Chapter 04 Accounting for Merchandising Operations
Chapter 04
Accounting for Merchandising Operations
Student Learning Objectives and Related Assignment Materials*
Student Learning Objectives
Discussion
Questions
Quick
Studies
Exercises
Problems
(A &B set)**
Beyond the
Numbers
Conceptual objectives:
C1. Describe merchandising
activities and identify income
components for a
merchandising company.
1, 2, 3
4-1, 4-15
4-6, 4-10
EC, TTN,
TIA, ED,
HTR
C2. Identify and explain the
inventory asset and cost flows
of a merchandising company.
1, 2
4-2, 4-18
4-1, 4-3,
4-10
4-4, 4-5
CIP, TIA,
ED
Analytical objectives:
A1. Compute the acid-test ratio
and explain its use to assess
liquidity.
4-8, 4-9
4-11, 4-13
4-3
RIA
A2. Compute the gross margin ratio
and explain its use to assess
profitability.
14
4-5
4-12
4-3
CA, TTN,
GD
Procedural objectives:
P1. Analyze and record transactions
for merchandise purchases
using a perpetual system.
6, 7, 9
4-3, 4-16,
4-17
4-2, 4-3, 4-5,
4-7, 4-8,
4-14
4-1, 4-2
P2. Analyze and record transactions
for merchandise sales using
a perpetual system.
4, 6, 7, 8, 9,
15
4-4
4-3, 4-4, 4-7,
4-8, 4-14
4-1, 4-2
EC
P3. Prepare adjustments and close
accounts for a merchandising
company.
4-6, 4-7
4-9
4-3, 4-5, 4-6
CIP
P4. Define and prepare multiple-
step and single-step income
statements.
3, 10, 11, 12,
13, 14
4-10, 4-14
4-15, 4-20
4-3, 4-4
ED, GD
Grid continues on next page.
Chapter 04 Accounting for Merchandising Operations
a website, in whole or part. 4-2
Student Learning Objectives and Related Assignment Materials
Student Learning Objectives
Questions
Quick
Studies
Exercises
Problems
(A &B set)*
Beyond the
Numbers
P5. Record and compare
merchandising transactions
using both periodic and
perpetual inventory systems.
(Appendix 4A)
4-11, 4-12,
4-13
CIP
* Assignment materials that can be completed by students using:
Sage 50 and QuickBooks Pro 2013 templates– Problems 4-1A and P4-5A, and the Serial
Problem for Success Systems, which covers numerous learning objectives. (The serial
problem, which began in chapter 1, continues in most of the chapters. Even if previous
segments were not assigned, students can begin the segment of the serial problem that is
included in this chapter.)
Excel templates – Problem 4-3A.
McGraw-Hill’s Connect – All of the Quick Studies, all of the Exercises, and Problems in set A.
Synopsis of Chapter Revisions
• Faithful Fish: NEW opener with new entrepreneurial assignment
• Enhanced exhibit on transportation costs and FOB terms, with inclusion of entries
• New discussion of online ordering, tracking numbers, RFID, and FOB
• Revised the two-step explanation of recording merchandise sales
• New discussion on the importance and risks of accounting for sales returns
• Revised visual display of a sales invoice
• Revised discussion of merchandising purchases and sales
• New Volkswagen example for IFRS income statement
PowerPoint® Slides
Chapter Learning Objective
PowerPoint® Slides
C1
6-8
C2
9-10
P1
11-27
P2
28-34
P3
35-40
P4
41-43
A1
44
A2
45
Chapter 04 Accounting for Merchandising Operations
Chapter Outline
Notes
I. Merchandising Activities
Products that a company acquires to resell to customers are referred to
as merchandise (also called goods). A merchandiser earns net
income by buying and selling merchandise. A wholesaler is an
intermediary that buys products from manufacturers or other
wholesalers and sells them to retailers or other wholesalers.
A. Reporting Income for a Merchandiser
Revenue (net sales) from selling merchandise minus the cost of
goods sold (the expense of buying and preparing the merchandise)
to customers is called gross profit (also called gross margin). This
amount minus expenses (generally called operating expenses)
determines the net income or loss for the period.
