CHAPTER 5
Merchandising Operations
and the Multiple-Step Income Statement
Learning Objectives
1. Describe merchandising operations and inventory systems.
2. Record purchases under a perpetual inventory system.
3. Record sales under a perpetual inventory system.
4. Prepare a multiple-step income statement and a comprehensive income statement.
5. Determine cost of goods sold under a periodic inventory system.
6. Compute and analyze gross profit rate and profit margin.
*7. Record purchases and sales of inventory under a periodic inventory system.
Summary of Questions by Learning Objectives and Bloom’s Taxonomy
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Brief Exercises
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Do It! Exercises
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Problems: Set A
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*Continuing Cookie Solutions for this chapter are available online.
ASSIGNMENT CHARACTERISTICS TABLE
Problem
Number
Description
Difficulty
Level
Time
Allotted (min.)
1A
Journalize, post, prepare partial income statement, and
calculate ratios.
Simple
30–40
2A
Journalize purchase and sale transactions under a
perpetual system.
Moderate
20–30
3A
Journalize, post, and prepare trial balance and partial
income statement.
Simple
30–40
4A
Prepare financial statements and calculate profitability
ratios.
Moderate
40–50
5A
Prepare a correct multiple-step income statement.
Complex
20–30
6A
Journalize, post, and prepare adjusted trial balance and
financial statements.
Moderate
40–50
7A
Determine cost of goods sold and gross profit under a
periodic system.
Moderate
40–50
8A
Calculate missing amounts and assess profitability.
Moderate
20–30
*9A
Journalize, post, and prepare trial balance and partial
income statement under a periodic system.
Simple
30–40
ANSWERS TO QUESTIONS
1. (a) Disagree. The steps in the accounting cycle are the same for both a merchandising company
and a service company.
(b) The measurement of income is conceptually the same. In both types of companies, net
income (or loss) results from the matching of expenses with revenues.
LO 1 BT: C Diff: M TOT: 2 min. AACSB: None AICPA FC: Reporting
2. The components of revenues and expenses differ as follows:
Merchandising
Service
Revenues
Expenses
Sales revenue
Cost of Goods Sold and Operating
Fees, Rents, etc.
Operating (only)
LO 1 BT: C Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting
3. Under a periodic inventory system the company does not keep track of how many units are on
hand. Instead it takes a physical count at the end of the period to determine ending inventory and
cost of goods sold. Under a perpetual system the company adjusts its inventory account each time
it purchases or sells inventory. Thus it always has a record of its available inventory. Having
knowledge of inventory balances helps a company avoid lost sales due to “stock–outs” as well as
carrying too much inventory on hand (which results in additional storage and handling costs). The
purchasing department can make better decisions with the aid of perpetual inventory records.
LO 1 BT: C Diff: M TOT: 4 min. AACSB: None AICPA FC: Reporting
4. (a) The income measurement process is as follows:
Sales
Revenue
Less
Cost of
Goods
Sold
Equals
Gross
Profit
Less
Operating
Expenses
Equals
Net
Income
(Loss)
(b) Income measurement in a merchandising company differs from a service company as
follows: (a) sales are the primary source of revenue and (b) expenses are divided into two
main categories: cost of goods sold and operating expenses.
LO 1 BT: C Diff: M TOT: 4 min. AACSB: None AICPA FC: Reporting
5. Sales revenue …………………………………………………………………………………………….. $100,000
Cost of goods sold……………………………………………………………………………………….. 70,000
Gross profit …………………………………………………………………………………………………. $ 30,000
LO 1 BT: AP Diff: E TOT: 2 min. AACSB: Analytic AICPA FC: Reporting
6. Agree. In accordance with the revenue recognition principle, sales revenues are generally con–
sidered to be recognized when the goods are transferred from the seller to the buyer; that is,
when the performance obligation is satisfied. The recognition of revenue is not dependent on the
collection of credit sales.
LO 3 BT: K Diff: E TOT: 2 min. AACSB: None AICPA FC: Measurement & Reporting
7. (a) The primary source documents are (1) cash sales—cash register tapes and (2) credit sales—
sales invoice.
(b) The entries are:
Debit
Credit
Cash sales—
Cash ……………………………………………………………
Sales Revenue ………………………………………
Cost of Goods Sold ……………………………………….
