Page 1

Accounting for Merchandising

Activities
Page 2
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JOIN KHALID AZIZ
ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS,
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FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4
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Page 6
Outline
Merchandising activities
Operating cycle of merchandising
companies
Merchandising cost accounts
Inventory systems
Merchandise purchases
Sales transactions
Adjusting and closing entries
Page 7
Introduction
Scandals in stock market occur now and
then. Among them, financial frauds or
income manipulation are common. Income
manipulation typically starts from making
up sales revenues as well as purchases.
Why these income statement numbers
are so important?
How they are recorded in accounting
system?
Page 8
Manufacturer Wholesaler Retailer Customer
Merchandising Companies
Merchandising Activities
Page 9
Reporting Financial Performance
Service organizations sell time to earn revenue.
Examples: accounting firms, law firms, and plumbing
services
Revenues Expenses
Net
income

Page 10
Reporting Financial Performance
Merchandising companies sell merchandise to earn
revenue.
Examples: sporting goods, clothing, and auto parts stores
Net
Sales
Cost of
Goods Sold
Gross
Profit
Expenses
Net
Income

Page 11
Operating Cycle of Merchandise Companies
Begins with the purchase of merchandise and ends with
the collection of cash from the sale of merchandise.
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Merchandising Cost Accounts
+
+
Beginning inventory
Year 1
Net cost of
purchases
Merchandise
available for sale
Ending Inventory
Year 1
Cost of Goods
Sold
=
Income
Statement
Becomes beginning
inventory of Year 2
Balance
Sheet
Page 13
Inventory Systems
Periodic Method
Requires updating the inventory account only at the end
of the period. Acquisition of merchandise inventory is
recorded in a temporary Purchases account.
Perpetual Method
Gives a continual record of the amount of inventory on
hand. When an item is sold it is recorded in the Cost of
Goods Sold account.
Page 14
Inventory Systems
Perpetual provides a continuous record of:
The amount of inventory on hand.
Cost of goods sold to date.
Periodic requires a physical count of goods
to determine:
The amount of inventory on hand.
Cost of goods sold.
Page 15
JOIN KHALID AZIZ
ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS,
B.COM.
FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4
ICAP MODULE B, B.COM, BBA, MBA & PIPFA.
COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP
MODULE D, BBA, MBA & PIPFA.

CONTACT:
0322-3385752
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA,
KARACHI, PAKISTAN

Page 16
Comparison of Perpetual and Periodic
Systems
Source of Information
Equation Periodic System Perpetual System
Beginning Inventory
Carried over from
prior period
Carried over from
prior period
Add: Purchases
Accumulated in the
Purchases account
Accumulated in the
Inventory account
Equals:
Less: Ending Inventory
Measured at end of
period by physical
inventory count
Perpetual record
updated at every sale
Cost of Goods Sold
Computed as a
residual amount at
end of period
Measured at every
sale based on
perpetual record
Cost of Goods Available for Sale
Page 17
Purchases XX Inventory XX
Accounts Payable XX Accounts Payable
XX
Accounts Payable XX Accounts Payable XX
Purchases Returns & Allow. XX Inventory
XX
Accounts Receivable XX Accounts Receivable XX
Sales XX Sales XX
Cost of Goods Sold XX
Inventory XX
Merchandise
sold to
customer on
account.
Merchandise
purchased from
supplier on
account.
Merchandise
returned to
supplier.
Comparison of Periodic and
Perpetual Systems
Page 18
Transaction Periodic Perpetual
Merchandise
returned by
customer. Sales Returns and Allow. XX Sales Returns and Allow. XX
Accounts Receivable XX Accounts Receivable XX
Inventory XX
Cost of Goods Sold XX
At end of
accounting
period. Cost of Goods Sold XX No entry.
Inventory (beginning) XX
Purchases XX
Inventory (ending) XX
Cost of Goods Sold XX
Comparison of Periodic and
Perpetual Systems
Page 19



Oct. 1 Inventory 5,000
Accounts Payable /cash 5,000
Purchased inventory.
The operating cycle of merchandise companies
involves the purchase and subsequent sale of
merchandise inventory.
Purchase of inventory can either on account or by
cash.
Merchandise Purchases
Page 20
Trade Discounts
Trade discounts are used by manufacturers and
wholesalers to change selling prices without republishing
their catalogs.
Example
MarCo, Inc. offers a 20% trade
discount on orders of 100
units or more of their popular
product Racer. Each Racer
has a list price of $5.00.
Quantity sold 100
Price per unit 5.00 $
Total 500
Less 20% discount (100)
Invoice price 400 $
Page 21
Purchase discount is a deduction from the invoice
price granted to induce early payment of the
amount due. Example 2/10, n30
Terms

