Financial accounting ch.5

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Replace with Title Page for Weygandt Financial 7e

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Chapter 5
Accounting forAccounting for
MerchandisingMerchandising
OperationsOperations
Financial Accounting,
Seventh Edition

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1. Identify the differences between service and
merchandising companies.
2. Explain the recording of purchases under a perpetual
inventory system.
3. Explain the recording of sales revenues under a perpetual
inventory system.
4. Explain the steps in the accounting cycle for a
merchandising company.
5. Distinguish between a multiple-step and a single-step
income statement.
6. Explain the computation and importance of gross profit.
Study ObjectivesStudy ObjectivesStudy ObjectivesStudy Objectives

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Forms ofForms of
FinancialFinancial
StatementsStatements
Forms ofForms of
FinancialFinancial
Accounting for Merchandising OperationsAccounting for Merchandising OperationsAccounting for Merchandising OperationsAccounting for Merchandising Operations
Freight costsFreight costs
PurchasePurchase
returns andreturns and
allowancesallowances
PurchasePurchase
discountsdiscounts
Summary ofSummary of
purchasingpurchasing
transactionstransactions
RecordingRecording
Purchases ofPurchases of
MerchandiseMerchandise
RecordingRecording
Purchases ofPurchases of
RecordingRecording
Sales ofSales of
RecordingRecording
Sales ofSales of
CompletingCompleting
thethe
AccountingAccounting
CycleCycle
CompletingCompleting
thethe
AccountingAccounting
CycleCycle
OperatingOperating
cyclescycles
Flow of costsFlow of costs
—perpetual—perpetual
and periodicand periodic
inventoryinventory
systemssystems
Sales returnsSales returns
andand
allowancesallowances
SalesSales
discountsdiscounts
AdjustingAdjusting
entriesentries
Closing entriesClosing entries
Summary ofSummary of
merchandisingmerchandising
entriesentries
Multiple-stepMultiple-step
incomeincome
statementstatement
Single-stepSingle-step
incomeincome
statementstatement
ClassifiedClassified
balance sheetbalance sheet

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Merchandising OperationsMerchandising OperationsMerchandising OperationsMerchandising Operations
SO 1 Identify the differences between service and merchandising companies.SO 1 Identify the differences between service and merchandising companies.
Merchandising CompaniesMerchandising Companies
Buy and Sell Goods
Wholesaler Retailer Consumer
The primary source of revenues is referred to as
sales revenue or sales.

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Income MeasurementIncome Measurement
Illustration 5-1
Cost of goods sold is the total
cost of merchandise sold
during the period.
Not used in a
Service business.
Net
Income
(Loss)
Less
LessEquals
Equals
Sales
Revenue
Cost of
Goods Sold
Gross
Profit
Operating
Expenses

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The operating
cycle of a
merchandising
company
ordinarily is
longer than that
of a service
company.
Illustration 5-2
Operating
Cycle

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Perpetual System
1. Purchases increase Merchandise Inventory.
2. Freight costs, Purchase Returns and Allowances and Purchase
Discounts are included in Merchandise Inventory.
3. Cost of Goods Sold is increased and Merchandise Inventory is
decreased for each sale.
4. Physical count done to verify Merchandise Inventory balance.
The perpetual inventory system provides a continuous record
of Merchandise Inventory and Cost of Goods Sold.
Flow of Costs

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1. Purchases of merchandise increase Purchases.
2. Ending Inventory determined by physical count.
3. Calculation of Cost of Goods Sold:
Beginning inventory
$ 100,000
Add: Purchases, net
800,000
Goods available for saleSO 1 Identify the differences between service and merchandising companies.SO 1 Identify the differences between service and merchandising companies.
Flow of Costs
Periodic System

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Made using cash or
credit (on account).
Normally recorded when
goods are received.
Purchase invoice should
support each credit
purchase.
Recording Purchases of MerchandiseRecording Purchases of MerchandiseRecording Purchases of MerchandiseRecording Purchases of Merchandise
SO 2 Explain the recording of purchases under a perpetual inventory system.SO 2 Explain the recording of purchases under a perpetual inventory system.
Illustration 5-5

