Accounting principles chapter 05

Accounting
Principles

Second Canadian Edition
Weygandt · Kieso · Kimmel ·
Trenholm

Prepared by:
Carole Bowman, Sheridan College


CHAPTER

5
ACCOUNTING FOR
MERCHANDISING
OPERATIONS


MERCHANDISING COMPANY




A merchandising company is an enterprise
that buys and sells goods to earn a profit.
1. Wholesalers sell to retailers.
2. Retailers sell to consumers.
A merchandiser’s primary source of
revenue is sales, whereas a service
company’s primary source of revenue is

service revenue.


OPERATING CYCLES FOR A
SERVICE COMPANY AND A
MERCHANDISING COMPANY
Service Company

Receive
Cash

Cash

Perform
Services

Accounts
Receivable
Merchandising
Company
Receive
Cash

Cash

Buy
Inventory

Sell Inventory

Accounts
Receivable

Merchandise
Inventory


ILLUSTRATION 5-1

INCOME MEASUREMENT PROCESS
FOR A MERCHANDISING COMPANY
Sales
Revenue

Less

Equals

Cost
Costof
of
Goods
GoodsSold
Sold

Gross
Gross
Profit
Profit

Less

Equals

Operating
Expenses

Net
Income
(Loss)


INVENTORY SYSTEMS
Merchandising entities may use either (or
both) of the following inventory systems:
1. Perpetual – where detailed records of each
inventory purchase and sale are maintained.
Cost of goods sold is calculated at the time of
each sale.
2. Periodic – detailed records are not
maintained. Cost of goods sold is calculated
only at the end of the accounting period.
This chapter covers the perpetual method.


RECORDING COST OF
GOODS PURCHASED






When merchandise is purchased for
resale to customers, the account,
Merchandise Inventory, is debited for the
cost of the goods.
Purchases may be made for cash or on
account (credit).
The purchase is normally recorded
by the purchaser when the goods
are received from the seller.


PURCHASES OF
MERCHANDISE
General Journal
Date Account Title and Explanation Ref
May 4 Merchandise Inventory
Accounts Payable
To record goods purchased on
account, terms n/30.

Debit
3,800

For purchases on account, Merchandise
Inventory is debited and Accounts Payable is
credited. For cash purchases, Merchandise
Inventory is debited and Cash is credited.

J1
Credit
3,800


FREIGHT COSTS






The sales agreement should indicate whether the seller or
the buyer is to pay the cost of transporting the goods to the
buyer’s place of business.
FOB Shipping Point
1. Goods delivered to shipping point by seller
2. Buyer pays freight costs from shipping
point to destination
FOB Destination
1. Goods delivered to destination
by seller
2. Seller pays freight costs


ACCOUNTING FOR
FREIGHT COSTS




Merchandise Inventory is debited by the buyer, if
the buyer pays the freight bill (FOB shipping
point).
Freight Out (or Delivery Expense) is debited by the
seller, if the seller pays the freight bill (FOB
destination).


ACCOUNTING FOR
FREIGHT COSTS

General Journal
Date Account Title and Explanation
May 4 Merchandise Inventory
Cash
To record payment of freight.

Ref

Debit
150

J1
Credit

When the purchaser directly incurs the freight
costs, the account Merchandise Inventory is
debited and Cash is credited.

150


PURCHASE RETURNS AND
ALLOWANCES


A purchaser may be dissatisfied with
merchandise received because the goods
1. are damaged or defective,
2. are of inferior quality, or
3. are not in accord with the
purchaser’s specifications.


PURCHASE RETURNS AND
ALLOWANCES

General Journal
Date Account Title and Explanation
May 8 Accounts Payable
Merchandise Inventory
To record return of goods.

Ref

Debit
300

J1

Credit

For purchases returns and allowances that were
originally made on account, Accounts Payable is
debited and Merchandise Inventory is credited.
For cash returns and allowances, Cash is debited
and Merchandise Inventory is credited.

300


QUANTITY DISCOUNTS
• Volume purchase terms may permit the
buyer to claim a quantity discount.
• The merchandise inventory is simply
recorded at the discounted cost.


PURCHASE DISCOUNTS





Credit terms may permit the buyer to
claim a cash discount for the prompt
payment of a balance due.
The buyer calls this discount a
purchase discount.
A purchase discount is based on

the invoice cost less any returns
and allowances granted.


SALES TRANSACTIONS


Revenues are reported when earned in
accordance with the revenue recognition
principle. In a merchandising company.
revenues are earned when the goods are
transferred from seller to buyer.


SALES TRANSACTIONS
General Journal
Date Account Title and Explanation
May 4 Accounts Receivable
Sales
To record credit sale.
May 4 Cost of Goods Sold
Merchandise Inventory
To record cost of merchandise
sold.

Ref

Debit
3,800

J1
Credit
3,800

2,400
2,400

1. The first entry records the sale of goods to a
customer at the retail (selling) price.
2. The second entry releases the goods from inventory
at cost and charges the goods to cost of goods sold.


SALES TAXES
•

•

Sales tax is expressed as a percentage of the sales
price on selected goods sold to customers by a
retailer. They are collected on most revenues, and
paid on many costs.
Sales taxes may include the federal goods and
services tax (GST) and the provincial sales tax
(PST), if any. These two taxes have been combined
into one harmonized sales tax (HST) in some
Atlantic Provinces.


SALES TAXES ON REVENUES

• The retailer collects the tax from the
customer when the sale occurs, and
periodically (usually monthly) remits the
collections to the Receiver General.
• Sales taxes are not revenue but are a current
liability until remitted.


SALES RETURNS AND
ALLOWANCES




Sales Returns occur when customers are
dissatisfied with merchandise and are
allowed to return the goods to the seller for
credit or a refund.
Sales Allowances occur when
customers are dissatisfied, and the
seller allows a deduction from
the selling price.


SALES RETURNS AND
ALLOWANCES
The normal balance of Sales Returns and
Allowances is a debit.
 Sales Returns and Allowances is a contra
revenue account to the Sales account.




RECORDING SALES RETURNS
AND ALLOWANCES
General Journal
Date Account Title and Explanation
May 8 Sales Returns and Allowances
Accounts Receivable
To record returned goods.
May 8 Merchandise Inventory
Cost of Goods Sold
To record cost of goods
returned.

Ref

Debit
300

J1
Credit
300

140
140

1. The first entry reduces the balance owed by the customer
and records the goods returned at retail price.
2. The second entry records the physical return of goods to

inventory at cost and removes the goods from the cost
of goods sold account.


QUANTITY DISCOUNTS
• A quantity discount is the offer of a cash
discount to a customer in return for a volume
sale.
• Quantity discounts result in a sales price
reduction. They are not separately
journalized. Instead the sale is recorded at the
reduced price.


SALES DISCOUNTS




A sales discount is the offer of a cash discount
to a customer in exchange for the prompt
payment of a balance due.
Similar to Sales Returns and Allowances,
Sales Discounts is also a contra revenue
account with a normal debit balance.


COMPLETING THE
ACCOUNTING CYCLE




A merchandising company requires the same
types of adjusting entries as a service company,
with one additional adjustment for inventory to
ensure the recorded inventory amount agrees
with the actual quantity on hand.
A physical count is an important control
feature since a perpetual system indicates what
should be there but a count will determine what
is actually there.