1. Chapter 5 Accounting for Merchandising Businesses
Financial and Managerial Accounting
8th Edition
Warren Reeve Fess

2. Objectives
1. Distinguish the activities of a service business from those of a merchandising business.
2. Describe and illustrate the financial statements of a merchandising business.
3. Describe the accounting for the sale of merchandise.
Describe the accounting for the purchase of merchandise.
Describe the accounting for transportation costs, sales taxes, and trade discounts.
6. Illustrate the dual nature of merchandising transactions.
7. Prepare a chart of accounts for a merchandising business.
8. Describe the accounting cycle for a merchandising business.
9. Compute the ratio of net sales to assets as a measure of how effectively a business is using its assets.

3. Merchandising Business
Nature of Businesses
Service Business
Fees earned $XXX
Operating expenses –XXX
Net income $XXX
Merchandising Business
Sales $XXX
Cost of Merchandise Sold –XXX
Gross Profit $XXX
Operating Expenses –XXX
Net Income $XXX

4. The Operating Cycle Collection Activity Purchasing Activity
Cash
Raw Materials
Accounts Receivable
The Operating Cycle
Products
Sales Activity
Production Activity

5. NetSolutions Income Statement For the Year Ended December 31, 2007
Multiple-Step Income Statement
NetSolutions Income Statement For the Year Ended December 31, 2007
Revenue from sales:
Sales $720,185
Less:Sales returns and allowances $ 6, Sales discounts 5, ,930
Net sales $708,255
Cost of merchandise sold 525,305
Gross profit $182,950
Continued

6. Continued Operating expenses: Selling expenses:
Sales salaries expense $56,230
Advertising expense 10,860
Depr. Expense–store equipment 3,100
Miscellaneous selling expense
Total selling expenses $ 70,820
Administrative expenses:
Office salaries expense $21,020
Rent expense 8,100
Depr. expense–office equipment 2,490
Insurance expense 1,910
Office supplies expense 610
Misc. administrative expense
Total admin. expenses ,890
Total operating expenses ,710
Income from operations $ 77,240
Other income and expenses:
Rent revenue $ 600
Interest expense (2,440) (1,840)
Net income $75,400
Continued

7. Periodic vs. Perpetual Methods of Accounting
Periodic Method
A method of determining the cost of merchandise sold and the amount of merchandise on hand
Under this method, the inventory records do not show the amount available for sale or the amount sold during the period
Perpetual Method
Under this method, each purchase and sale of merchandise is recorded in the inventory and the cost of merchandise sold accounts.
The amount of merchandise available for sale and the amount sold are continuously disclosed in the inventory records.

8. Cost of Merchandise Purchased
Purchases $521,980
Less: Purchase returns and allowances $9,100
Purchase discounts 2, ,625
Net purchases $510,355
Add transportation-in ,400
Cost of merchandise purchased $527,755

9. Cost of Merchandise Sold
Merchandise inventory, 1/1/07 $ 59,700
Purchases $521,980
Less: Purchase returns and allowances $9,100
Purchase discounts 2, ,625
Net purchases $510,355
Add transportation-in ,400
Cost of merchandise purchased ,755
Merchandise available for sale $587,455
Less merchandise inventory, 12/31/ ,150
Cost of merchandise sold $525,305

10. NetSolutions Income Statement For the Year Ended December 31, 2007
Single-Step Income Statement for a Merchandising Business
NetSolutions Income Statement For the Year Ended December 31, 2007
Revenues:
Net sales $708,255
Rent revenue
Total revenues $708,855
Expenses:
Cost of merchandise sold $525,305
Selling expenses 70,820
Administrative expenses 34,890
Interest expense ,440
Total expenses ,455
Net income $ 75,400

11. Retained Earnings Statement
NetSolutions Retained Earnings Statement For the Year Ended December 31, 2007
Retained earnings, 1/1/07 $128800
Net income for year $75,400
Less dividends 18,000
Increase in owner’s equity ,400
Retained earnings, 12/31/07 $186,200

12. NetSolutions - Balance Sheet- December 31, 2007
Assets
Current assets:
Cash $52,950
Accounts receivable 91,080
Merchandise inventory 62,150
Office supplies 480
Prepaid insurance 2, Total current assets $209,310
Property, plant, and equipment:
Land $20,000
Store equipment $27,100
Less accumulated
depreciation 5,700 21,400
Office equipment $15,570
depreciation ,720 10,850 Total property, plant, and
equipment ,250
Total assets $261,560