Time

Due
Discount Period
= 10 days
(Full amount minus 2%
discount) due between
Oct.1 and Oct.11
Credit Period = 30 days
Full amount due
anytime between
Oct.12 and Oct.31
Purchase
Oct.1 Oct.11 Oct.31
Purchase Discounts
Page 22
2/10,n/30
Purchase Discounts
Discount
Percent
Number of
Days
Discount Is
Available
Otherwise,
Net (or All)
Is Due
Credit
Period
Page 23
Assume the purchase of $4,000 inventory on
October 1 was on the terms 2/10,n30.
Case 2-Discount not taken
Oct.31 Accounts Payable 4,000
Cash 4,000
Purchase Discounts
Oct.11 Accounts Payable 4,000
Inventory 80
Cash 3,920
2% x (5,000 - 1,000) = 80
Case 1-Discount taken
Page 24
Managing Discounts
Failing to take a 2/10, n/30 discount is
really expensive!
365 days 20 days 2% = 36.5% annual rate
Days
in a
year
Number
of additional
days before
payment
Percent
paid to
keep
money
Page 25
Purchase Returns and Allowances
Purchase Return . . .
Merchandise returned by the purchaser to the
supplier.
Purchase Allowance . . .
A reduction in the cost of defective merchandise
received by a purchaser from a supplier.
Accounts Payable XXX
Inventory XXX
Defective merchandise returned to supplier.
Purchase Returns and Allowances
Page 26
Purchase Returns and Allowances
On Nov. 1, Helo Inc. purchased $10,000 of Merchandise
Inventory on account, credit terms are 2/10, n/30.
GENERAL JOURNAL Page 29
Date Description PR Debit Credit
Nov 1 Merchandise Inventory 10,000
Accounts Payable 10,000
Page 27
Purchase Returns and Allowances
On Nov 5, Helo Inc. returned $250 of defective
merchandise to the supplier.
GENERAL JOURNAL Page 31
Date Description PR Debit Credit
Nov 5 Accounts payable 250
Merchandise Inventory 250
Page 28
Purchase Returns and Allowances
On Nov 9, Helo Inc. paid the amount owed for the
purchase of Nov 1.
GENERAL JOURNAL Page 54
Date Description PR Debit Credit
Nov 9 Accounts payable 9,750
Merchandise inventory 195
Cash 9,555
Purchase 10,000 $
Return (250)
Amount Due 9,750
Discount (195)
Cash Paid 9,555 $
Page 29
Transportation Costs
Terms
Ownership transfers
to buyer when goods
are passed to
Transportation
costs paid by
FOB shipping point Carrier Buyer
FOB destination Buyer Seller
Transportation Charges


