1. Merchandising Activities
Chapter 6
Merchandising Activities
Chapter 6: Merchandising Activities

2. Comparing Merchandising Activities with Manufacturing Activities
Manufacture inventory and have a longer and more complex operating cycle.
Purchase inventory in ready-to-sell condition.
Manufacturing companies use raw materials to make the inventory they sell. Their operating cycles are typically longer and more complex because of the time it takes to make and sell the inventory and then to collect the account receivable.
Merchandising companies purchase the inventory they sell in a ready-to-sell condition. Since they do not have to make the inventory, their operating cycle is typically shorter.
Manufacturing Company
Merchandising Company

3. Income Statement of a Merchandising Company
Cost of goods sold represents the expense of goods that are sold to customers.
Gross profit is a useful means of measuring the profitability of sales transactions.
The income statements of merchandising companies have an additional expense item called Cost of Goods Sold. The Cost of Goods Sold account represents the cost of merchandise sold during the period to help earn revenue.
Cost of Goods Sold is presented as a separate expense item on the income statement. Net Sales minus Cost of Goods Sold equals Gross Profit. Gross Profit is the amount left, after subtracting the cost of the inventory sold, to cover all other expenses and a profit.

4. Operating Cycle of a Merchandising Company
Cash
1. Purchase of merchandise
3. Collection of the receivables
Accounts Receivable
Inventory
The operating cycle of a business is the time it takes a business to start with cash, purchase inventory, sell the inventory, and finally collect cash from customers.
The operating cycle of a business that sells inventory on credit is typically longer than that of a business that sells only on a cash basis. This is due to additional time between when a customer buys inventory and when the customer pays off the account receivable.
2. Sale of merchandise on account
The series of transactions through which a business generates its revenue and its cash receipts from customers is called the OPERATING CYCLE.

5. Accounting System Requirements for Merchandising Companies
Although general ledger accounts provide useful information, they do not provide much of the detailed information needed in the daily business operations.
Who owes us money?
In the General Ledger, the control account for Accounts Receivable indicates that customers owe seven thousand dollars. But, it does not indicate how much each customer owes. To find out, we must look at the Accounts Receivable Subsidiary Ledger for each customer.

6. Accounting System Requirements for Merchandising Companies
Control Account
Subsidiary Ledgers
Detail for each specific customer can be found by looking in the subsidiary ledgers. By looking there, it’s clear that Jake Sparks owes two thousand dollars and that Heather Jacobs owes five thousand dollars.
Notice that the total of the balances in the subsidiary accounts equals the total balance in the control account.

7. Two Approaches Used in Accounting for Merchandise Inventories
Perpetual Inventory System
Periodic Inventory System
There are two approaches used to account for merchandise transactions: the perpetual inventory system and the periodic inventory system. Let’s first look at the perpetual inventory system.

8. Perpetual Inventory Systems
The inventory account is continuously updated to reflect items on hand. Purchases of merchandise are recorded by debiting an asset account entitled INVENTORY at Cost.
In the perpetual inventory system, the inventory account is continuously updated to reflect purchases, sales, and returns of inventory. Let’s look at how entries are made in the perpetual inventory system.

9. Periodic Inventory System
No effort is made to keep up-to-date records of either inventory or the cost of goods sold. Instead these amounts are determined only periodically usually at the end of the year. The foundation of the periodic inventory system is the taking of a complete physical inventory at year-end.

10. Perpetual Inventory Systems
Most business use Perpetual Systems
Let’s look at some entries to learn about debits and credits!
In the perpetual inventory system, the inventory account is continuously updated to reflect purchases, sales, and returns of inventory. Let’s look at how entries are made in the perpetual inventory system.

11. Perpetual Inventory Systems
On September 5, Worley Co. purchased 100 laser lights for resale for $30 per unit from Electronic City on account.
On September 5th, Worley Company purchased on account from Electronic City one hundred laser lights for thirty dollars each. Worley Company would debit Inventory and credit Accounts Payable for three thousand dollars.
Now, let’s look at how to record a sale using the perpetual inventory system.

