This
is followed by an extensive discussion of additional transactions relating to purchases and sales.
Topics covered include: recording purchases by the net and gross price methods, recording
purchase returns, transportation costs, recording sales discounts and sales returns and allowances,
delivery expenses, and accounting for sales taxes.
The chapter concludes by demonstrating the use of gross profit in evaluating the
performance of a merchandising company.
Learning Objectives
1. Describe the operating cycle of a merchandising company.
2. Understand the components of a merchandising company’s income statement.
3. Account for purchases and sales of merchandise in a perpetual inventory system.
4. Explain how a periodic inventory system operates.
5. Discuss the factors to be considered in selecting an inventory system.
6. Account for additional merchandising transactions related to purchases and sales.
7. Define special journals and explain their usefulness.
8. Measure the performance of a merchandising business.
Chapter 06 – Merchandising Activities
Brief topical outline
AMerchandising companies
1The operating cycle of a merchandising company
aComparing merchandising activities with manufacturing
activities
bRetailers and wholesalers
2 Income statement of a merchandising company
3 Accounting system requirements for merchandising companies
4Two approaches used in accounting for merchandise inventories
BPerpetual inventory systems
1Purchases of merchandise
2Sales of merchandise
3Payment of accounts payable to suppliers
4Collection of accounts receivable from customers
5Taking a physical inventory – see Case in Point (page 254)
6Closing entries in a perpetual inventory system – see Your Turn (page 254)
CPeriodic inventory systems
1Operation of a periodic inventory system
2Recording purchases of merchandise
3Computing cost of goods sold
4Recording inventory and cost of goods sold
5Closing process in a periodic inventory system
a Creating a cost of goods sold account
bCompleting the closing process
6Comparison of perpetual and periodic inventory systems
aWho uses perpetual systems? – see Case in Point (page 258)
bWho uses periodic systems?
7Selecting an inventory system
aThe trend in today’s business world – see Your Turn (page 259)
DTransactions relating to purchases
1Credit terms and cash discounts
aRecording purchases at gross invoice price
2Returns of unsatisfactory merchandise
3Transportation costs on purchases
xETransactions relating to sales
1Sales returns and allowances
2Sales discounts
3Delivery expenses
4Accounting for sales taxes
FModifying an accounting system
1Special journals provide speed and efficiency
GFinancial analysis and decision making
1Net sales
2Gross profit margins
aThe overall gross profit margin
Chapter 06 – Merchandising Activities
bSegment gross profit margins
cUsing information about gross profit margins – see Ethics, Fraud &
Corporate Governance (page 266)
HConcluding remarks
Topical coverage and suggested assignment
Homework Assignment
(To Be Completed Prior to Class)
Class
Meetings
on Chapter
Topical
Outline
Coverage
Discussion
Questions
Brief
Exercises Exercises Problems
Critical
Thinking
Cases
1 A – B 1, 2, 3, 1, 2 2, 3, 4 1, 2, 5 1
2 C – D 6, 7 4, 6 6, 7, 8, 13 4
3 E – H 9, 13 15 10, 11 5, 9, 10, 11 4, 6
Comments and observations
Teaching objectives for Chapter 6
Our objectives in presenting this chapter are to:
1Describe the operating cycle of a merchandising company.
2 Understand the components of a merchandising company’s income statement.
3 Account for purchases and sale of merchandise using a perpetual inventory system.
4 Describe accounting for purchases and sale of merchandise using a periodic inventory system.
5Distinguish between perpetual and periodic inventory systems.
6 Illustrate accounting for cash discounts, merchandise returns, transportation costs, and sales
taxes.
7 Demonstrate the computation and interpretation of gross profit margins.
General comments
We continue to use the perpetual inventory system as our primary means of accounting for
inventories and the cost of goods sold. This reflects our goal of developing students’
understanding of the real-world environment in which accounting information is developed and
used. Today, all large businesses — and many small ones — use perpetual inventory systems.
Because of the increasing use of inventory software by even the smallest business operations, the
trend toward perpetual systems is certain to continue.
We also find that perpetual systems are considerably easier for students to understand.
