Financial and Managerial Accounting, 8th Edition
4-1
CHAPTER 4
ACCOUNTING FOR MERCHANDISING OPERATIONS
Related Assignment Materials
Student Learning Objectives
Questions
Quick
Studies*
Exercises*
Problems*
AA
and
BTN
Conceptual objectives
BTN 4-6
inventory asset and cost flows of
a merchandising company.
BTN 4-4,
BTN 4-5
C1. Describe merchandising
activities and identify income
1, 2, 3, 4
4-1
4-1
BTN 4-1,
BTN 4-3,
Analytical objectives:
A1. Compute the acid-test ratio and
explain its use to assess
liquidity.
4-14
4-14
4-5, GL 4-3
AA 4-1
A2. Compute the gross margin ratio
and explain its use to assess
profitability.
4-15
4-13
4-5, GL 4-3
AA 4-2,
AA 4-3
Procedural objectives:
P1. Analyze and record transactions
for merchandise purchases using
a perpetual system.
6, 7, 8, 9,
15
4-1, 4-4, 4-5,
4-6, 4-7
4-3, 4-5, 4-6,
4-7, 4-8, 4-9,
4-25
4-1, 4-2, SP
GL 4-1,
GL 4-2
BTN 4-5
for merchandise sales using a
perpetual system.
4-8, 4-9
GL 4-1,
GL 4-2
BTN 4-6
company.
and single-step income
statements.
13, 14
4-13
4-16
GL 4-3, ES
4-19, 4-20
4-20, 4-21,
Financial and Managerial Accounting, 8th Edition
discounts, returns, and
allowances per revenue
recognition rules.
(Appendix 4B)
4-22
using the gross method and net
method. (Appendix 4C)
*See additional information on next page that pertains to these quick studies, exercises, and problems.
SP refers to the Serial Problem
Additional Information on Related Assignment Material
See Chapter 1 of the Instructor’s Resource Manual for more information on materials for this text available in
Connect.
Connect
Available on the instructor’s course-specific website, Connect:
• All numerical Quick Studies, all Exercises and Problems Set A.
Hints/Guided Examples
Please note that the Guided Examples are labeled as “Hints” in Connect assignments. The animated PowerPoints
Need-to-Know Videos
LO
Need–to-Know
Title
Time
C1, C2
4-1
Merchandise Accounts and Computations
1:58
P1
4-2
Merchandise Purchases
3:22
P2
4-3
Merchandise Sales
4:46
P3
4-4
Recording Shrinkage and Closing Entries
3:02
P4
4-5
Multiple-and Single-Step Income Statements
2:33
P6
4-8
Estimating Discounts, Returns, and Allowances
4:35
Concept Overview Videos
LO
Title
Time
C1
Describe merchandising activities and identify income components for a
merchandising company.
Financial and Managerial Accounting, 8th Edition
4-3
Income Statement
0:36
C2
Identify and explain the inventory asset and cost flows of a merchandising
company.
Reporting Inventory
0:29
Operating Cycle for a Merchandiser
0:43
Cost of Goods Sold
0:33
Cost Flow Example
0:59
Inventory Systems
0:45
A1
Compute the acid-test ratio and explain its use to assess liquidity.
Acid-Test Ratio
1:08
Acid-Test Ratio—Background Information
1:09
Acid-Test Ratio Illustration
1:22
A2
Compute the gross margin ratio and explain its use to assess profitability.
Gross Margin Ratio
1:04
Gross Margin Ratio Illustration
1:29
P1
Analyze and record transactions for merchandise purchases using a perpetual
system.
Purchases without Cash Discounts
0:26
Credit Terms and Cash Discounts
1:43
Purchases with Cash Discounts
3:15
Purchases with Returns and Allowances
2:09
Purchases and Transportation Costs
2:42
Itemized Costs of Purchases
1:30
P2
Analyze and record transactions for merchandise sales using a perpetual
system.
Sales without Cash Discounts
1:20
Sales with Cash Discounts
2:38
Sales with Returns
2:23
Sales with Allowances
0:32
P3
Prepare adjustments and close accounts for a merchandising company.
Adjusting Entries for Merchandisers
0:17
Adjusting Entries for Inventory Shrinkage
0:59
Overview of Closing Entries
0:30
Closing Entries Illustration
1:04
P4
Define and prepare multiple-step and single-step income statements.
Multiple-Step Income Statement
0:53
Multiple-Step Income Statement Illustration
3:17
Single-Step Income Statement
0:31
Classified Balance Sheet
0:23
Record and compare merchandising transactions using both periodic and
Periodic versus Perpetual Inventory Systems
1:35
Periodic Inventory System
1:04
Purchases Transactions
1:43
Financial and Managerial Accounting, 8th Edition
4-4
Sales Transactions
1:35
Adjusting Entries
0:53
Closing Entries
1:58
Gross and Net Methods
0:45
Purchases Using Net Method
2:02
Sales Using Net Method
1:59
Synopsis of Chapter Revisions
NEW opener—Build-A-Bear and entrepreneurial assignment.