Inventory ……………………………………………….
XX
XX
XX
XX
Credit sales—
Accounts Receivable ……………………………………..
Sales Revenue ………………………………………
Cost of Goods Sold ……………………………………….
Inventory ……………………………………………….
XX
XX
XX
XX
LO 3 BT: AP Diff: M TOT: 3 min. AACSB: Analytic AICPA FC: Reporting
8. July 19 Cash ($800 – $8) …………………………………………………………………. 792
Sales Discounts ($800 X 1%) ………………………………………………… 8
Accounts Receivable ($900 – $100) ………………………………… 800
LO 3 BT: AP Diff: M TOT: 3 min. AACSB: Analytic AICPA FC: Reporting
9. Shipping unwanted goods to customers is generally considered unethical behavior. In addition, if
proper accounting is applied, in most cases it won’t achieve the desired result of increasing sales. If
it is expected that the unwanted goods will be shipped back to the seller, then they should not be
treated as sales in the first place. (Note: The practice of shipping more goods than were ordered in
order to meet sales goals and get rid of extra inventory is referred to as channel stuffing.)
LO 3 BT: E Diff: H TOT: 5 min. AACSB: Analytic & Reflective Thinking AICPA BB: Critical Thinking
10. In most industries returns are not significant, and they are therefore accounted for as they occur.
When returns are expected to be significant, the company should make an adjusting entry at the
end of the period to estimate the amount of returns that will result from the period’s sales, so that
revenues will not be overstated during the period.
LO 3 BT: C Diff: M TOT: 3 min. AACSB: Analytic AICPA FC: Reporting
11. July 24 Accounts Payable ($1,900 – $300) …………………………………………. 1,600
Cash ($1,600 – $32) …………………………..…………………………. 1,568
Inventory ($1,600 X 2%) ………………………………………………… 32
LO 2 BT: AP Diff: M TOT: 2 min. AACSB: Analytic AICPA FC: Reporting
12. Gross profit ………………………………………………………………………………………… $560,000
Less: Net income ……………………………………………………………………………….. 230,000
Operating expenses …………………………………………………………………………….. $330,000
LO 4 BT: AP Diff: E TOT: 2 min. AACSB: Analytic AICPA FC: Reporting
13. Its current terms of 1/10, n/30 means that customers get a 1% discount if they pay within 10 days,
otherwise they have to pay the full amount within 30 days. If they switch to 2/10, n/45 customers
would get a 2% discount for paying within 10 days, otherwise they have to pay the full amount in
45 days. By offering 2%, more of Mai’s customers would likely pay within the 10 day period.
Management would have to determine whether it is worth the additional cost to be paid quicker.
Also, by extending the full payment period from 30 to 45 days, Mai would end up receiving its
money even later from its slow payers.
LO 2 & 3 BT: E Diff: H TOT: 5 min. AACSB: Analytic & Reflective Thinking AICPA BB: Critical
Thinking
14. The gain on the sale of the plant represents a one–time gain. That is, it won’t be recurring next
year. If you eliminate the effect of this one-time gain, then the company’s income actually declined
by $5 million relative to the prior year. When predicting future earnings investors frequently place
little weight on non-recurring events such as this.
LO 4 BT: AN Diff: H TOT: 4 min. AACSB: Analytic & Reflective Thinking AICPA BB: Critical Thinking
15. There are three distinguishing features in the income statement of a merchandising company:
(1) a sales revenues section, (2) a cost of goods sold section, and (3) gross profit.
LO 4 BT: K Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting
16. The normal operating cycle for a merchandising company is likely to be longer than for a service
company because inventory must first be purchased and sold, and then the receivables must be
collected.
LO 1 BT: C Diff: E TOT: 2 min. AACSB: None AICPA FC: Reporting
17. Apple uses the term gross margin. Total gross margin increased by $6,233 million.
LO 4 BT: AP Diff: M TOT: 3 min. AACSB: Analytic AICPA FC: Reporting
18. Of the merchandising accounts, only Inventory will appear in the post-closing trial balance.
LO 4 BT: E Diff: M TOT: 3 min. AACSB: Analytic AICPA FC: Reporting
19. Businesses most likely to use a perpetual inventory system would include automobile dealerships,
equipment supply companies, and other companies selling products having a high unit-value.
