Accounting For Merchandising Businesses: Student Version

Accounting for Merchandising
Businesses
Chapter 5
Student Version
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2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Prepared by: C. Douglas

Cloud
Professor Emeritus of
Accounting
Pepperdine University
Learning Objective 1
Distinguish between the

activities and financial
statements of service
and merchandise
businesses.
LO 1
Nature of Merchandising
Businesses
Most services businesses, such as
plumbing repair and accounting
services, have no merchandise.
Merchandising businesses, such as a
department store or sandwich shop,
generate revenue by selling a
product.
Merchandise on hand (not sold) at the
end of an accounting period is called
merchandise inventory.
Describe and
illustrate the financial
statements of a
merchandising
business.
LO 2
Multiple-Step Income
Statement
The multiple-step income statement

contains several sections,
subsections, and subtotals.
Below is the revenue section for
NetSolutions.
LO 2
Revenue from Sales

Sales is the total amount charged
customers for merchandise sold,
including cash sales and sales on
account.
Sales
returns and allowances are
granted by the seller to customers
for damaged or defective
merchandise.
LO 2
Revenue from Sales

Sales discounts are granted by the
seller to customers for early payment
of amounts owed.
Net sales is determined by
subtracting sales returns and
allowances and sales discounts from
sales.
LO 2
Cost of Merchandise Sold

The cost of merchandise sold is the
cost of the merchandise sold to
customers. Merchandise costs consist
of all the costs of acquiring the
merchandise and readying it for sale,
such as purchase and freight costs.
A single figure for cost of merchandise
sold is shown on the multiple-step
income statement on the next slide.
LO 2

The buyer may return merchandise to
the seller (purchase return), or the
buyer may receive a reduction in the
initial price at which the merchandise
was purchased
(purchase
allowance).
You have seen that sellers may offer
customers sales discounts for early
payment of their bills. From the buyers
perspective, such discounts are referred
to as purchase discounts.
LO 2

If merchandise inventory at the end
of the period is determined by taking
a physical count of inventory on
hand, a periodic inventory system is
being used.
Under
the perpetual inventory
system, the amounts of inventory
purchased, available for sale, and
sold are continuously (perpetually)
updated in the inventory records.
LO 2
Gross Profit
Gross profit is computed by
subtracting the cost of merchandise
sold from net sales.
Gross
Profit
LO 2
Multiple-Step Income
Statement
Selling expenses are incurred directly

in the selling of merchandise.
Administrative expenses, sometimes

called general expenses, are
incurred in the administration or
general operations of the business.
Income from operations, sometimes
called operating income, is
determined by subtracting operating
expenses from gross profit.
LO 2
Other Income and Expense

Other income is revenue from
sources other than the primary
operating activity of a business.
Other expense is an expense that
cannot be traced directly to the
normal operations of the business.
LO 2
Single-Step Income Statement

An alternative form of income
statement is the single-step income
statement. As shown in the next
slide, the income statement for
NetSolutions deducts the total of all
expenses in one step from the total
of all revenues.
LO 2
Balance Sheet
The form of balance sheet with the
assets on the left-hand side and the
liabilities and stockholders equity on
the right-hand side is called the
account
form.
When
the
balance sheet is presented
in a downward sequence in three
sections, it has been prepared using
the report form.
Describe and illustrate the
accounting for merchandise
transactions including: sale of
merchandise; purchase of
merchandise; freight; sales taxes
and trade discounts; dual nature of
merchandising transactions.
LO 3
Cash Sales
On January 3, NetSolutions sold $1,800 of
merchandise for cash.
LO 3
Cash Sales
Using the perpetual inventory system, the cost of
merchandise sold and the decrease in
merchandise inventory are also recorded. The
cost of merchandise sold on January 3 is $1,200.
LO 3
Cash Sales
Sales made to customers using credit cards are
recorded as cash sales. Assume that NetSolutions
paid credit card processing fees of $48 on January
31.
LO 3
Sales on Account
On January 12, NetSolutions sold merchandise
on account for $510.
The cost of merchandise sold was $280.
LO 3
Sales Discounts
The terms for when payments for
merchandise are to be made are
called credit terms.
If payment is required on delivery,
the terms are cash or net cash.
Otherwise, the buyer is allowed an
amount of time, known as the credit
period, in which to pay.
LO 3
Receipts on Account
On January 17, NetSolutions receives the amount
due within ten days, so the buyer deducted $30
($1,500 x 2%) from the invoice amount.
LO 3
Credit Memo
A credit memorandum, often called a
credit memo, authorizes a credit to
(decreases) the buyers account
receivable.
LO 3
Credit Memo
On January 13, issued Credit Memo No. 32 to Krier
Company for merchandise returned to NetSolutions.
Selling price, $225; cost to NetSolutions, $140.
LO 3
Purchase Transactions
On January 3, NetSolutions purchased merchandise
for cash (assume a perpetual inventory is used).
LO 3
On January 4, NetSolutions purchased
merchandise on account
from Thomas Corporation.
*
LO 3
Purchases Discounts
A buyer may receive a discount from
the seller (sales discount) for early
payment of the amount owed.
From the buyers perspective, such
discounts are called purchases
discounts.
LO 3
Alpha Technologies issues an invoice for $3,000 to
NetSolutions dated March 12, with terms 2/10,
n/30. NetSolutions is trying to determine if it should
pay the invoice within the discount period.
LO 3
Alpha Technologies issued an invoice for $3,000 to
NetSolutions dated March 12, with terms 2/10,
n/30.
Based on the calculation in the previous slide,