Updated introduction for servicers vs. merchandisers using Liberty Tax and Nordstrom.
Revised NTK 4-1 covers basics of merchandising.
Reorganized “Purchases” section to aid learning.
Financial and Managerial Accounting, 8th Edition
4-5
Chapter Outline
I. Merchandising Activities
A. Merchandise refers to products, also called goods, which a company buys to resell. Merchandisers
can be either wholesalers (those that buy from manufacturers and sell to retailers) or retailers (those
that buy from manufacturers or wholesalers and sell to consumers).
E. Inventory Systems
Two alternative inventory systems that can be used to collect information about the cost of goods
sold and the inventory (cost of goods available) are:
1. Perpetual inventory system—updates accounting records for each purchase and each sale of
Note: This outline describes the accounting using a Perpetual Inventory System. Periodic
Inventory is discussed in the Appendix 4A section of this outline. Also note, the terms inventory
and merchandise inventory are synonymous. Inventory is used for brevity.
II. Accounting for Merchandise Purchases
The invoice serves as a source document for the event.
A. Purchases without Cash Discounts.
1. Entry to record purchase—debit Inventory, credit Cash or Accounts Payable.
B. Purchase with Cash Discounts
1. Credit terms describe cash discounts offered to purchasers by the seller for payment within a
specified period of time called the discount period.
Financial and Managerial Accounting, 8th Edition
C. Purchases with Returns and Allowances
4. Entry on buyer’s books—debit Accounts Payable or Cash (if refund given) and credit Inventory.
1. Purchases allowances refers to a reduction in the cost of defective merchandise that a buyer
D. Purchases and Transportation Costs—the point at which ownership is transferred (called FOB or free
on board). Two alternative points of title transfer are:
1. FOB shipping point—title transfers at shipping point and buyer pays shipping costs.
a. Increases cost of merchandise (cost principle)
b. Debit Inventory, credit Cash or Accounts Payable (if to be paid for with merchandise
later)
III. Accounting for Merchandise Sales—involves sales, sales discount, sales returns and allowances,
and cost of goods sold
A. Each sale of merchandise transaction involves two entries: the revenue entry and the cost
entry.
1. Recognize revenue—debit Accounts Receivable (or cash), credit Sales (both for the
invoice amount).
B. Sales without Cash Discounts—Revenue side: Inflow of Assets. Debit Accounts Receivable
(or Cash) and credit Sales. Cost side: Outflow of Assets: debit Cost of Goods Sold and credit
Inventory.
C. Sales with Cash Discounts
1. Sales on Credit—revenue side using the gross method is a debit Accounts Receivable and a
Financial and Managerial Accounting, 8th Edition
4-7
4. Sales Discounts is a contra revenue account—subtraction from Sales.
Sales with Returns and Allowances
10. Returned goods are defective—debit Inventory for estimated value; debit Loss from
Defective Merchandise (difference between cost and estimated value) and credit Cost of
Goods Sold (for cost).
11. Sales Returns and Allowances is a contra revenue account that is subtracted from
Sales.
12. Credit Memorandum—issued by the seller to inform buyer of a credit made to
buyer’s Accounts Receivable in seller’s books.
IV. Adjusting and Closing for Merchandisers
A. Adjusting Entries for Merchandisers
Generally same as discussed for a service business with an additional adjustment needed to
update inventory to reflect any loss of inventory referred to as shrinkage.
1. Shrinkage determined by comparing a physical count of the inventory with recorded
quantities.
B. Preparing Financial Statements—statements similar to service business with the following
differences:
1. Income Statement includes the cost of goods sold and gross profit. Also, net sales is
affected by discounts, returns, and allowances and possibly delivery expense.
Financial and Managerial Accounting, 8th Edition
4-8
goods sold. Debit balance accounts are closed with the expense accounts to Income Summary.
V. More on Financial Statement Formats—Common formats include multiple-step and single-step.
receivable, according to how quickly they can be converted to cash.
A. Multiple-Step Income Statement—details of net sales and expenses. Has three main parts:
1. Gross profit—net sales minus cost of goods sold.
VI. Decision Analysis—Acid-Test Ratio and Gross Margin Ratio
A. Acid-Test Ratio
3. Quick assets are cash, short-term investments, and current receivables.
2. Calculated by dividing gross margin by net sales.
1. Used to assess the company’s liquidity or ability to pay its current liabilities. Differs from
VII. Periodic System (Appendix 4A)—textbook shows comparison of periodic and perpetual in this
appendix. The following chapter notes relate only to the periodic system, because the preceding notes
outline the perpetual system.