13. Note payable (current portion) 5,000 Salaries payable 1,140
Liabilities
Current liabilities:
Accounts payable $22,420
Note payable (current portion) 5,000
Salaries payable 1,140
Unearned rent 1,800
Total current liabilities $ 30,360
Long-term liabilities:
Note payable (due 2017) ,000
Total liabilities $ 50,360
Stockholders’ Equity
Capital stock $ 25,000
Retained earnings 186, ,200
Total liab. and stockholders’ equity $261,560

14. Sales Transactions

15. On January 3, a firm sold $1,800 of merchandise for cash.
Cash Sales
JOURNAL
PAGE 26
Post. Ref.
Description
Dr Cr.
Date
2007 1
Jan. 3 Cash 2
Sales
To record cash sales. 3 4 5
On January 3, a firm sold $1,800 of merchandise for cash.

16. Cash Sales 6
3 Cost of Merchandise Sold 7
Merchandise Inventory 8
To record the cost of
merchandise sold. 9 10
Using a perpetual inventory, the inventory cost of $1,200 must be recorded.

17. Cash Sales
JOURNAL
PAGE 28
Post. Ref.
Description
Dr Cr.
Date
2007 1
Jan. 31 Credit Card Expense 2
Cash 3
To record service charges
on credit card sales for the
month. 4 5
Credit card sales (MasterCard or Visa) are recorded as cash sales.
At the end of the month, $48 was sent to cover this service charge.

18. Sales on Account
Jan. 12 Accounts Receivable—Sims Co
Sales
Invoice No
12 Cost of Merchandise Sold
Merchandise Inventory
Cost of merchandise sold on Invoice No
On January 12, a firm sold Sims Company merchandise on account, $510. The cost of the merchandise to the seller was $280.

19. Sales Discounts
The terms for when payments for merchandise are to be made are called credit terms.
If buyer is allowed an amount of time to pay, it is known as the credit period.

20. Sales Discounts Credit Terms
Invoice for $1,500
Terms:
2/10, n/30
If invoice is paid within 10 days of invoice date
If invoice is NOT paid within 10 days of invoice date
$1,470 paid (less 2% as a cash discount)
$1,500 PAID

21. Sales Discounts
Jan Cash
Sales Discounts
Accounts Receivable—Sims Co
Collection of Invoice No. 7172, less discount.
On January 22, the firm receives $1,470 from Sims Co. which is the amount due of $1,500 less a 2 percent discount.

22. Sales Returns and Allowances
Merchandise that is returned to the vendor is referred to as a sales return.
If there is a defect in the product or the wrong item was shipped, the seller may reduce the initial price at which the goods were sold. This is known as a sales allowance.

23. Sales Returns and Allowances
Jan. 13 Sales Returns and Allowances
Accounts Receivable—Krier Co
Credit Memo No. 32.
13 Merchandise Inventory
Cost of Merchandise Sold
Cost of merchandise returned—Credit Memo 32.
On January 13, issued Credit Memo 32 to Krier Company for merchandise returned to NetSolutions. Selling price, $225; cost to NetSolutions, $140.

24. Purchase Transactions

25. Purchase Transactions
Post. Ref.
Description
Dr Cr.
Date
2007 1
Jan. 3 Merchandise Inventory 2
Cash
Purchased inventory from Bowen Co. 3 4 5
On January 13, Purchased merchandise for cash from Alden Company, $2,510.

26. What’s the last day the invoice can be paid?
Purchase Discounts
What’s the last day the invoice can be paid?
Alpha Technologies issues an invoice for $3,000 to NetSolutions dated March 12, with terms 2/10, n/30.

27. Purchase Discounts The full amount is due on April 11.
Let’s do a simple calculation.
Invoice period 30
Days in March 31
Date of invoice 12
Remaining days 19
April 11

28. Purchase Discounts
We can borrow at an annual interest rate of 6%. Should we borrow the to pay the invoice within the discount period?
$60 discount (2% x $3,000)?

29. Let’s see… Interest on the amount due of $3,000 less the 2 percent…
Purchase Discounts
Let’s see… Interest on the amount due of $3,000 less the 2 percent…
Discount $60.00
Interest for 20 days at the rate of 6% on $2,940 –9.80
Savings from borrowing $50.20

30. Purchase Discounts
Looks like we should take advantage of the discount even if we have to borrow the money.
Discount $60.00
Interest for 20 days at the rate of 6% on $2,940 –9.80
Savings from borrowing $50.20

31. Purchase Discounts
JOURNAL
PAGE 27
Post. Ref.
Description
Dr Cr.
Date
2007 1
Mar. 12 Merchandise Inventory 2
Accounts Payable—Alpha
Technologies 3 4 5
On March 12, NetSolutions purchased merchandise on account from Alpha Technologies, $3,000.