B. Reporting Inventory for a Merchandiser
1. A merchandiser’s balance sheet is the same as a service
business with the exception of one additional current asset,
merchandise inventory, or simply inventory.
2. The cost of this asset includes the cost incurred to buy the
goods, ship them to the store, and make them ready for sale.
C. Operating Cycle for a Merchandiser
A merchandising company’s operating cycle begins by purchasing
merchandise and ends by collecting cash from selling the
merchandise. Companies try to keep their operating cycles short
because assets tied up in inventory and receivables are not
productive.
D. Inventory Systems
1. Merchandise available for sale consists of beginning inventory
and what it purchases (net purchases). The merchandise
available is either sold (cost of goods sold) or kept for future
sales (ending inventory).
2. Two alternative inventory systems are used to collect
information about cost of goods sold and the cost of inventory:
a. Perpetual inventory system—continually updates
accounting records for merchandise transactions,
specifically, for those records of inventory available for
sale and inventory sold.
b. Periodic inventory system—updates the accounting
records for merchandise transactions only at the end of a
period.
c. Some companies use a hybrid system where the perpetual
system is used for tracking units available and the periodic
system is used to compute cost of sales.
Chapter 04 Accounting for Merchandising Operations
Chapter Outline
Notes
The following sections of this outline use the perpetual inventory system.
Appendix 4A uses the period system (with perpetual results on the side). An
instructor can choose to cover either one or both inventory systems.
II. Accounting for Merchandise Purchases
The invoice serves as a source document for this event.
A. Purchase Discounts
Credit terms for a purchase include the amounts and timing of
payments from a buyer to a seller. The amount of time before full
payment is due is called the credit period.
1. Sellers can grant a cash discount to encourage the buyer to
pay earlier. A seller views a cash discount as a sales discount
and a buyer views a cash discount as a purchase discount.
This reduced payment applies only for the discount period.
2. Example: credit terms, 2/10 n/30, offers a 2 % discount if the
invoice is paid within 10 days of invoice date.
3. Entry for buyer for purchase of merchandise on credit: debit
Merchandise Inventory, credit Accounts Payable.
4. Entry for buyer to record payment within discount period:
debit Accounts Payable (full invoice amount), credit Cash
(amount paid = invoice – discount), credit Merchandise
Inventory (amount of discount).
B. Purchase Returns and Allowances
1. Purchase returns refer to merchandise a buyer acquires but
then returns to the seller.
2. A purchase allowance is a reduction in the cost of defective or
unacceptable merchandise that a buyer acquires.
3. The buyer issues a debit memorandum to inform the seller of
a debit made to the supplier’s account.
4. Entry for buyer to record purchase return or allowance: debit
Accounts Payable or Cash (if refund given) and credit
Merchandise Inventory.
5. When goods are returned, a buyer can take a purchase
discount on only the remaining balance of the invoice.
Chapter 04 Accounting for Merchandising Operations
Chapter Outline
Notes
C. Transportation Costs and Ownership Transfer
The buyer and seller must agree on who is responsible for paying
any freight costs and who bears the risk of loss during transit for
merchandising transactions. The point of transfer is called the
FOB (free on board) point.
1. FOB shipping point—buyer accepts ownership when goods
depart sellers’ place of business; buyer pays shipping costs.
a. Shipping costs increase the cost of merchandise acquired
(cost principle).
b. Entry for buyer to record shipping costs: Debit
Merchandise Inventory, credit Cash or Accounts Payable
(if to be paid with merchandise later).
2. FOB destination—ownership of goods transfers to buyer when
goods arrive at buyer’s place of business; seller pays shipping
costs.
a. Shipping costs are an operating (selling) expense for seller
b. Entry for seller to record shipping costs: Debit Delivery
Expense (or Transportation-Out or Freight-Out), credit
Cash.
III. Accounting for Merchandise Sales
A. Sales of Merchandise
Each sales transaction involves two parts and will therefore
require two entries:
1. Recognize revenue received —entry for seller to record: debit
Accounts Receivable (or cash), credit Sales (for the invoice
amount).
2. Recognize cost of merchandise sold— entry for seller to
record: debit Cost of Goods Sold, credit Merchandise
Inventory (for the cost of the merchandise sold).