The periodic model ¾ beginning inventory + purchases – ending inventory ¾ is not a familiar
Chapter 06 – Merchandising Activities
concept to the introductory student. Also, this model seems to undermine the very concept of
accounting providing useful (in this case, timely) information to decision makers. (We dislike
being asked whether managers can run a business if accounting information is available only at
annual intervals.) The evaluation of merchandising operations via gross profit rates emphasizes the
timeliness of the information provided by a perpetual system. A perpetual system not only
provides timely information but also follows the same “flow of costs” as has been described for
office supplies, prepaid insurance, and depreciable assets. That is, when an asset is acquired, its
cost is debited to an asset account; when the asset is consumed in business operations, its cost is
transferred to an expense account.
In illustrating the flow of merchandise through a perpetual inventory system, we quickly
review Exercise 4, which takes only a couple of minutes, and reinforce the concepts with a
thorough review of Problem 1. We especially recommend Problem 1, because it requires students
to interpret and use the information that they have developed.
We use Exercise 13 to introduce the periodic system that illustrates not only the mechanics
of this method but also the environment in which it is most likely to be found. We also
recommend Case 1 for highlighting the environmental factors leading to a choice of inventory
system. One of our Group Assignments, Case 4, addresses the same issues and may be used to
reinforce Case 1.
We also stress the need for an annual physical inventory even when a perpetual system is
in use, and review the adjusting entry to record shrinkage loss. Without this discussion, some
students are confused by the fact that many businesses record sales transactions on modern point-
of-sale terminals but then are still “Closed for Taking Inventory,” or offer “Inventory Clearance
Sales” near year-end.
Supplemental Exercises
Group Exercise
The concept of internal control will be introduced in conjunction with Cash in Chapter 7.
This chapter hints at one form of strong internal control in the form of the Purchases Discounts
Lost account. For a merchandise company internal control over inventory is critical to success.
Interview a local business and determine what internal controls are in place to: 1) safeguard its
inventory assets and 2) assure that inventory is accounted for as accurately as possible.
If Case 6-4 was assigned, the same businesses could be used as the subjects for this study
as well.
Internet Exercise
Revisit the homepages of American Eagle at www.mci.com and Old Navy at
www.gap.com. Select their most recent annual reports and compare the two companies in terms
of the values of their inventories. CHAPTER 6 NAME
#
10-MINUTE QUIZ A SECTION
Indicate the best answer for each question in the space provided.
1 Which of the following businesses is most likely to use a periodic
inventory system?
Chapter 06 – Merchandising Activities
aAn aircraft manufacturer.
bA supermarket that is part of a national chain.
cAn independently owned art gallery with a manual
accounting system.
dA beer bar.
2 A periodic inventory system eliminates the need for:
aTaking an annual physical inventory.
bRecording the revenue from sales transactions.
cRecording the cost of merchandise sold as sales occur.
dNone of the above.
3 If management wants to know the cost and quantity of
merchandise on
hand at all times, the business will probably:
aUse a periodic inventory system.
bMaintain an inventory subsidiary ledger.
cTake a complete physical inventory each day.
dDebit all purchases of merchandise directly to the Cost of
Goods Sold
account.
4 In a perpetual inventory system, the entry to record the cost of
goods
sold always includes an entry of equal amount to the:
aInventory account.
bSales account.
cPurchases account.
dNone of the above.
5 Prior to taking a physical inventory at year-end, the perpetual
inventory
records of Athena Designs showed an inventory of $26,000,
sales of
$358,000, and a cost of goods sold of $215,000. The year-end
physical
inventory indicated merchandise on hand costing $24,000. The
company’s gross profit for the year was:
a$334,000.
b$145,000.
c$141,000.
dSome other amount.
Chapter 06 – Merchandising Activities
CHAPTER 6 NAME #
10-MINUTE QUIZ B SECTION
At the end of last year, Helen’s, Inc. had merchandise costing $115,000 in
inventory. During January of the current year, the company purchased merchandise
costing $35,000, and sold merchandise which it had purchased at a total cost of
$55,000.
Based upon the above information, place the best answer in the space provided. In
questions 1 through 3, assume that Helen’s uses a perpetual inventory system.