32. Purchase Discounts
JOURNAL
PAGE 27
Post. Ref.
Description
Dr Cr.
Date
2007 1
Mar. 22 Accounts Payable—Alpha Technol
Cash
Merchandise Inventory 2 3 4 5
If payment is made by March 22 NetSolutions records the discount as a reduction in cost.

33. Purchase Discounts
JOURNAL
PAGE 27
Post. Ref.
Description
Dr Cr.
Date
2007 1
Apr. 11 Accounts Payable—Alpha Technol
Cash 2 3 4 5
If NetSolutions does not pay the invoice until April 11, it would pay the full amount.

34. Purchases Returns and Allowances
A purchases return involves actually returning merchandise that is damaged or does not meet the specifications of the order.
When the defective or incorrect merchandise is kept by the buyer and the vendor makes a price adjustment, this is a purchases allowance.

35. Purchases Returns and Allowances
You sent me the wrong interface cards. We’ll send a debit memorandum with the returned items.
NetSolutions received the delivery from Maxim Systems and determined that $900 of the items were not the merchandise ordered. Debit memorandum #18 is issued to Maxim Systems.

36. Purchases Returns and Allowances
Mar. 7 Accounts Payable—Maxim Systems
Merchandise Inventory
Debit Memo No. 18

37. Purchases Returns and Allowances
On May 2, NetSolutions purchased $5,000 of merchandise from Delta Data Link, subject to terms 2/10, n/30.
May 2 Merchandise Inventory
Purchased merchandise.
Accounts Payable—Delta Data

38. Purchases Returns and Allowances
On May 4, NetSolutions returns $3,000 of the merchandise.
May 4 Accounts Payable—Delta Data Links
Returned portion of merchandise purchased.
Merchandise Inventory

39. Purchases Returns and Allowances
On May 12, NetSolutions pays the amount due.
May 12 Accounts Payable—Delta Data Links
Paid invoice.
Cash
Merchandise Inventory
($5,000 – $3,000) x 2%

40. Transportation Costs FOB Shipping Point
Buyer pays freight costs and debits Merchandise Inventory
Fruit Express
Title passes to buyer as shipment leaves shipping point.

41. FOB Shipping Point
June 10 Merchandise Inventory
Accounts Payable—Magna Data
Purchased merchandise, terms FOB shipping point.
10 Merchandise Inventory
Cash
Paid shipping cost on merchandise purchased.
On June 10, NetSolutions buys merchandise from Magna Data on account, $900, terms FOB shipping point and pays the transportation cost of $50.

42. FOB Destination
Seller pays freight costs and debits Transportation Out
Fruit Express
Title passes to buyer upon arrival at destination.

43. FOB Destination
June 15 Accounts Receivable—Kranz Co
Sales
Sold merchandise, terms FOB destination.
15 Cost of Merchandise Sold
Merchandise Inventory
Cost of sale of Kranz Co .
On June 15, NetSolutions sells merchandise to Kranz Company on account, $700, terms FOB destination. The cost of the merchandise sold is $480. NetSolutions pays the transportation cost of $40.

44. FOB Destination
June 15 Transportation Out
Cash
Paid shipping cost on merchandise sold.
On June 15, NetSolutions sells merchandise to Kranz Company on account, $700, terms FOB destination. The cost of the merchandise sold is $480. NetSolutions pays the transportation cost of $40.

45. Sales Taxes
Aug. 12 Accounts Receivable—Lemon Co
Sales
Sales Taxes Payable
Invoice No. 339
On August 12, merchandise is sold on account to Lemon Company, $100. The state has a 6% sales tax.

46. Sales Taxes
Sept.15 Sales Tax Payable
Cash
Payment for sales taxes collected during August.
On September 15, the seller sends in a payment of $2,900 to the taxing unit for the August taxes collected.

47. Illustration of Accounting for Merchandise Transactions
Scully Company (Seller)
Accounts Receivable—Burton Co. 7,500
Sales 7,500
Cost of Merchandise Sold 4,500
Merchandise Inventory 4,500
Burton Company (Buyer)
Merchandise Inventory. 7,500
Accounts Payable—Scully Co. 7,500
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.

48. Illustration of Accounting for Merchandise Transactions
Scully Company (Seller)
No entry.
Burton Company (Buyer)
Merchandise Inventory 150
Cash 150
July 2. Burton Company paid transportation charges of $150 on July 1 purchase from Scully Company.