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Under the perpetual inventory system, companies record in the
Merchandise Inventory account the purchase of goods they
intend to sell.
Illustration:Illustration: From INVOICE NO. 731 (Illustration 5-5) record
the journal entry Sauk Stereo would make to record its
purchase from PW Audio Supply.
Merchandise inventory 3,800May 4
Accounts payable 3,800

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Illustration 5-6
Seller places goods Free
On Board the carrier, and
buyer pays freight costs.
Seller places goods Free
On Board to the buyer’s
place of business, and
seller pays freight costs.
Freight Costs – Terms of Sale– Terms of Sale
Freight costs incurred by the seller are an operating expense. SO 2SO 2

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Illustration: Assume upon delivery of the goods on May 6,
Sauk Stereo pays Acme Freight Company $150 for freight
charges, the entry on Sauk Stereo’s books is:
Merchandise inventory 150May 6
Cash 150
Assume the freight terms on the invoice in Illustration 5-5
had required PW Audio Supply to pay the freight charges, the
entry by PW Audio Supply would have been:
Freight-out (or Delivery Expense) 150May 6
Cash 150

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Purchaser may be dissatisfied because goods are
damaged or defective, of inferior quality, or do not
meet specifications.
Purchase Returns and Allowances
Return goods for credit
if the sale was made on
credit, or for a cash
refund if the purchase
was for cash.
May choose to keep the
merchandise if the seller
will grant an allowance
(deduction) from the
purchase price.
Purchase Return Purchase Allowance

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In a perpetual inventory system, a return of
defective merchandise by a purchaser is
recorded by crediting:
a. Purchases
b. Purchase Returns
c. Purchase Allowance
d. Merchandise Inventory
QuestionQuestion

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Illustration: Assume that on May 8 Sauk Stereo returned to
PW Audio Supply goods costing $300.
Accounts payable 300May 8
Merchandise inventory 300

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Credit terms may permit buyer to claim a cash
discount for prompt payment.
Advantages:
Purchaser saves money.
Seller shortens the operating cycle.
Purchase Discounts
Example: Credit terms of 2/10, n/30, is read “two-ten, net
thirty.” 2% cash discount if payment is made within 10 days.

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Purchase Discount TermsTerms
2% discount if
paid within 10
days, otherwise
net amount due
within 30 days.
1% discount if
paid within
first 10 days of
next month.
2/10, n/30 1/10 EOM
Net amount due
within the first
10 days of the
next month.
n/10 EOM

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Merchandise Inventory 70
Accounts payable 3,500May 14
(Discount = $3,500 x 2% = $70)
Illustration: Assume Sauk Stereo pays the balance due of
$3,500 (gross invoice price of $3,800 less purchase returns
and allowances of $300) on May 14, the last day of the
discount period. Prepare the journal entry Sauk makes to
record its May 14 payment.
Cash 3,430

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Accounts payable 3,500June 3
Cash 3,500
Illustration: If Sauk Stereo failed to take the discount, and
instead made full payment of $3,500 on June 3, the journal
entry would be:

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Should discounts be taken when offered?
Purchase Discounts
Discount of 2% on $3,500 70.00$
$3,500 invested at 10% for 20 days 19.18
Savings by taking the discount 50.82$
Example: 2% for 20 days = Annual rate of 36.5%
(365/20 = 18.25 twenty-day periods x 2% = 36.5%)
Passing up the discount offered equates to paying an
interest rate of 2% on the use of $3,500 for 20 days.

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Merchandise Inventory
Debit Credit
$3,800 8th
- Return$300
Balance
4th
- Purchase
$3,580$3,580
70 14th
- Discount
Summary of Purchasing TransactionsSummary of Purchasing Transactions
1506th
– Freight-in
IllustrationIllustration

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Made for cash or credit (on account).
Normally recorded when
earned, usually when
goods transfer from
seller to buyer.
Sales invoice should
support each credit
sale.
Recording Sales of MerchandiseRecording Sales of MerchandiseRecording Sales of MerchandiseRecording Sales of Merchandise
SO 3 Explain the recording of sales revenuesSO 3 Explain the recording of sales revenues
under a perpetual inventory system.under a perpetual inventory system.
Illustration 5-5