1 The total debited to the Inventory account during January was:
a$0. c$55,000.
b$35,000. dSome other answer.
2 The balance in the Inventory account at January 31 was:
a$35,000. c$95,000.
b$205,000. dSome other answer.
3 The amount of costs transferred from the Inventory account to
the Cost
of Goods Sold account during January was:
a$0. c$55,000.
b$35,000. dSome other answer.
In questions 4 through 6, assume that Jerome’s, Inc. uses a periodic inventory
system and takes a physical inventory only at year-end.
4 The total debited to the Inventory account during January was:
a$0. c$55,000.
b$35,000. dSome other answer.
5 The balance in the Inventory account at January 31 was:
a$0. c$115,000.
b$105,000. dSome other answer.
6 The amount of costs transferred from the Inventory account to
the Cost
of Goods Sold account during January was:
a$0. c$55,000.
b$35,000. dSome other answer.
CHAPTER 6 NAME #
10-MINUTE QUIZ C SECTION
At the end of last year, Baron’s Bazaar had merchandise costing $381,000 in
Chapter 06 – Merchandising Activities
aAssume that Baron’s Bazaar uses a perpetual inventory system.
(1) The total amount debited to the Inventory account during January was:
$________________
(2) The balance in the Inventory account at January 31 was:
$________________
(3) The amount of costs transferred from the Inventory account to
the Cost of Goods Sold account during January was:
$________________
bAssume that Baron’s Bazaar uses a periodic inventory system and takes a
physical inventory only at year–end (December 31). (Note: $0 may be an
appropriate answer to one or more of the following questions.)
(1) The total amount debited to the Inventory account during January was:
$________________
(2) The balance in the Inventory account at January 31 was:
$________________
(3) The amount of costs transferred from the Inventory account to the Cost of
Goods Sold account during January was:
$________________
CHAPTER 6 NAME #
10-MINUTE QUIZ D SECTION
Phillips Co. is an o?ce supply store. The company uses a perpetual inventory
system, records purchases at net cost, and records sales revenue at full invoice
price.
Record the following transactions in the company’s general journal. To conserve
space, you may omit the written explanations which normally should accompany
the entries.
July 1 Purchased four Lorac copying machines on account from Lorac Corp.
Total
invoice price was $2,500 per machine ($10,000 total); terms of
2/10, n/30. These
machines are intended for resale.
3 Found one of the Lorac copiers to be defective and returned it to Lorac,
thus
reducing the amount owed.
9 Sold one of the Lorac copiers to Morris Realty. The sales price was $3,500, terms
2/10, n/60.
10 Paid the remaining amount owned to Lorac Corp., less the allowable
discount.
Chapter 06 – Merchandising Activities
19 Received full payment from Morris, less the allowable discount.
Date General Journal
SOLUTIONS TO CHAPTER 6 10-MINUTE QUIZZES
QUIZ A QUIZ B
1D1B
Learning Objective: Learning Objective:
3, 4, 5 3, 4
QUIZ C
a (1) $ 133,500 (The merchandise purchases)
occur
from the Inventory account to the Cost of Goods Sold account)
Learning Objective: 3, 4*QUIZ D
Date General Journal
Chapter 06 – Merchandising Activities
20__
Chapter 06 – Merchandising Activities
July 1 Inventory 9,800
Accounts Payable (Lorac Corp.) 9,800
3 Accounts Payable (Lorac Corp.) 2,450
Inventory 2,450
Learning Objective: 6
Assignment Guide to Chapter 6
Brief
Exercises Exercises Problems Cases Ne
t
1-11 1-15 1 2 3 4 5 6 7 8 1 2 3 4 5
Time estimate (in minutes) <10 <15 40 4
0
4
0
2
5
3
0
60 40 2
0
35 25 30 2
0
25
difficulty rating E E M M M S M S M E M M M M E
Learning Objectives:
1, 2 √ √ √
1. Describe the operating cycle of
a merchandising company.
2. Understand the components of
7. De>ne special journals and
explain their usefulness. 2, 10 √ √
8. Measure the performance of a
merchandising business.
1, 3, 4, 5, 6,
11
3, 4, 5, 9,
11, 14, 15 √ √ √