12. Sales of Merchandise
When merchandise is sold, two entries are necessary: one to recognize the actual sale and the second to recognize the related cost of goods sold.

13. Perpetual Inventory Systems
On September 10, Worley Co. sold 10 laser lights for $50 per unit on account to ABC Radios.
10 ´ $30 = $300
Retail
Part I
On September 10th, Worley Company sold 10 laser lights for fifty dollars each to ABC Radios on account. Under the perpetual inventory system, a sale of inventory requires two entries. One entry is a debit to Accounts Receivable and a credit to Sales for the retail amount of the sale, which in this case is five hundred dollars. Another entry is a debit to Cost of Goods Sold and a credit to Inventory for the cost of the inventory sold, which in this case is three hundred dollars.
Part II
The retail amount is the selling price to the customer and the cost amount is the cost paid for the inventory sold.
Now, let’s look at the payment entries for Worley Company’s purchase and sale of inventory.
Cost

14. REMEMBER
The matching principle requires that revenue be matched (offset) with all the costs and expenses incurred in producing that revenue. Therefore, a second journal entry is required at the time of the sale to record the COST of GOODS Sold.

15. Perpetual Inventory Systems
On September 15, Worley Co. paid Electronic City $3,000 for the September 5 purchase.
On September 15th, Worley Company paid Electronic City three thousand dollars for the September 5th purchase. Worley Company would debit Accounts Payable and credit Cash for three thousand dollars.

16. Perpetual Inventory Systems
On September 22, Worley Co. received $500 from ABC Radios as payment in full for their purchase on September 10.
On September 22nd, Worley Company received five hundred dollars from ABC Radios for their purchase on September 10th. Worley Company would debit Cash and credit Accounts Receivable for five hundred dollars.

17. Taking a Physical Inventory
In order to ensure the accuracy of their perpetual records, most businesses take a complete physical count of the merchandise on hand at least once a year.
Reasonable amounts of inventory shrinkage are viewed as a normal cost of doing business. Examples include breakage, spoilage theft, and shoplifting.
Most companies take a physical count of inventory at least once a year. Theoretically, the physical count should match the number of items in the inventory records. In reality, this is not the case. The physical count does not match the records due to spoilage, breakage, damage, obsolescence, and theft. The physical count helps get the records up to date to reflect what is actually on hand.

18. Taking a Physical Inventory
On December 31, Worley Co. counts its inventory. An inventory shortage of $2,000 is discovered.
When a physical count identifies inventory shrinkage, an entry is made to debit Cost of Goods Sold and credit Inventory. This entry increases Cost of Goods Sold, an expense account, and decreases the Inventory account.

19. Closing Entries in a Perpetual Inventory System
The closing entries are the same!
Close Revenue accounts (including Sales) to Income Summary.
Close Expense accounts (including Cost of Goods Sold) to Income Summary.
Close Income Summary account to Retained Earnings or Capital.
Close Dividends/Drawings to Retained Earnings/Capital.
The steps for closing entries in a perpetual inventory system are the same as discussed earlier.
Step 1 is to close Revenue to Income Summary. Since Revenue has a credit balance, a debit is made to close it and a credit is made to Income Summary.
Step 2 is to close all expense accounts to Income Summary. This includes the Cost of Goods Sold expense account. Since these accounts have a debit balance, they are credited and a debit is made to Income Summary for their total.
Step 3 is to close Income Summary to Retained Earnings.
Step 4, the final step, is to close Dividends to Retained Earnings. Since the Dividend account has a debit balance, a credit is made to close it and a debit is made to the Retained Earnings account.

