Chapter 6

Accounting for Merchandising Businesses

Learning Objectives
1. Nature of Merchandising Business
2. Accounting for Purchases
3. Accounting for Sales
4. Transportation Costs
5. Merchandise Transactions
6. Merchandising Chart of Accounts
7. Merchandising Income Statement
8. Merchandising Accounting Cycle
9. Financial Analysis and Interpretation

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 Nature of merchandise business
Service business
– Provide service
– Usually it is a small business
Merchandise business
– Purchase and sell merchandise inventory
– Bigger than service business

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 Comparison
Comparison of
of Income
Income Statements:
Statements:
Service
Service Co.
Co. And
And Merchandising
Merchandising Co.
Co.

Service Co. Merchandising Co.

Income Statement Income Statement
Year ended June 30, 20xx Year ended June 30, 20xx
Service revenue $xxx Sales revenue $xxx
Expenses: Cost of goods sold x
Salary expense x Gross profit xx
Depreciation expense x Operating expenses:
Income tax expense x Salary expense x
Net income $ xx Depreciation expense x
Income tax expense x
Net income $C6xx
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 Special terms
• sales revenue or sales
– the amount that a business earns from selling
merchandise inventory is called sales revenue, or sales.
• cost of merchandise sold
– the major expense of a merchandiser is cost of goods
sold.
• Gross margin or Gross profit
– The excess of sales over cost of sales is called gross
margin.
• Merchandise inventory
– Merchandise on hand at the end of an account period
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 Compute the net income
• Service business:
– Fees earned – operating expenses = net income

• Merchandise business:
– Sales – cost of merchandise sold = gross profit
– Gross profit – operating expenses = net income

The cost of merchandise sold is the largest expense for

the merchandise business, say 70% or more

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 Income Statement Comparison

Service Business
Fees earned $150,000
Operating expenses 120,000
Net income $ 30,000 20% of revenues

Merchandising Business
Sales revenue $600,000
Cost of mdse. sold 450,000 75% of revenues
Gross profit $150,000
Operating expenses 120,000
Net income $ 30,000 5% of revenues

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 Merchandise Inventory

 Merchandising involves selling inventory

 Inventory is usually an important asset
 Inventory must be accounted for periodically or
perpetually
 Inventory system
 Perpetual inventory system
 Periodic inventory system

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 Perpetual inventory system

• In a perpetual inventory system, each

purchase and the cost of each sale are
recorded in Merchandise Inventory.

• Most companies using the perpetual

inventory system.

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 Periodic inventory system

• In a periodic inventory system, the inventory

records do not show the amount available for sale
or sold during the period. Instead, a detailed
listing of merchandise for sale at the end of the
accounting period is prepared by the physical
count.
• This physical inventory is used to determine the
cost of the merchandise inventory on hand and the
cost of merchandise sold.

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Advantages of Using Perpetual Inventory

 Continuous determination of inventory value

 Continuous determination of gross profit
 Affordable with computers, scanners, and bar codes on most products
 Perpetual inventory accounting provides management controls
 Managers know which items are selling fastest and the profit margin on
those items

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 Accounting for purchase

• Purchase order
• Receive the inventory
• Invoice and payment

• Exhibit 1 invoice
– Netsolutions purchase $1,500 merchandise inventor
– Credit term: 2/10; n/30

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 Purchase and payment
Payment without discount

Jan. 12
Merchandise inventory 1500
Accounts payable 1500

Jan. 22
Accounts payable 1500
Cash 1500

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 Purchase and payment
Payment with the discount: 1500 *2% = $30

Jan. 12
Merchandise inventory 1500
Accounts payable 1500

Jan. 22
Accounts payable 1500
Cash 1470
Merchandise inventory 30

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 Discount rate
• Purchase amount: $1500
• Discount rate: 2% for 20 days
1500* 2% =30
• Interest rate: 12% per year
1470*12%*20/360= 9.80
• Savings from borrowing:
30 –9.80 =20.20

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 What is the due date of the
invoice?
• Question 1:
– An invoice dated august 13, has terms n/30.

