Chapter 06 – Merchandising Activities
Financial and Managerial Accounting, 17e 6-1
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.
Chapter 06 – Merchandising Activities
7. Define special journals and explain their usefulness.
8. Measure the performance of a merchandising business.
Brief topical outline
A Merchandising companies
1 The operating cycle of a merchandising company
a Comparing merchandising activities with manufacturing
activities
b Retailers and wholesalers
2 Income statement of a merchandising company
3 Accounting system requirements for merchandising companies
4 Two approaches used in accounting for merchandise inventories
B Perpetual inventory systems
1 Purchases of merchandise
2 Sales of merchandise
3 Payment of accounts payable to suppliers
4 Collection of accounts receivable from customers
5 Taking a physical inventory – see Case in Point (page 254)
6 Closing entries in a perpetual inventory system – see Your Turn (page 254)
C Periodic inventory systems
1 Operation of a periodic inventory system
2 Recording purchases of merchandise
3 Computing cost of goods sold
4 Recording inventory and cost of goods sold
5 Closing process in a periodic inventory system
a Creating a cost of goods sold account
b Completing the closing process
6 Comparison of perpetual and periodic inventory systems
a Who uses perpetual systems? – see Case in Point (page 258)
b Who uses periodic systems?
7 Selecting an inventory system
a The trend in today‘s business world – see Your Turn (page 259)
D Transactions relating to purchases
1 Credit terms and cash discounts
a Recording purchases at gross invoice price
2 Returns of unsatisfactory merchandise
3 Transportation costs on purchases
Chapter 06 – Merchandising Activities
Financial and Managerial Accounting, 17e 6-3
E Transactions relating to sales
1 Sales returns and allowances
2 Sales discounts
3 Delivery expenses
4 Accounting for sales taxes
F Modifying an accounting system
1 Special journals provide speed and efficiency
G Financial analysis and decision making
1 Net sales
2 Gross profit margins
a The overall gross profit margin
b Segment gross profit margins
c Using information about gross profit margins – see Ethics, Fraud &
Corporate Governance (page 266)
H Concluding 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
Critical
Thinking
Cases
1
A – B
1, 2, 3,
1, 2
2, 3, 4
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
Comments and observations
Teaching objectives for Chapter 6
Our objectives in presenting this chapter are to:
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 sale of merchandise using a perpetual inventory system.
4 Describe accounting for purchases and sale of merchandise using a periodic inventory system.
5 Distinguish between perpetual and periodic inventory systems.
6 Illustrate accounting for cash discounts, merchandise returns, transportation costs, and sales
taxes.
Chapter 06 – Merchandising Activities
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
beginning inventory + purchases – ending inventory is not a familiar
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.
Chapter 06 – Merchandising Activities
Financial and Managerial Accounting, 17e 6-5
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 06 – Merchandising Activities
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?
a An aircraft manufacturer.
b A supermarket that is part of a national chain.
c An independently owned art gallery with a manual accounting system.
d A beer bar.
2 A periodic inventory system eliminates the need for:
a Taking an annual physical inventory.
b Recording the revenue from sales transactions.
c Recording the cost of merchandise sold as sales occur.
d None of the above.
3 If management wants to know the cost and quantity of merchandise on
hand at all times, the business will probably:
a Use a periodic inventory system.
b Maintain an inventory subsidiary ledger.
c Take a complete physical inventory each day.
d Debit 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:
a Inventory account.
b Sales account.
c Purchases account.
d None 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.
d Some other amount.