20. Credit Terms and Cash Discounts
When manufacturers and wholesalers sell their products on account, the credit terms are stated in the invoice.
2/10, n/30
Cash discounts are provided to customers as an incentive for them to pay early.
The credit period is the normal period of time a company allows for customers to extend their account receivable, typically 30 or 60 days. The discount period is a much shorter period of time, typically 10 or 15 days. If payment is received during the discount period, a discount may be taken. If payment is made after the discount period expires, then the full payment is due on or before the end of the credit period.
Read as: “Two ten, net thirty”

21. Credit Terms and Cash Discounts
Cash discount terms are typically written as this slide shows. This particular discount term would be read as “two ten net thirty.”
The first number represents the discount percentage.
The second number represents the discount period.
The letter “n” stands for the word net.
The last number represents the entire credit period.
In this case, if the customer pays within 10 days, then a 2% discount may be taken. If not, then the full amount is due within 30 days.
Percentage of Discount
# of Days Discount Is Available
Otherwise, the Full Amount Is Due
# of Days when Full Amount Is Due

22. Recording Purchases at Net Cost
Most well-managed companies have a policy of taking advantage of all cash discounts available on the purchase of merchandise.
Purchases are recorded at their net amounts.
Net Method
Purchase Discounts Lost are recorded when payment is made outside the discount period.
Many companies plan to take advantage of cash discounts offered, so they record their purchases net of the discount. Since they typically take the discount, this process simplifies future entries. If a cash discount is not taken in the future, then a purchase discounts lost account is used.
Let’s see how these entries work.

23. Recording Purchases at Net Cost
On July 6, Play Clothes purchased $4,000 of merchandise on credit with terms of
2/10, n/30 from Kid’s Clothes.
Prepare the journal entry for Play Clothes.
On July 6th, Play Clothes purchased four thousand dollars of merchandise on account from Kid’s Clothes with terms two ten net thirty.

24. Recording Purchases at Net Cost
On July 6, Play Clothes purchased $4,000 of merchandise on credit with terms of
2/10, n/30 from Kid’s Clothes.
Prepare the journal entry for Play Clothes.
Play Clothes debits Inventory and credits Accounts Payable for three thousand nine hundred twenty dollars, which is net of the two percent cash discount.
$4,000 ´ 98% = $3,920

25. Recording Purchases at Net Cost
On July 15, Play Clothes pays the full amount due to Kid’s Clothes.
Prepare the journal entry for Play Clothes.
On July 15th, Play Clothes pays the full amount due to Kid’s Clothes.

26. Recording Purchases at Net Cost
On July 15, Play Clothes pays the full amount due to Kid’s Clothes.
Prepare the journal entry for Play Clothes.
In this entry, Play Clothes debits Accounts Payable and credits Cash for three thousand nine hundred twenty dollars. Since Accounts Payable was originally recorded for the net amount, this entry completely takes care of the balance in the Accounts Payable account.

27. Recording Purchases at Gross Invoice Price
Now, assume that Play Clothes waited until July 20 to pay the full amount due to Kid’s Clothes.
Prepare the journal entry for Play Clothes.
Now, assume that Play Clothes waited until July 20th to pay Kid’s Clothes. This is outside the discount period. Let’s look at this entry.

28. Recording Purchases at Net Cost
Now, assume that Play Clothes waited until July 20 to pay the amount due in full to Kid’s Clothes.
Prepare the journal entry for Play Clothes.
Nonoperating Expense
Play Clothes will have to pay the full amount of four thousand dollars since they did not pay within the discount period. This is recorded as a credit to Cash. The debit to Accounts Payable can only be for the originally recorded amount of three thousand nine hundred twenty dollars. The difference is a debit to Purchase Discounts Lost, a nonoperating expense account, for eighty dollars.

29. Recording Purchases at Gross Invoice Price
Purchases are recorded at their gross amounts.
Gross Method
Purchase discounts taken are recorded when payment is made inside the discount period.
Other companies use the gross method to record their purchase. Under the gross method, the purchases are originally recorded at the full amount. If a cash discount is taken in the future, then a purchase discounts account is used.
Let’s see how these entries work.