Inventory XXX
Accounts Payable XXX
Transportation charges on goods purchased FOB
shipping point.
Page 30
Recording Purchases Information
Invoice cost of merchandise purchases 692,500 $
Less:
Purchase discounts received (10,388)
Purchase returns and allowances (4,275)
Add:
Cost of transportation-in 4,895
Total cost of merchandise purchases 682,732 $
Matrix, Inc.
Total Cost of Merchandise Purchases
For Year Ended May 31, 2002
Page 31
Sales Transactions
On March 10,
TomCom sold
$20,000 of
merchandise on
account. The
merchandise was
carried in inventory
at a cost of $16,000.
GENERAL JOURNAL Page 3
Date Description PR Debit Credit
Mar. 10 Accounts Receivable 20,000
Sales 20,000
Cost of Goods Sold 16,000
Merchandise Inventory 16,000
For a business engaged in a merchandising activity, revenue takes the
form of sales.
The entry to record the sale of merchandise on credit under a perpetual
inventory system requires two entries
Page 32
Sales Discounts
On May 8, Joye Co. sold merchandise costing $3,000 for
$5,000 on account. Credit terms were 2/10, n/30.
A sales discount is a cash discount taken by customers
against an amount owed to the seller.
GENERAL JOURNAL Page 5
Date Description PR Debit Credit
May 8 Accounts Receivable 5,000
Sales 5,000
Cost of Goods Sold 3,000
Merchandise Inventory 3,000
Page 33
Sales Discounts
On May 17, Joye Co.
received a check for $4,900
in full payment of the May 8
sale.
GENERAL JOURNAL Page 7
Date Description PR Debit Credit
May 17 Cash 4,900
Sales Discounts 100
Accounts Receivable 5,000
Page 34
Sales Returns and Allowances
On May 12, Joye Co. sold merchandise costing
$4,000 for $6,000 on account The credit terms
were 2/10, n/30.
GENERAL JOURNAL Page 6
Date Description PR Debit Credit
May 12 Accounts Receivable 6,000
Sales 6,000
Cost of Goods Sold 4,000
Merchandise Inventory 4,000
Page 35
Sales Returns and Allowances
On May 14, merchandise with a sales price of
$600 and a cost of $400 was returned to Joye
Co. The return is related to the May 12 sale.
GENERAL JOURNAL Page 7
Date Description PR Debit Credit
May 14 Sales Returns and Allowance 600
Accounts Receivable 600
Merchandise Inventory 400
Cost of Goods Sold 400
Page 36
Sales Returns and Allowances
On May 20, Joye received the amount owed to
it from the sale of May 12.
GENERAL JOURNAL Page 7
Date Description PR Debit Credit
May 20 Cash 5,292
Sales Discounts 108
Account Receivable 5,400
Sale 6,000 $
Return (600)
Amount Due 5,400 $
Discount (108)
Cash Received 5,292 $
Page 37
Recording Sales Information
Unix Inc.
Computation of Gross Profit
For Year Ended December 31, 2002
Sales 2,451,000 $
Less:
Sales discounts 29,412 $
Sales returns and allowances 18,500 47,912
Net sales 2,403,088 $
Cost of goods sold (1,928,600)
Gross profit 474,488 $
Sales discounts and returns
and allowances are
Contra Revenue accounts.
Page 38
Adjustments-Perpetual Inventory
Perpetual inventory systems keep a
running total of inventory levels by
recording sales and purchase
transactions.
Periodic adjustments must be made
to account for shrinkage (loss due to
theft or deterioration of inventory).
Page 39
JOIN KHALID AZIZ
ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS,
B.COM.
FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4
ICAP MODULE B, B.COM, BBA, MBA & PIPFA.
COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP
MODULE D, BBA, MBA & PIPFA.

CONTACT:
0322-3385752
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA,
KARACHI, PAKISTAN

Page 40
Inventory per accounting records: $198,000
Inventory per physical count: $194,200
Difference (shrinkage) $3,800

Adjustment required:
Adjustments-Perpetual Inventory
Oct.31 Cost of Goods Sold 3,800
Inventory 3,800
To record inventory shrinkage revealed by
physical count.

Page 41
Closing Entries-Perpetual System
The closing process is similar for
merchandising and service companies.
Merchandising companies have additional
temporary accounts that must be closed.
These include:
Sales
Sales Returns & Allowances
Sales Discounts
Cost of Goods Sold
Page 42
Discussion Case
CIMC
CIMC is the number one stock in China, mainly due to its
excellent operating performance. However, in early
2005, the operating performance of CIMC was
challenged. Analysts argued that, the surprisingly high
operating performance is questionable. Specifically,
abnormal growth was found in the following items,
Sales revenue
Gross profits
Accounts receivable
Inventory
However, no growth was found in cash collected from
customers.
Page 43
Discussion Case
Required:
How to calculate the growth
rates in sales, gross profits,
inventory, accounts
receivables, and cash?
Are there are relationships
between the above items?
How to verify the growth in
above items?
Page 44
Summary
The operating cycle of merchandise companies begins with the
purchase of merchandise and end with the collection of cash from
the sale of merchandise.
Perpetual method and period method are two inventory systems.
Today perpetual method is more and more adopted.
Accounting for merchandise purchases records purchases, trade
discount, cash discounts, purchase returns and allowance,
transportation costs.
Accounting for sales transactions records sales, sales discount,
sales returns and allowance, etc.
Under perpetual inventory system, adjustments must be made for
shrinkage at the end of period.
Closing entries transfers balances in sales, sales returns and
allowance, sales discounts and cost of goods sold into income
summary account.
Page 45



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