B. Sales Discounts
Sales discounts are usually not recorded until a customer actually
pays with the discount period.
1. Entry for seller to record collection after discount period—
Debit Cash, Credit Accounts Receivable (full invoice amount).
2. Entry for seller to record collection within discount period—
debit Cash (invoice amount less discount), debit Sales
Discounts (discount amount), credit Accounts Receivable
(invoice amount).
3. Sales Discounts is a contra-revenue account; it is subtracted
from Sales when computing a company’s net sales.
4. Sales discounts are monitored to assess the effectiveness and
cost of its discount policy.
Chapter 04 Accounting for Merchandising Operations
Chapter Outline
Notes
C. Sales Returns and Allowances
1. Sales returns—merchandise that a customer returns to the
seller after a sale.
2. Sales allowances—reductions in the selling price of
merchandise sold to customers (usually for damaged or
defective merchandise that a customer is willing to keep at a
reduced price).
3. Entry for seller to record sales returns or allowances: debit
Sales Returns and Allowances and credit Accounts
Receivable; additional entry if returned merchandise is
salable: debit Merchandise Inventory, credit Cost of Goods
Sold.
4. Seller prepares a credit memorandum to inform buyer of the
seller’s credit to the buyer’s Accounts Receivable (on the
seller’s books).
IV. Completing the Accounting Cycle
A. Adjusting Entries for Merchandisers
Generally same as discussed in chapter 3 for a service business.
1. Additional adjustment needed to update inventory to reflect
any loss of merchandise, including theft and deterioration, is
referred to as shrinkage.
2. Shrinkage is determined by comparing a physical count of the
inventory with recorded quantities.
3. Entry to record shrinkage: debit Cost of Goods Sold, credit
Merchandise Inventory.
B. Preparing Financial Statements
The financial statement for a merchandiser are similar to those for
a service company described in chapters 2 and 3.
1. The income statement mainly differs by the inclusion of cost
of goods sold and gross profit. Net sales is affected by
discounts, returns, and allowances, and some additional
expenses are possible such as delivery expense and loss from
defective merchandise.
2. The balance sheet mainly differs by the inclusion of
merchandise inventory as part of current assets.
C. Closing Entries for Merchandisers
Closing entries are similar to a service business except that some
new temporary accounts that arise from merchandising activities
must be closed (e.g., Sales Discount, Sales Returns and
Allowances, and Cost of Goods Sold). These debit balance
accounts are closed with the expense accounts to Income
Chapter 04 Accounting for Merchandising Operations
Chapter Outline
Notes
V. Financial Statement Formats—No specific format is required in
practice. Two common income statement formats:
A. Multiple-Step Income Statement
1. A multiple-step income statement has three main parts:
a. Gross profit—net sales minus cost of goods sold),
b. Income from operations—gross profit less operating
expenses, and
c. Net income—income from operations adjusted for
nonoperating items.
2. Operating expenses are classified into two sections:
a. Selling expenses—the expenses of promoting sales,
making sales, and delivering goods to customers, and
b. General and administrative expenses—expenses related
to accounting, human resource management, and financial
management.
3. Nonoperating activities—consist of other expenses, revenues,
losses, and gains that are unrelated to a company’s operations;
reported in two sections:
a. Other revenues and gains—interest revenue, dividend
revenue, rent revenue, and gains from asset disposals.
b. Other expenses and losses—interest expense, losses from
asset disposals, and casualty losses.
B. Single-Step Income Statement
A single-step income statement includes cost of goods sold as an
operating expense and shows only one subtotal for total expenses,
one subtraction to arrive at net income.
C. Classified Balance Sheet
The merchandiser’s classified balance sheet reports merchandise
inventory as a current asset, usually after accounts receivable.
VI. Global View
A. Accounting and Reporting for Merchandising Purchases and
Sales – Both GAAP and IFRS include similar guidance in
accounting for merchandise purchases and sales. All of the
transactions presented in this chapter, including the closing process,
(or net revenue) followed by cost of goods sold for
merchandisers/manufacturers.
1. GAAP offers little guidance about the presentation or order of
Chapter 04 Accounting for Merchandising Operations
Chapter Outline
financing costs, income tax expense and other special items.