30. Recording Purchases at Gross Invoice Price
On July 6, Play Clothes purchased $4,000 of merchandise on credit with terms of
2/10, n/30 from Kid’s Clothes.
Prepare the journal entry for Play Clothes.
On July 6th, Play Clothes purchased four thousand dollars of merchandise on account from Kid’s Clothes with terms two ten net thirty.

31. Recording Purchases at Gross Invoice Price
On July 6, Play Clothes purchased $4,000 of merchandise on credit with terms of
2/10, n/30 from Kid’s Clothes.
Prepare the journal entry for Play Clothes.
Play Clothes debits Inventory and credits Accounts Payable for four thousand dollars, which is the gross amount of the purchase.

32. Recording Purchases at Gross Invoice Price
On July 15, Play Clothes pays the full amount due to Kid’s Clothes.
Prepare the journal entry for Play Clothes.
On July 15th, Play Clothes pays the full amount due to Kid’s Clothes.

33. Recording Purchases at Gross Invoice Price
On July 15, Play Clothes pays the full amount due to Kid’s Clothes.
Prepare the journal entry for Play Clothes.
Reduces Cost of Goods Sold
$4,000 ´ 98% = $3,920
Play Clothes does not have to pay the full amount of four thousand dollars since the are paying within the discount period. As a result, the credit to Cash is for three thousand nine hundred twenty dollars, which is the net amount. This payment removes the entire accounts payable of four thousand dollars and is recorded as a debit to Accounts Payable for four thousand dollars. The difference is a credit to Purchase Discounts Taken, an account that reduces the cost of goods sold for the period.

34. Recording Purchases at Gross Invoice Price
Now, assume that Play Clothes waited until July 20 to pay the full amount due to Kid’s Clothes.
Prepare the journal entry for Play Clothes.
Now, assume that Play Clothes waited until July 20th to pay Kid’s Clothes. This is outside the discount period. Let’s look at this entry.

35. Recording Purchases at Gross Invoice Price
Now, assume that Play Clothes waited until July 20 to pay the full amount due to Kid’s Clothes.
Prepare the journal entry for Play Clothes.
In this entry, Play Clothes debits Accounts Payable and credits Cash for four thousand dollars. This payment must be for the gross amount since it is made outside of the discount period.
Now, let’s see how to record inventory returns.

36. Returns of Unsatisfactory Merchandise
On August 5, Play Clothes returned $500 of unsatisfactory merchandise purchased from Kid’s Clothes on credit terms of 2/10, n/30. The purchase was originally recorded at net cost.
Prepare the journal entry for Play Clothes.
On August 5th, Play Clothes returned five hundred dollars of unsatisfactory merchandise to Kid’s Clothes. The inventory was originally purchased on credit with terms of two ten net thirty, and the purchase was originally recorded at net cost.

37. Returns of Unsatisfactory Merchandise
On August 5, Play Clothes returned $500 of unsatisfactory merchandise purchased from Kid’s Clothes on credit terms of 2/10, n/30. The purchase was originally recorded at net cost.
Prepare the journal entry for Play Clothes.
To record the return, Play Clothes would debit Accounts Payable and credit Inventory for the net cost of the goods returned, which in this case would be four hundred ninety dollars.
What if we had used gross invoice price?
$500 ´ 98% = $490

38. Transportation Costs on Purchases
Transportation costs related to the ACQUISITION of assets are part of the cost of the asset being acquired.
Debit Inventory and Credit Payment (Cash or AP):
Inventory
Cash 50
In general, the cost of any asset includes any transportation costs related to getting the asset to the buyer’s place of business. This is also the case for inventory. Transportation costs incurred by the buyer are included in the cost of Inventory.