• Question 2:
– An invoice dated November 22

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 What is the due date of the
invoice?
• Question 1:
– An invoice dated august 13, credit terms n/30.
Solution:
– Sep. 12
• Question 2:
– An invoice dated November 22, credit terms:2/10,n/30
Solution:
– Dec. 2
– Dec. 22

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Purchases returns and allowances
• Purchase returns
– Purchase business return the merchandise inventory to
selling business
– get a debit memorandum from the sales business
• Purchase allowances
– Purchase business do not return the merchandise
inventory to selling business
– get a debit memorandum from the sales business
•

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Purchases returns and allowances
Example : p.231
1. May 2, purchases $5,000 of inventory.
2. May 4, returns $3,000 of inventory
3. Credit term: 2/10; n/30
4. Discount: (5000-3000) * 2% = $40

Recording in the journal

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 Accounting for sales
• To record:
– Sales revenue
– Cost of sales
– Sales expenses
• Example: p. 233
– Sales :$ 1000
– Cost of sales: $550
– Credit card charges: $50

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 Sales discount
To set up a separate account: sales discounts
– It is a contra account to Sales.
– Balance on usually on the debit side.
• Example : p. 233
– Sales: $1500
– Discount: $30
– Net sales: $1470

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 Sales returns and allowances
To set up a separate account:
– Sales returns and allowances
– It is a contra account to Sales.
– Balance on usually on the debit side.
• Example : p. 234
– Sales returns: $225, cost $140
– Record the deduction of sales
– Record the deduction of cost of sales

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 Sales taxes
Example p.235
– Sales price $100
– Sales tax rate 6%
– Total amount $106 of accounts receivable

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 Sales taxes
Example p.235
– Sales price $100
– Sales tax rate 6%
– Total amount $106 of accounts receivable

Accounts receivable 106

Sales 100
sales tax payable 6

Sales tax payable 6

Cash 6

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 Trade discount
• Wholesalers give the purchaser the discount
for large amount of purchase.
• P. 235
– 30% of discount for $2400 sales
– The sales revenue: 2400 * 70%=1680

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 Transportation cost
• FOB shipping point
• FOB destination

seller Shipping buyer

point

• If FOB shipping point, the buyer pays the

transportation costs.
• If FOB destination, the seller pays the transportation
costs.
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 Example: FOB shipping point
• Buyer’s record:
– Buy merchandise inventory $ 900
– Transportation cost $ 50

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 Example: FOB shipping point
• Buyer’s record:
Merchandise inventory 900
Accounts payable 900

Merchandise inventory 50
Cash 50

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 More example
• Under the term of FOB shipping point,
sometimes the seller prepaid the
transportation cost, then to get the refund
from the buyer.
– Selling merchandise inventory $800
– Term: FOB shipping point
– Transportation cost $45

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 More example
The seller’s record:

Accounts receivable 800

Sales 800

Cost of merchandise sold 360

Merchandise inventory 360

Transportation out 45
Cash 45
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 Example : FOB destination
• seller’s record
– selling merchandise inventory $700
– Cost of sales $480
– Transportation cost 40

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 Example : FOB destination
• seller’s record
Accounts receivable 700
Sales 700

Cost of merchandise sold 48

Merchandise inventory 48

Transportation out 40
Cash 40
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 Illustration of Accounting for
merchandise inventory

Seller: Scully company

Buyer: Burton company

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 Selling and Buying Merchandise Inventory
Seller Buyer
Description Debit Credit Description Debit Credit

Accts. Receivable 7,500 Mdse. Inventory 7,500

Sales 7,500 Accts. Payable 7,500
Cost of Mdse. Sold 4,500 Recorded at full cost
Mdse. Inventory 4,500

July1. Merchandise was sold with credit terms of n/45.

No entry
Mdse. Inventory 150
Cash 150

July 2. Paid transportation cost.

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 Accounting for Merchandise Transactions
Scully Company (Seller) Burton Co. (Buyer)
Description Debit Credit Description Debit Credit

Accts. Receivable 5,000 Mdse. Inventory 5,000

Sales 5,000 Accts. Payable 5,000
Cost of Mdse. Sold 3,500
Mdse. Inventory 3,500
July 5. Scully Company sold merchandise on account to
Burton Co., $5,000, terms FOB destination, n/30. The cost
of the merchandise sold was $3,500.

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 Accounting for Merchandise Transactions
Scully Company (Seller) Burton Co. (Buyer)
Description Debit Credit Description Debit Credit
Accts. Receivable 5,000 Mdse. Inventory 5,000
Sales 5,000 Accts. Payable 5,000
Cost of Mdse. Sold 3,500
Mdse. Inventory 3,500

Transportation Out 250 No entry.