With automation, perpetual systems are becoming increasingly cost-effective.
LO 1 BT: C Diff: E TOT: 2 min. AACSB: None AICPA FC: Reporting
20. (a) (b)
Accounts Added/Deducted Normal Balance
Purchase Returns and Allowances Deducted Credit
Purchase Discounts Deducted Credit
Freight-In Added Debit
LO 5 BT: K Diff: E TOT: 2 min. AACSB: None AICPA FC: Reporting
21. (a) X = Purchase returns and allowances and
Y = Purchase discounts, or vice versa.
(b) X = Freight-in.
(c) X = Cost of goods purchased.
(d) X = Ending inventory.
LO 5 BT: C Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting
22. Profitability is affected by gross profit, as measured by the gross profit rate, and by manage-
ment’s ability to control operating expenses, as measured by the profit margin.
LO 6 BT: K Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting
23. Factors affecting a company’s gross profit rate include selling products with a higher (or lower)
“markup,” increased competition that results in lower selling prices, and price increases or
decreases from suppliers.
LO 6 BT: C Diff: M TOT: 2 min. AACSB: None AICPA FC: Reporting
24. Gross profit represents the amount by which sales exceeds cost of goods sold. In order for the
company to be profitable, gross profit must exceed the company’s operating expenses. Before
the selling price is cut, the company should do a careful analysis estimating what its gross profit
and operating expenses would be if more units were sold at a lower selling price. In addition, a
big concern is what the likely reaction of competitors will be. If competitors also cut their price,
then volume will not increase, and the company’s net income will be lower.
LO 6 BT: AN Diff: M TOT: 4 min. AACSB: Analytic AICPA BB: Critical Thinking
25. Mark Coney should calculate the company’s quality of earnings ratio. This is calculated by
dividing net cash provided by operating activities by net income. A measure significantly below 1
would suggest that the company might be using aggressive accounting techniques to recognize
income early.
LO 6 BT: AN Diff: M TOT: 3 min. AACSB: Analytic AICPA PC: Problem Solving
*26. July 24 Accounts Payable ($1,900 – $400) ……………………………. 1,500
Cash ($1,500 – $30) ………………………………………… 1,470
Purchase Discounts ($1,500 X 2%) …………………… 30
LO 7 BT: AP Diff: M TOT: 2 min. AACSB: Analytic AICPA FC: Reporting
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 5-1
(a) Sales = $181,500 ($71,900 + $109,600).
BRIEF EXERCISE 5-2
Rita Company
Inventory ………………………………………………………. 900
BRIEF EXERCISE 5-3
(a) March 2 Accounts Receivable …………………… 800,000
Sales Revenue ……………………. 800,000
2 Cost of Goods Sold …………………….. 540,000
BRIEF EXERCISE 5-3 (Continued)
(c) 12 Cash ($660,000 – $13,200) ……………. 646,800
BRIEF EXERCISE 5-4
(a) March 2 Inventory …………………………………….. 800,000
Accounts Payable ……………….. 800,000
BRIEF EXERCISE 5-5
BARTO COMPANY
Income Statement (Partial)
For the Month Ended October 31, 2017
Sales
Sales revenue ($300,000 + $150,000) …………………. $450,000
BRIEF EXERCISE 5-6
As the name suggests, numerous steps are required in determining net
income in a multiple-step statement.
Item
Section
Sales returns and allowances
Sales revenues
Gain on disposal of plant assets
Other revenues and gains
BRIEF EXERCISE 5-7
(a) Service revenue ……………………………………………. $ 62,500
Less:
Salaries and wages expense …………………………. $28,000
(b)
KAREN WEIGEL INC.