39. Now, let’s talk about sales!
Now, let’s switch our thinking to the sales side of these transactions.

40. Transactions Relating to Sales
Credit terms and merchandise returns affect the amount of revenue earned by the seller.
Just as inventory returns and cash discounts impact a buyer’s entries, they also impact a seller’s entries.
Sellers use the Sales Returns and Allowances account to record inventory returned to the seller, or adjustments in prices sellers allow due to customer dissatisfaction.
Sellers use the Sales Discounts account to record cash discounts taken by customers who pay within the discount period.
Net sales equals Sales minus Sales Returns and Allowances and Sales Discounts.
Let’s see how these accounts are treated in journal entries.

41. Sales
On August 2, Kid’s Clothes sold $2,000 of merchandise to Play Clothes on credit terms 2/10, n/30. Kid’s Clothes originally paid $1,000 for the merchandise.
Because Kid’s Clothes uses a perpetual inventory system, they must make two entries.
Kid’s Clothes sold two thousand dollars of merchandise to Play Clothes on credit terms of two ten net thirty. Kid’s Clothes originally paid one thousand dollars for the merchandise.
Because Kid’s Clothes uses a perpetual inventory system, two entries are required to record this sale. One entry is a debit to Accounts Receivable and a credit to Sales for the retail amount of the sale, which in this case is two thousand dollars.

42. Sales
On August 2, Kid’s Clothes sold $2,000 of merchandise to Play Clothes on credit terms 2/10, n/30. Kid’s Clothes originally paid $1,000 for the merchandise.
Because Kid’s Clothes uses a perpetual inventory system, they must make two entries.
Another required entry is a debit to Cost of Goods Sold and a credit to Inventory for the cost of the inventory sold, which in this case is one thousand dollars.

43. Sales Returns and Allowances
On August 5, Play Clothes returned $500 of unsatisfactory merchandise to Kid’s Clothes from the August 2 sale. Kid’s Clothes cost for this merchandise was $250.
Because Kid’s Clothes uses a perpetual inventory system, they must make two entries.
Contra-revenue
On August 5th, Play Clothes returned five hundred dollars of merchandise to Kid’s Clothes. The cost of this inventory to Kid’s Clothes is two hundred fifty dollars.
Because Kid’s Clothes uses a perpetual inventory system, two entries are required to record this return. One entry is a debit to Sales Returns and Allowances and a credit to Accounts Receivable for the retail amount of the sale, which in this case is five hundred dollars.
Sales Returns and Allowances is a contra-revenue account that is subtracted from Sales to arrive at Net Sales for the period.

44. Sales Returns and Allowances
On August 5, Play Clothes returned $500 of unsatisfactory merchandise to Kid’s Clothes from the August 2 sale. Kid’s Clothes cost for this merchandise was $250.
Because Kid’s Clothes uses a perpetual inventory system, they must make two entries.
Another required entry is a debit to Inventory and a credit to Cost of Goods Sold for the cost of the inventory returned, which in this case is two hundred fifty dollars.
Now, let’s look at some more sale entries.

45. Sales
On July 6, Kid’s Clothes sold $4,000 of merchandise to Play Clothes on credit with terms of 2/10, n/30. The merchandise originally cost Kid’s Clothes $2,000.
Because Kid’s Clothes uses a perpetual inventory system, they must make two entries.
On July 6th, Kid’s Clothes sold four thousand dollars of merchandise to Play Clothes on credit terms of two ten net thirty. Kid’s Clothes originally paid two thousand dollars for the merchandise.
Because Kid’s Clothes uses a perpetual inventory system, two entries are required to record this sale. One entry is a debit to Accounts Receivable and a credit to Sales for the retail amount of the sale, which in this case is four thousand dollars.

46. Sales
On July 6, Kid’s Clothes sold $4,000 of merchandise to Play Clothes on credit with terms of 2/10, n/30. The merchandise originally cost Kid’s Clothes $2,000.
Because Kid’s Clothes uses a perpetual inventory system, they must make two entries.
Another required entry is a debit to Cost of Goods Sold and a credit to Inventory for the cost of the inventory sold, which in this case is two thousand dollars.