NetSolutions pays the amount due, less the
discount, on March 22.
LO 3
Discount Not Taken

Assume that, instead of paying the invoice within
the discount period, NetSolutions pays the invoice
on April 11.
LO 3
Purchases Returns and

Allowances
A purchases return involves actually

returning merchandise that is
damaged or does not meet the
specifications of the order.
From a buyers perspective, such
returns are called purchases returns
and allowances.
LO 3
Debit Memo
A debit memorandum, often called a
debit memo, informs the seller of the
amount the buyer proposes to debit
to the account payable due the seller.
LO 3
Debit Memo
NetSolutions receives a delivery from Maxim
Systems and determines that $900 of the items
are not the merchandise ordered. Debit
memorandum #18 is issued to Maxim System.
NetSolutions records the return of the
merchandise as follows:
LO 3
Merchandise Purchased
On May 2, NetSolutions purchased $5,000 of
merchandise on account from Delta Data Link,
terms 2/10, n/30.
On May 4 , NetSolutions returned $3,000 of the

merchandise purchased from Delta Data Link.
LO 3
Invoice Paid
On May 12, NetSolutions paid for the purchase of
May 2 less the return and discount.
LO 3
Freight
If ownership of the merchandise
passes to the buyer when the seller
delivers the merchandise to the
freight carrier, the terms are said to
be FOB (free on board) shipping
point.
If
ownership of the merchandise
passes to the buyer when the buyer
receives the merchandise, the terms
are said to be FOB (free on board)
destination.
LO 3
Freight
On June 10, NetSolutions buys merchandise from
Magna Data on account, $900, terms FOB
shipping point and pays the shipping cost of $50.
Two entries are required.
LO 3
Sale Plus Freight Cost

On June 15, NetSolutions sells merchandise to
Kranz Company on account, $700, terms FOB
destination. The cost of the merchandise sold is
$480. Again, two entries are required.
LO 3
Sale Plus Freight Cost

On June 15, NetSolutions pays freight of $40 on
the sale of June 15.
LO 3
Seller Prepays Freight

On June 20, NetSolutions sells merchandise to
Planter Company on account, $800, terms FOB
shipping point. NetSolutions paid freight of $45,
which was added to the invoice. The cost of the
merchandise sold is $360. Three entries are
needed. These are shown on the next slide.
LO 3
Seller Prepays Freight
LO 3
Sales Taxes
On August 12, merchandise is sold on account to
Lemon Company, $100 (plus a 6% sales tax).
The seller pays to the taxing authority (state) the

total amount of the sales taxes collected.
LO 3
Trade Discounts
When wholesalers offer special
discounts to certain classes of buyers
who order large quantities, these
discounts are called trade discounts.
LO 3
Dual Nature of Merchandise

Transactions
Each merchandising transaction

affects a buyer and a seller. In the
following illustrations, we show how
the same transactions would be
recorded by both the seller and the
buyer.
LO 3

Transactions
July 1. Scully Company sold merchandise on

account to Burton Co., $7,500, terms
FOB shipping point, n/45. The cost of the
merchandise sold was $4,500.
LO 3

Transactions
Scully Company (Seller)
Accounts ReceivableBurton Co. 7,500

Sales
7,500
Merchandise Inventory
4,500
4,500
Burton Company (Buyer)
Accounts PayableScully Co.
7,500
7,500
LO 3

Transactions
July 2. Burton Company paid
transportation charges of $150 on
the July 1 purchase from Scully
Company.
LO 3

Transactions
No entry.
Cash
150
150
LO 3

Transactions
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.
LO 3

Transactions

Sales
5,000
3,500
3,500
Merchandise Inventory.
5,000
5,000
LO 3

Transactions
July 7. Scully Company paid transportation
costs of $250 for delivery of
merchandise sold to Burton Company
on July 5.
LO 3