Cash 250

July 7. Scully Company paid transportation costs of $250

for delivery of merchandise sold to Burton Co. on July 5.

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 Accounting for Merchandise Transactions
Scully Company (Seller) Burton Co. (Buyer)
Description Debit Credit Description Debit Credit

Accts. Receivable 5,000 Mdse. Inventory 5,000

Sales 5,000 Accts. Payable 5,000
Cost of Mdse. Sold 3,500
Mdse. Inventory 3,500

Transportation Out 250 No entry.

Cash 250

Sales Ret. & Allow. 1,000 Accts. Payable 1,000

Accts Receivable 1,000 Mdse. Inventory 1,000
Mdse. Inventory 700
Cost of Mdse. Sold 700
July 13. Scully Company issued Burton Co. a credit memo for
merchandise returned, $1,000. The merchandise cost was $700.
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 Accounting for Merchandise Transactions
Scully Company (Seller) Burton Co. (Buyer)
Description Debit Credit Description Debit Credit

Cash 4,000 Accts. Payable 4,000

Accts. Receivable 4,000 Cash 4,000

July 15. Scully Company received payment from

Burton Co. for purchase of July 5.

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 Accounting for Merchandise Transactions
Scully Company (Seller) Burton Co. (Buyer)
Description Debit Credit Description Debit Credit

Cash 4,000 Accts. Payable 4,000

Accts. Receivable 4,000 Cash 4,000

Accts. Receivable 12,500 Mdse. Inventory 12,500

Sales 12,000 Accts. Payable 12,500
Cash 500
Cost of Mdse. Sold 7,200
Mdse. Inventory 7,200

July 18. Scully Company sold merchandise on

account to Burton Co., $12,000, terms FOB
shipping point, 2/10, n/eom. Scully Company
prepaid transportation costs of $500. Cost of
merchandise sold was $7,200.

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 Accounting for Merchandise Transactions
Scully Company (Seller) Burton Co. (Buyer)
Description Debit Credit Description Debit Credit

Cash 4,000 Accts. Payable 4,000

Accts. Receivable 4,000 Cash 4,000

Accts. Receivable 12,500 Mdse. Inventory 12,500

Sales 12,000 Accts. Payable 12,500
Cash 500
Cost of Mdse. Sold 7,200
Mdse. Inventory 7,200

Cash 12,260 Accts. Payable 12,500

Sales Discounts 240 Mdse. Inventory 240
Accts. Receivable 12,500 Cash 12,260

July 28. Scully Company received payment from

Burton Co. less discount (2% x $12,000).
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 Chart of accounts for a
merchandise business
• What are new accounts in the chart of accounts?
1. Assets
2. Liabilities
3. Owner’s equity
4. Revenue
5. Costs and expense
6. Other income
7. Other expense

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 NetSolutions
Merchandising Chart of Accounts
Balance Sheet Accounts
100 Assets 200 Liabilities
110 Cash 210 Accounts Payable
111 Notes Receivable 211 Salaries Payable
112 Accounts Receivable 212 Unearned Rent
113 Interest Receivable 215 Notes Payable
115 Merchandise Inventory
116 Office Supplies 300 Owner’s Equity
117 Prepaid Insurance 310 Chris Clark, Capital
120 Land 311 Chris Clark, Drawing
123 Store Equipment 312 Income Summary
124 Accumulated Depreciation—
Store Equipment
125 Office Equipment
126 Accumulated Depreciation—
Office Equipment

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 NetSolutions
Merchandising Chart of Accounts
Income Statement Accounts

400 Revenues 500 Costs and Expenses

410 Sales 510 Cost of Merchandise Sold
411 Sales Returns and 520 Sales Salaries Expense
Allowances 521 Advertising Expense
412 Sales Discounts 522 Depreciation Expense—
Store Equipment
600 Other Income 523 Transportation Out
610 Rent Income 529 Misc. Selling Expense
611 Interest Income 530 Office Salaries Expense
531 Rent Expense
700 Other Expense 532 Depreciation Expense—
710 Interest Expense Office Equipment
533 Insurance Expense
534 Office Supplies Expense
539 Misc. Admin. Expense