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Two Journal Entries to Record a Sale
Cash or Accounts receivable XXX
Sales XXX
#1
Cost of goods sold XXX
Merchandise inventory XXX
#2
Selling
Price
Cost

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Accounts receivable 3,800May 4
Sales 3,800
Illustration: Assume PW Audio Supply records its May 4
sale of $3,800 to Sauk Stereo (Illustration 5-5) as follows.
Assume the merchandise cost PW Audio Supply $2,400.
Cost of goods sold 2,4004
Merchandise inventory 2,400

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“Flipside” of purchase returns and allowances.
Contra-revenue account (debit).
Sales not reduced (debited) because:
 would obscure importance of sales returns and
allowances as a percentage of sales.
 could distort comparisons between total sales in
different accounting periods.
Sales Returns and Allowances

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Illustration: Prepare the entry PW Audio Supply would make
to record the credit for returned goods that had a $300
selling price (assume a $140 cost). Assume the goods were not
defective.
Sales returns and allowances 300May 8
Accounts receivable 300
Cost of goods sold 140

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Illustration: Assume the returned goods were defective and
had a scrap value of $50, PW Audio would make the following
entries:

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The cost of goods sold is determined and recorded
each time a sale occurs in:
a. periodic inventory system only.
b. a perpetual inventory system only.
c. both a periodic and perpetual inventory system.
d. neither a periodic nor perpetual inventory
system.
Review QuestionReview Question

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Offered to customers to promote prompt payment.
“Flipside” of purchase discount.
Contra-revenue account (debit).
Sales Discount

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Cash 3,430May 14
Accounts receivable 3,500
Sales discounts 70
* [($3,800 – $300) X 2%]
*
Illustration: Assume Sauk Stereo pays the balance due of
$3,500 (gross invoice price of $3,800 less purchase returns
and allowances of $300) on May 14, the last day of the
discount period. Prepare the journal entry PW Audio Supply
makes to record the receipt on May 14.

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Generally the same as a service company.
One additional adjustment to make the records
agree with the actual inventory on hand.
Involves adjusting Merchandise Inventory and
Cost of Goods Sold.
Adjusting Entries
Completing the Accounting CycleCompleting the Accounting CycleCompleting the Accounting CycleCompleting the Accounting Cycle
SO 4 Explain the steps in the accounting cycle for a merchandising company.SO 4 Explain the steps in the accounting cycle for a merchandising company.

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SO 4 Explain the steps in the accounting cycle for a merchandising company.SO 4 Explain the steps in the accounting cycle for a merchandising company.
Illustration: Suppose that PW Audio Supply has an
unadjusted balance of $40,500 in Merchandise Inventory.
Through a physical count, PW Audio determines that its actual
merchandise inventory at year-end is $40,000. The company
would make an adjusting entry as follows.

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Closing
Entries
Dividends

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Shows several steps in determining net income.
Two steps relate to principal operating activities.
Distinguishes between operating and non-
operating activities.
Multiple-Step Income Statement
Forms of Financial StatementsForms of Financial StatementsForms of Financial StatementsForms of Financial Statements
SO 5 Distinguish between a multiple-step and a single-step income statement.SO 5 Distinguish between a multiple-step and a single-step income statement.

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Illustration 5-8
Income Statement Presentation of Sales
Multiple-Step Income StatementMultiple-Step Income StatementMultiple-Step Income StatementMultiple-Step Income Statement

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SO 6 Explain the computation and importance of gross profit.SO 6 Explain the computation and importance of gross profit.
Illustration 5-13
Key Items:Key Items:
Net salesNet sales
Gross profitGross profit
raterate
Illustration 5-10
Gross Profit
Multiple-Step Income StatementMultiple-Step Income StatementMultiple-Step Income StatementMultiple-Step Income Statement

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Forms ofForms of
FinancialFinancial
Forms ofForms of
FinancialFinancial
Net salesNet sales
OperatingOperating
expensesexpenses
Illustration 5-13
Multiple-
Step

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Forms ofForms of
FinancialFinancial
Forms ofForms of
FinancialFinancial
Net salesNet sales
OperatingOperating
expensesexpenses
NonoperatingNonoperating
activitiesactivities
Net incomeNet income
Illustration 5-13