Transactions
Delivery Expense
Cash
No entry.
250
250
LO 3

Transactions
July 13. Scully Company issued Burton
Company a credit memorandum for
merchandise returned, $1,000. The
cost of the merchandise returned was
$700.
LO 3

Transactions
Sales Returns and Allowances

1,000
Accounts ReceivableBurton Co.
1,000
700
700

1,000
1,000
LO 3

Transactions
July 15. Scully Company received payment
from Burton Company for purchase
of July 5.
LO 3

Transactions
Cash
4,000
4,000

Cash
4,000
4,000
LO 3

Transactions
July 18. Scully Company sold merchandise
on account to Burton Company,
$12,000, terms FOB shipping point,
2/10, n/eom. Scully prepaid
transportation costs of $500, which
were added to the invoice. The cost
of the merchandise sold was $7,200.
LO 3

Transactions

Sales
12,000
500
Cash
500
7,200
7,200
12,500
12,500
LO 3

Transactions
July 28. Scully Company received payment
from Burton Company for purchase
of July 18, less discount (2%
$12,000).
LO 3

Transactions
Cash
12,260
Sales Discounts
240
12,500

Cash
12,500
240
12,260
Describe the adjusting and

closing process for a
merchandising business.
LO 4
Adjusting Entry for Inventory

Shrinkage
Merchandising businesses may
experience some loss of inventory
due to shoplifting, employee theft, or
errors in recording or counting
inventory.
If
the balance of the Merchandise
Inventory account is larger than the
total amount of the merchandise
count, the difference is often called
inventory shrinkage or inventory
shortage.
LO 4
Step 1: Closing Entries

Debit each temporary account with a credit
balance, such as Sales, for its balance and credit
Income Summary.
LO 4
Step 2: Closing Entries

Credit each temporary account with a debit
balance, such as an expense, for its balance and
debit Income Summary.
LO 4
Steps 3 and 4: Closing Entries

3. Debit Income Summary for the amount of its
balance (net income) and credit Retained
Earnings.
4. Debit Retained Earnings for the balance of the

Dividends account and credit the Dividends
account.
Describe and illustrate the

use of the ratio of net sales
to assets in evaluating a
companys operating
performance.
LO 5
Ratio of Net Sales to Assets

The ratio of net sales to assets
measures how effectively a business
is using its assets to generate sales.
Ratio of Net
Net Sales
Sales to =
Average Total Assets
Assets
LO 5
Ratio of Net Sales to Assets

The ratio of net sales to assets for
each year are as follows:
Accounting for Merchandising

Businesses
The End
Prepared by: C. Douglas
Cloud
Professor Emeritus of
Accounting
Pepperdine University

Accounting For Merchandising Businesses: Student Version

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Accounting for Merchandising

Prepared by: C. Douglas

Distinguish between the

The multiple-step income statement

Revenue from Sales

Revenue from Sales

Cost of Merchandise Sold

Cost of Merchandise Sold

Cost of Merchandise Sold

Selling expenses are incurred directly

Administrative expenses, sometimes

Other Income and Expense

Single-Step Income Statement

The cost of merchandise sold was $280.

Based on the calculation in the previous slide,

Discount Not Taken

Purchases Returns and

A purchases return involves actually

On May 4 , NetSolutions returned $3,000 of the

Sale Plus Freight Cost

Sale Plus Freight Cost

Seller Prepays Freight

Seller Prepays Freight

The seller pays to the taxing authority (state) the

Dual Nature of Merchandise

Each merchandising transaction

Dual Nature of Merchandise

July 1. Scully Company sold merchandise on

Dual Nature of Merchandise

Accounts ReceivableBurton Co. 7,500

Burton Company (Buyer)

Dual Nature of Merchandise

Dual Nature of Merchandise

Burton Company (Buyer)

Dual Nature of Merchandise

Dual Nature of Merchandise

Accounts ReceivableBurton Co. 5,000

Burton Company (Buyer)

Dual Nature of Merchandise

Dual Nature of Merchandise

Burton Company (Buyer)

Dual Nature of Merchandise

Dual Nature of Merchandise

Sales Returns and Allowances

Burton Company (Buyer)

Accounts PayableScully Co.

Dual Nature of Merchandise

Dual Nature of Merchandise

Burton Company (Buyer)

Accounts PayableScully Co.

Dual Nature of Merchandise

Dual Nature of Merchandise

Accounts ReceivableBurton Co. 12,000

Burton Company (Buyer)

Dual Nature of Merchandise

Dual Nature of Merchandise

Accounts PayableScully Co.

Describe the adjusting and

Adjusting Entry for Inventory

Step 1: Closing Entries

Step 2: Closing Entries

Steps 3 and 4: Closing Entries

4. Debit Retained Earnings for the balance of the