47. Prepare the journal entry for Kid’s Clothes.
Sales Discounts
On July 15, Kid’s Clothes receives the full amount due from Play Clothes from the July 6 sale.
Prepare the journal entry for Kid’s Clothes.
On July 15th, Kid’s Clothes receives the full payment due from Play Clothes.

48. Prepare the journal entry for Kid’s Clothes.
Sales Discounts
On July 15, Kid’s Clothes receives the full amount due from Play Clothes from the July 6 sale.
Prepare the journal entry for Kid’s Clothes.
Contra-revenue
$4,000 ´ 98% = $3,920
Kid’s Clothes debits Cash for three thousand nine hundred twenty dollars, which is the net amount due since payment was made within the discount period. Accounts Receivable is credited for the entire original amount of four thousand dollars. The difference is debited to Sales Discounts, a contra-revenue account, for eighty dollars.

49. Prepare the journal entry for Kid’s Clothes.
Sales Discounts
Now, assume that it wasn’t until July 20 that Kid’s Clothes received the full amount due from Play Clothes from the July 6 sale.
Prepare the journal entry for Kid’s Clothes.
Now assume that payment was not received until July 20th, which is outside the discount period.

50. Prepare the journal entry for Kid’s Clothes.
Sales Discounts
Now, assume that it wasn’t until July 20 that Kid’s Clothes received the full amount due from Play Clothes from the July 6 sale.
Prepare the journal entry for Kid’s Clothes.
Kid’s Clothes would debit Cash and credit Accounts Receivable for the full amount of four thousand dollars.

51. Delivery Expenses
Delivery costs incurred by sellers are debited to Delivery Expense, an operating expense.
Delivery Expense
Cash 50
When sellers incur transportation costs, they are debited to an operating expense account called Delivery Expense. This is considered a cost of doing business and is treated as a regular operating expense of the business.

52. Accounting for Sales Taxes
Businesses collect sales tax at the point of sale.
Then, they remit the tax to the appropriate governmental agency at times specified by law.
$1,000 sale ´ 7% tax = $70 sales tax
When a business makes a sale, in most cases it collects more than the selling price of the goods sold. This extra amount is the sales tax on the transaction. Sellers do not get to keep this amount. They must remit it to the proper taxing authority.
The entry to record the collection of sales tax includes a debit to Cash for the entire amount of cash collected, a credit to Sales for the retail amount of the sale, and a credit to Sales Tax Payable for the amount of the sales tax to be remitted to the proper taxing authority.

53. Special Journals
A special journal is an accounting record or device designed to record a specific type of routine transaction quickly and efficiently. Most businesses use separate special journals to record repetitive transactions such as Sales of Merchandise, Cash Receipts, Cash Payments, Purchases of Merchandise on Account.

54. Special Journals
Buying Merchandise is recorded in the Purchases Journal.
Selling Merchandise on account is recorded in the Sales Journal
Merchandising business pays its salary expense or any other payment is recorded in the Cash Payment Journal
When merchandising business receives payment on account it is recorded in the Cash Receipts Journal.
When a customer is given an allowance for merchandise that was not to their satisfaction it is recorded in the General Journal.

55. Forms of Financial Statements
Illustration 5-11
Forms of Financial Statements
Key Items:
Net sales
Gross profit
Gross profit rate
LO 5 Distinguish between a multiple-step and a single-step income statement.
LO 6 Explain the computation and importance of gross profit.

56. Forms of Financial Statements
Illustration 5-11
Forms of Financial Statements
Key Items:
Net sales
Gross profit
Gross profit rate
Operating expenses
LO 5 Distinguish between a multiple-step and a single-step income statement.

57. Forms of Financial Statements
Illustration 5-11
Forms of Financial Statements
Key Items:
Net sales
Gross profit
Gross profit rate
Operating expenses
Nonoperating activities
Net income
LO 5 Distinguish between a multiple-step and a single-step income statement.