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The multiple-step income statement for a
merchandiser shows each of the following features
except:
a. gross profit.
b. cost of goods sold.
c. a sales revenue section.
d. investing activities section.
Review QuestionReview Question

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Subtract total expenses from total revenues
Two reasons for using the single-step format:
1) Company does not realize any type of profit
until total revenues exceed total expenses.
2) Format is simpler and easier to read.
Single-Step Income Statement

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Illustration 5-14
Single-
Step

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Illustration 5-15
Classified Balance Sheet

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Periodic System
Separate accounts used to record purchases,
freight costs, returns, and discounts.
Company does not maintain a running account of
changes in inventory.
Ending inventory determined by physical count.
SO 7 Explain the recording of purchases and sales ofSO 7 Explain the recording of purchases and sales of
inventory under a periodic inventory system.inventory under a periodic inventory system.
Periodic Inventory SystemPeriodic Inventory SystemPeriodic Inventory SystemPeriodic Inventory System

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Calculation of Cost of Goods Sold
$316,000
Illustration 5A-1
Periodic Inventory SystemPeriodic Inventory SystemPeriodic Inventory SystemPeriodic Inventory System

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Illustration:Illustration: On the basis of the sales invoice (Illustration 5-5)
and receipt of the merchandise ordered from PW Audio
Supply, Sauk Stereo records the $3,800 purchase as follows.
Purchases 3,800May 4
Accounts payable 3,800
Recording Purchases under Periodic SystemRecording Purchases under Periodic SystemRecording Purchases under Periodic SystemRecording Purchases under Periodic System

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Illustration:Illustration: If Sauk pays Acme Freight Company $150
for freight charges on its purchase from PW Audio Supply on
May 6, the entry on Sauk’s books is:
Freight-in (Transportation-in) 150May 6
Cash 150
Freight CostsFreight Costs

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Illustration:Illustration: Sauk Stereo returns $300 of goods to PW Audio
Supply and prepares the following entry to recognize the
return.
Accounts payable 300May 8
Purchase returns and allowances 300
Purchase Returns and AllowancesPurchase Returns and Allowances

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Illustration:Illustration: On May 14 Sauk Stereo pays the balance due on
account to PW Audio Supply, taking the 2% cash discount
allowed by PW Audio for payment within 10 days. Sauk
Stereo records the payment and discount as follows.
Accounts payable 3,500May 14
Purchase discounts 70
Purchase DiscountsPurchase Discounts
Cash 3,430

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No entry is recorded for cost of goods sold at the time
of the sale under a periodic system.
Illustration:Illustration: PW Audio Supply, records the sale of $3,800 of
merchandise to Sauk Stereo on May 4 (sales invoice No. 731,
Illustration 5-5) as follows.
Accounts receivable 3,800May 4
Sales 3,800
Recording Sales under Periodic SystemRecording Sales under Periodic SystemRecording Sales under Periodic SystemRecording Sales under Periodic System

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Illustration:Illustration: To record the returned goods received from
Sauk Stereo on May 8, PW Audio Supply records the $300
sales return as follows.
Sales Returns and AllowancesSales Returns and Allowances

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Illustration:Illustration: On May 14, PW Audio Supply receives payment of
$3,430 on account from Sauk Stereo. PW Audio honors the 2%
cash discount and records the payment of Sauk’s account
receivable in full as follows.
Sales DiscountsSales Discounts
Cash 3,430May 14
Accounts receivable 3,500
Sales discounts 70

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Illustration 5A-2
Comparison of Entries-Perpetual vs. PeriodicComparison of Entries-Perpetual vs. PeriodicComparison of Entries-Perpetual vs. PeriodicComparison of Entries-Perpetual vs. Periodic

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Illustration 5A-2
Comparison of Entries-Perpetual vs. PeriodicComparison of Entries-Perpetual vs. PeriodicComparison of Entries-Perpetual vs. PeriodicComparison of Entries-Perpetual vs. Periodic

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Illustration 5B-1
SO 8SO 8
Worksheet for a Merchandising CompanyWorksheet for a Merchandising CompanyWorksheet for a Merchandising CompanyWorksheet for a Merchandising Company

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