2. Both systems require separate disclosure of items when their
size, nature or frequency are important.
3. IFRS permits expenses to be presented by their function or
nature. GAAP provides no direction but the SEC requires
presentation by function.
4. Neither GAAP nor IFRS define operating income, which
results in latitude in reporting.
5. IFRS permits alternative income measures; US GAAP does
not.
C. Balance Sheet Presentation – GAAP balance sheets report
current items first, with assets listed from most liquid to least
liquid and liabilities are listed from nearest to maturity to
furthest from maturity. IFRS balance sheets present noncurrent
items first but this is not a requirement.
Notes
VII. Decision Analysis—Acid-Test and Gross Margin Ratios
A. Acid-Test Ratio
1. The acid-test ratio is used to assess the company’s liquidity or
ability to pay its current debts; it differs from the current ratio
by excluding less liquid current assets.
2. It is calculated by dividing quick assets by current liabilities;
quick assets are cash, short-term investments, and current
receivables.
3. Rule of thumb is that the acid-test ratio should have a value of at
least 1.0 to conclude that a company is unlikely to face near-term
liquidity problems.
B. Gross Margin Ratio
1. The gross margin ratio (also called gross profit ratio) is used
to assess a company’s profitability before considering
operating expenses.
2. It is calculated by dividing gross margin (net sales – cost of
goods sold) by net sales.
VIII. Periodic Inventory System (Appendix 4A)
A. Records merchandise acquisitions, discounts and returns in
temporary accounts (Purchases, Purchase Returns, Purchases
Discounts) rather than the merchandise inventory account.
B. Records only the revenue aspect of sales-related events; updates
inventory and determines cost of goods sold only at the end or the
accounting period.
C. The Merchandise Inventory account can be updated as part of the
adjusting or closing process.
Chapter 04 Accounting for Merchandising Operations
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Chapter Outline
Notes
D. Requires closing additional temporary accounts.
E. Financial statements of merchandisers using the periodic system
are similar to those of a service company. The cost of goods sold
and gross profit are included in the income statement. The balance
sheet includes merchandise inventory in current assets.
IX. Work Sheet—Perpetual System (Appendix 4B)
Differs slightly from the work sheet layout for a service company in
Chapter 3; includes additional accounts used by a merchandiser:
Merchandise Inventory, Sales, Sales Returns and Allowances, Sales
Discounts, and Cost of Goods Sold.
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Chapter 04 Accounting for Merchandising Operations
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Chapter 4 – Alternate Demonstration Problem #1
The following data was taken from ledger account balances and
supplementary data for the Whisk Company for the year ended
December 31, 20xx:
Merchandise inventory, 1/1/20xx ……………………………………………
$ 20,000
Merchandise inventory, 12/31/20xx ………………………………………..
23,000
Purchases …………………………………………………………………………….
215,000
Purchases discounts …………………………………………………………….
6,000
Purchases returns and allowances ………………………………………..
3,000
Sales …………………………………………………………………………………….
400,000
Sales discounts …………………………………………………………………….
3,200
Sales returns and allowances ………………………………………………..
1,800
Transportation-in …………………………………………………………………..
10,000
Required:
1. Compute the total cost of merchandise purchases.
2. Compute the cost of goods sold.
3. Prepare a multiple-step income statement (only through the gross
profit line) for the year ended December 31, 20xx.
Chapter 04 Accounting for Merchandising Operations
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Solution: Chapter 4 – Alternate Demonstration Problem #1
1.
Purchases
$215,000
Less: Purchase discounts
$6,000
Purchases returns and allowances
3,000
9,000
Net purchases
206,000
Add transportation–in
10,000
Total cost of merchandise purchases
$216,000
2.
Merchandise inventory, January 1, 20xx
$ 20,000
Total cost of merchandise purchases
216,000
Goods available for sale
236,000
Merchandise inventory, December 31, 20xx
23,000
Cost of goods sold
$213,000
3.
WHISK COMPANY
Partial Income Statement
For the Year Ended December 31, 20xx
Revenue from sales:
Gross sales
$400,000
Less: Sales discounts
$ 3,200
Sales returns and
allowances
1,800
5,000
Net sales
395,000
Cost of goods sold
213,000
Gross profit
$182,000