A. A periodic inventory system records merchandise acquisitions, discounts and returns in
temporary accounts (Purchases, Purchase Returns, Purchases Discounts) rather than the
merchandise inventory account.
VIII. Adjusting Entries under New Revenue Recognition Rules (Appendix 4B)
A. Expected Sales Discounts—Adjusting Entry: New revenue recognition rules require the
reporting of sales at the net amount expected. Period-end adjusting entry needed to estimate sales
discounts for current-period’s sales expected to be taken in future periods. Entry: debit Sales
Financial and Managerial Accounting, 8th Edition
4-9
VIX. Net Method (Appendix 4C)
Net method initially records the invoice at an amount net of any cash discount, so cash discounts
are deducted from Inventory when initially recorded.
H. Perpetual Inventory System Purchases—debit Inventory and credit Accounts Payable for the net
amount.
1. If invoice paid within discount period, debit Accounts Payable and credit Cash for net amount.
2. If invoice paid after discount period, debit Accounts Payable for net amount, debit Discounts
I. Periodic Inventory System Purchases—Merchandise Inventory remains unchanged during the
period and is updated only at period-end as part of the adjusting process.
1. Debit Purchases for net amount and credit Accounts Payable.
Financial and Managerial Accounting, 8th Edition
Chapter 4 Alternate Demonstration Problem #1
The following data was taken from ledger account balances and supplementary
data for the Whisk Company. Whisk Company uses periodic inventory method to
account for its inventory.
Merchandise inventory, beginning …………………………………………
$ 20,000
Merchandise inventory, ending ……………………………………………..
23,000
Purchases …………………………………………………………………………….
Purchases discounts …………………………………………………………….
Purchases returns and allowances ………………………………………..
Sales discounts …………………………………………………………………….
Sales returns and allowances ………………………………………………..
10,000
Required:
Show the computation, in Income Statement format, of net sales, cost of goods
sold, and gross profit for the year ended December 31, 2019.
4-11
Chapter 4 Solution: Alternate Demonstration Problem #1
WHISK COMPANY
Income Statement
For the Year Ended December 31, 2019
Revenue from sales:
Sales …………………………………..
$400,000
Less: Sales discounts ………….
$ 3,200
Sales returns and
allowances ……………..
1,800
5,000
Net sales …………………………..…
395,000
Merchandise inventory, 1/1/19
Purchases …………………………..
$215,000
Less: Purchase discounts ……
allowances ……………..
9,000
10,000
216,000
Goods available for sale ………
236,000
Merchandise inventory, 12/31/19
23,000
213,000
Gross profit from sales ……………
$182,000
Financial and Managerial Accounting, 8th Edition
Chapter 4 Alternate Demonstration Problem #2
Koda Company is a wholesale company that had the following purchase and sales transactions
related to its merchandise inventory during the month of May.
May 1
Purchased $20,000 of merchandise on account from Webber Mfg. Co.
Credit terms: 2/10, n/30. FOB shipping point
Received a credit memo for the return of $5,000 of the goods purchased
on March 1, which had arrived damaged.
15
Sold merchandise on account to Dover Company for $5,000. The cost of
the merchandise was $3,000 (cost is 60% of the retail value). Terms:
2/10, n/30; FOB Destination
Financial and Managerial Accounting, 8th Edition
Chapter 4 Solution: Alternate Demonstration Problem #2
PERPETUAL INVENTORY SYSTEM
PERIODIC INVENTORY SYSTEM
4-1
Inventory
20,000
4-1
Purchases
20,000
Accounts Payable
20,000
Accounts Payable
20,000
2
Inventory
1,000
1,000
Cash
1,000
Cash
1,000
6
Accounts Payable
5,000
Accounts Payable
5,000
Inventory
5,000
Purchase R & A
5,000
10
Accounts Payable
15,000
10
Accounts Payable
18,000
Inventory
Purch. Discount
Cash
14,700
Cash
14,700
15
Accts Receivable
5,000
15
Accts Receivable
5,000
Sales
5,000
Sales
5,000
15
Cost of Goods Sold
3,000
Inventory
3,000
16
Delivery Expense
16
Delivery Expense
Cash
Cash
17
Sales R & A
1,000
17
Sales R & A
1,000
Accts Receivable
1,000
Accts Receivable
1,000
17
Inventory
Cost of Goods
sold
24
Cash
3,920
24
Cash
3,920
Sales Discount
Sales Discount
80
Accts Receivable
4,000
Accts Receivable
4,000