49. Illustration of Accounting for Merchandise Transactions
Scully Company (Seller)
Accounts Receivable—Burton Co. 5,000
Sales 5,000
Cost of Merchandise Sold 3,500
Merchandise Inventory 3,500
Burton Company (Buyer)
Merchandise Inventory. 5,000
Accounts Payable—Scully Co. 5,000
July 5. Scully Company sold merchandise on account to Burton Co., $5,000, terms FOB shipping point, n/30. The cost of the merchandise sold was $3,500.

50. Illustration of Accounting for Merchandise Transactions
Scully Company (Seller)
Transportation Out 250
Cash 250
Burton Company (Buyer)
No entry.
July 7. Scully Company paid transportation costs of $250 for delivery of merchandise sold to Burton Company on July 5.

51. Illustration of Accounting for Merchandise Transactions
Scully Company (Seller)
Sales Returns and Allowances 1,000
Accounts Receivable—Burton Co. 1,000
Merchandise Inventory 700
Cost of Merchandise Sold 700
Burton Company (Buyer)
Accounts Payable—Scully Co. 1,000
Merchandise Inventory 1,000
July 13. Scully Company issued Burton Company a credit memorandum for $1,000 of merchandise returned from a July 5 purchase on account. The cost of the merchandise was $700.

52. Illustration of Accounting for Merchandise Transactions
Scully Company (Seller)
Cash 4,000
Accounts Receivable—Burton Co. 4,000
Burton Company (Buyer)
Accounts Payable—Scully Co. 4,000
Cash 4,000
July 15. Scully Company received payment from Burton Company for purchase of July 5.

53. Illustration of Accounting for Merchandise Transactions
Continued (Seller)
Cost of Merchandise Sold 7,200
Merchandise Inventory 7,200
Burton Company (Buyer)
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.

54. Illustration of Accounting for Merchandise Transactions
Scully Company (Seller)
Cost of Merchandise Sold 7,200
Merchandise Inventory 7,200
Burton Company (Buyer)
Merchandise Inventory 12,500
Accounts Payable—Scully Co. 12,500
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.

55. Illustration of Accounting for Merchandise Transactions
Scully Company (Seller)
Cash 12,260
Sales Discounts 240
Accounts Receivable—Burton Co. 12,500
Burton Company (Buyer)
Accounts Payable—Scully Co. 12,500
Merchandise Inventory 240
Cash 12,260
July 28. Scully Company received payment from Burton Company for purchase of July 18, less discount (2% x $12,000).

56. Balance Sheet Accounts
NetSolutions
Chart of Accounts
Balance Sheet Accounts
200 Liabilities
210 Accounts Payable
211 Salaries Payable
212 Unearned Rent
215 Notes Payable
300 Stockholders’ Equity
310 Capital Stock
311 Retained Earnings
Dividends
Income Summary
100 Assets
110 Cash
112 Accounts Receivable
115 Merchandise Inventory
116 Office Supplies
117 Prepaid Insurance
120 Land
123 Store Equipment
124 Accumulated Depreciation—
Store Equipment
125 Office Equipment
126 Accumulated Depreciation—
Office Equipment

57. Income Statement Accounts
NetSolutions
Chart of Accounts
Income Statement Accounts
500 Costs and Expenses
510 Cost of Merchandise Sold
520 Sales Salaries Expense
521 Advertising Expense
522 Depreciation Expense—
Store Equipment
523 Transportation Out
529 Miscellaneous Selling Expense
530 Office Salaries Expense
531 Rent Expense
532 Depreciation Expense—
Office Equipment
533 Insurance Expense
534 Office Supplies Expense
539 Miscellaneous Admin. Expense
400 Revenues
410 Sales
411 Sales Returns and
Allowances
412 Sales Discounts
600 Other Income
610 Rent Revenue
700 Other Expense
710 Interest Expense

58. Merchandise Inventory Shrinkage
NetSolutions inventory records indicate that $63,950 of merchandise should be available for sale on December 31, The physical count reveals that only $62,150 is actually available.

59. Merchandise Inventory Shrinkage
Adjusting Entry
Dec. 31 Cost of Merchandise Sold
Merchandise Inventory
Inventory records $63,950
Inventory count 62,150
Inventory shortage $ 1,800

60. Profitability Measures -- Effective Use of Assets
Ratio of Net Sales to Assets
Sears Penney
Net sales $41,366,000 $31,846,000
Total assets:
Beginning of year $50,409,000 $19,742,000
End of year $44,317,000 $20,908,000
Average $47,363,000 $20,325,000
Ratio of net sales to assets .87 to to 1
Ratio Use: To assess the effectiveness in the use of assets to generate sales.