Comprehensive Income Statement
For the Year Ended December 31, 2017
Net income ………………………………………………………… $ 19,200
BRIEF EXERCISE 5-8
Beginning inventory ………………………………………….. $ 67,000
BRIEF EXERCISE 5-9
Purchases …………………………………………………………. $404,000
Less: Purchase returns and allowances……………. $13,000
BRIEF EXERCISE 5-10
Net sales …………………………..………………………………. $612,000
Beginning inventory ………………………………………….. $ 60,000
BRIEF EXERCISE 5-11
(a) Profit margin = $32,500 ÷ $250,000 = 13.0%
The profit margin measures the extent by which selling price covers all
(b) Gross profit rate = ($250,000 – $150,000) ÷ $250,000 = 40.0%
BRIEF EXERCISE 5-12
(a) Profit margin = $68,000 ÷ $800,000 = 8.5%
(b) Gross profit rate = ($800,000 – $520,000) ÷ $800,000 = 35.0%
BRIEF EXERCISE 5-13
The quality of earnings ratio is calculated by dividing net cash provided
by operating activities by net income. For Cabo Corporation this would
*BRIEF EXERCISE 5-14
(a) March 2 Purchases …………………………………… 800,000
Accounts Payable ……………….. 800,000
SOLUTIONS TO DO IT! EXERCISES
DO IT! 5-1
1. True
DO IT! 5-2
Oct. 5 Inventory …………………………………………………………… 5,000
Accounts Payable ………………………………………. 5,000
DO IT! 5-3
Oct. 5 Accounts Receivable …………………………………………. 5,000
Sales Revenue …………………………………………… 5,000
Oct. 8 Sales Returns and Allowances …………………………... 640
Accounts Receivable …………………………………. 640
DO IT! 5-4
BERLIN CORP.
Income Statement
For the Year Ended December 31, 2017
Sales
Sales revenue ……………………………………….. $592,000
Less: Sales returns and allowances ………. 40,000
Net sales ……………………………………………………. $552,000
Cost of goods sold ……………………………………… 156,000
BERLIN CORP.
Comprehensive Income Statement
For the Year Ended December 31, 2017
Net income ………………………………………………………. $146,580
DO IT! 5-5
(a) Cost of goods purchased $161,400:
Purchases – Purchase returns and allowances – Purchase
(b) Cost of goods sold $165,170:
DO IT! 5-6
2017
2016
Gross profit rate
($150,000–$90,000) = 40%
($120,000–$72,000) = 40%
Profit margin
$10,000 ÷ $150,000 = 6.7%
$22,000 ÷ $120,000 = 18.3%
SOLUTIONS TO EXERCISES
EXERCISE 5-1
(3) April 7 Equipment …………………………………. 30,000
Accounts Payable ………………. 30,000
(5) April 15 Accounts Payable
($28,000 – $3,600) ……………………. 24,400
(b) May 4 Accounts Payable ($28,000 – $3,600) …. 24,400
EXERCISE 5-2
Sept. 6 Inventory ……………………………………………….. 1,650
Accounts Payable ……………………………. 1,650
EXERCISE 5-2 (Continued)
Sept. 14 Sales Returns and Allowances …………………. 45
Accounts Receivable ………………………… 45
EXERCISE 5-3
(a) (1) Dec. 3 Accounts Receivable……………….. 500,000
(3) Dec. 13 Cash ($475,000 – $4,750)………….. 470,250
Sales Discounts
(b) Jan. 2 Cash ……………………………………………… 475,000
EXERCISE 5-4
(a) June 10 Inventory …………………………………………… 9,000
Accounts Payable ………………………. 9,000
(b) June 10 Accounts Receivable ……………………………… 9,000
Sales Revenue ………………………………… 9,000
Cost of Goods Sold ……………………………….. 5,000
Inventory ………………………………………… 5,000
EXERCISE 5-5
DOQE COMPANY
Income Statement (Partial)
For the Year Ended October 31, 2017
Sales
Sales revenue ……………………………………………… $900,000
EXERCISE 5-6
(a) LIEU CO.
Income Statement
For the Month Ended January 31, 2017
Sales
Sales revenue ………………………………………. $370,000
Less: Sales returns and allowances …….. $20,000
Sales discounts …………………………. 8,000 28,000
EXERCISE 5-6 (Continued)
(b) LIEU CO.
Comprehensive Income Statement
For the Month Ended January 31, 2017
Net income ………………………………………………………………………………. $14,000
(c) Profit margin =
$14,000
$342,000
= 4.1%
EXERCISE 5-7
(a) Yoste Company
Sales …………………………………………………………………………… $ 90,000)
*Sales returns and allowances ($90,000 – $84,000) ………… (6,000)
Net sales …………………………………………………………………….. $ 84,000)