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 Income statement for a
merchandise business
• A service business
– Single-step form]
• A merchandise business
– Multiple-step form
– Exhibit 7

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 NetSolutions
Income Statement (Multiple-Step)
For the Year Ended December 31, 2004

Revenue from sales:

Sales $720,185
Less:Sales returns and allow. $ 6,140
Sales discounts 5,790 11,930
Net sales $708,255
Cost of merchandise sold 525,305
Gross profit $182,950

Continued

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Operating expenses:
Selling expenses:
Sales salaries expense $60,030
Advertising expense 10,860
Depr. expense–store equip. 3,100
Miscellaneous selling expense 630
Total selling expenses $ 74,620
Administrative expenses:
Office salaries expense $21,020
Rent expense 8,100
Depr. expense–office equip. 2,490
Insurance expense 1,910
Office supplies expense 610
Misc. admin. expenses 760
Total admin. expenses 34,890
Total operating expenses 109,510
Income from operations $ 73,440

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Other income:
Interest revenue $ 3,800
Rent revenue 600
Total other income $ 4,400
Other expense:
Interest expense 2,440 1,960
Net income $75,400

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 NetSolutions
Income Statement (Single-Step)
For the Year Ended December 31, 2004

Revenues:
Net sales $708,255
Interest revenue 3,800
Rent revenue 600
Total revenues $712,655
Expenses:
Cost of merchandise sold $525,305
Selling expenses 74,620
Administrative expenses 34,890
Interest expense 2,440
Total expenses 637,255
Net income $ 75,400

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 NetSolutions
Balance Sheet
December 31, 2002

Assets
Current assets:
Cash $ 52,950
Notes receivable 40,000
Accounts receivable 60,880
Interest receivable 200
Merchandise inventory 62,150
Office supplies 480
Prepaid insurance 2,650
Total current assets $219,310

Continued

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 NetSolutions
Balance Sheet
December 31, 2002

Property, plant, and

equipment:
Land $ 10,000
Store equipment $ 27,100
Less accum. depreciation 5,700 21,400
Office equipment $ 15,570
Less accum. depreciation 4,720 10,850
Total property, plant, and
equipment 42,250
Total assets $261,560

Continued

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 NetSolutions
Balance Sheet
December 31, 2002

Liabilities
Current liabilities:
Accounts payable $ 22,420
Note payable (current portion) 5,000
Salaries payable 1,140
Unearned rent 1,800
Total current liabilities $30,360
Long-term liabilities:
Note payable (due 2004) 20,000
Total liabilities $ 50,360
Owner’s Equity
Chris Clark, capital 211,200
Total liabilities and owner’s equity $261,560

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Merchandise inventory shrinkage

• Book records: $63,950

• Physical inventory : $ 62,150
• Inventory shortage: $ 1,800

• Adjusting:
Cost of merchandise sold 1800
Merchandise inventory 1800

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 Profitability Analysis

Profitability is the ability of an entity to earn profits.

This ability to earn profits depends on the
effectiveness and efficiency of operations as well
as resources available.
Profitability analysis focuses primarily on the
relationship between operating results reported in
the income statement and resources reported in
the balance sheet.

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 Profitability Measures — Effective Use of Assets

Ratio
Ratioof
ofNet
NetSales
Salesto
toAssets
Assets
2003 2002
Net sales $1,498,000 $1,200,000
Total assets:
Beginning of year $1,053,000 $1,010,000
End of year 1,044,500 1,053,000
Total $2,097,500 $2,063,000
Average $1,048,750 $1,031,500

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 Profitability Measures — Effective use of Assets

Ratio
Ratioof
ofNet
NetSales
Salesto
toAssets
Assets
2003 2002
Net sales on account $1,498,000 $1,200,000
Total assets:
Beginning of year $1,053,000 $1,010,000
End of year 1,044,500 1,053,000
Total $2,097,500 $2,063,000
Average $1,048,750 $1,031,500
Ratio of net sales to assets 1.4 to 1 1.2 to 1

Use:
Use: To
Toassess
assessthe
theeffectiveness
effectiveness
in
inthe
theuse
useof
ofassets
assets

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 HOME WORK
READING:
1. Illustrative problem
2. Self- examination questions
3. Multiple choice
Writing:
1. Exercise: 6-25;6-26;6-27
2. Problem : 6-5B
Discussion:

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This is the end of Chapter 6.

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