1. ACCOUNTING FOR MERCHANDISE OPERATIONS
Chapter 5
ACCOUNTING FOR MERCHANDISE OPERATIONS
Chapter 5: Accounting for Merchandise Operations

2. Inventory Systems
C 2
This slide illustrates the flow of costs in an inventory system. If we take what we start the period with and add the net purchases during the period, we have the total merchandise available for sale during the period. At the end of the period, one of two things must happen to the merchandise available for sale. It is either still in inventory or it is sold. If it is in inventory, the cost will appear on the balance sheet as Ending Inventory. If it is sold, the cost will appear on the income statement as Cost of Goods Sold.
Learning this flow of inventory costs will help you apply new material you will learn later.

3. Inventory Systems Perpetual systems Periodic systems
continually update accounting records for merchandising transactions
Periodic systems
accounting records relating to merchandise transactions are updated only at the end of the accounting period
Two alternative inventory accounting systems can be used to collect information about cost of goods sold and cost of inventory: perpetual system or periodic system.
The perpetual inventory system continually updates accounting records for merchandising transactions.
The periodic inventory system updates the accounting records for merchandise transactions only at the end of a period.

4. Accounting for Merchandise Purchases
This is an example of an invoice that would support the purchase of merchandise inventory. Notice all the different information on the invoice such as the seller, invoice date, purchaser, order date, credit terms, freight terms, goods purchased, and total invoice amount.
The invoice helps provide much of the information needed when recording the entry to purchase inventory.

5. Purchase Discounts P1
A deduction from the invoice price granted to induce early payment of the amount due.
Purchase discounts are provided to customers as an incentive for them to pay early. The credit period is the normal period of time the 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.

6. 2/10,n/30 Purchase Discounts Discount Percent
Number of Days Discount Is Available
Otherwise, Net (or All) Is Due in 30 Days
Credit Period
Purchase 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 all of the amount is due within 30 days.

7. Purchase Returns and Allowances
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.
In addition to purchase discounts, merchandisers also have to deal with returns of inventory and allowances. A purchase return is the return of merchandise by the purchaser to the supplier. An allowance is a price reduction granted to the customer because of some quality issue. An allowance may be given because of a slight defect in the merchandise or because a shipment was late. In these cases, the customer keeps the merchandise and just receives a price reduction as the allowance.

8. Transportation Costs and Ownership Transfer
Transportation costs are sometimes included in the cost of Merchandise Inventory. For example, when buyers pay transportation costs to get merchandise inventory to them, the transportation costs are included in the Merchandise Inventory cost. FOB terms designate when title passes and who pays the transportation cost.
FOB stands for Free On Board. So, if the shipping terms are Free On Board shipping point, that means that ownership transfers from the seller to the buyer when the seller provides the goods to the carrier. It also means that the buyer will pay the transportation cost. This transportation cost will be added to the merchandise inventory account. On the other hand, if the shipping terms are Free On Board destination, that means that ownership transfers from the seller to the buyer when the buyer receives the goods. It also means that seller will pay the transportation cost.

9. Accounting for MerchandiseP1
The accounting system described in this chapter does not provide separate records (accounts) for total purchases, total purchase discounts, total purchase returns and allowances, and total transportation-in. Yet nearly all companies collect this information in supplementary records because managers need this information to evaluate and control each of these cost elements. Supplementary records, also called supplemental records, refer to information outside the usual general ledger accounts.

10. Accounting for Merchandise SalesP2
Merchandise companies also must account for sales, sales discounts, sales returns and allowances, and cost of goods sold. A merchandising company such as Z-Mart reflects these items in its gross profit computation.

11. Sales of Merchandise P2
Each sales transaction for a seller of merchandise involves two parts:
Revenue received in the form of an asset from a customer
Recognition of the cost of merchandise sold to a customer
Each sales transaction for a seller of merchandise involves two parts:
Revenue received in the form of an asset from a customer
Recognition of the cost of merchandise sold to a customer
Accounting for a sales transaction under the perpetual system requires recording information about both parts. This means that each sales transaction for merchandisers, whether for cash or on credit, requires two entries: one for revenue and one for cost.

12. Sales Returns and AllowancesP2
Sales Returns and Allowances
Sales returns and allowances usually involve dissatisfied customers and the possibility of lost future sales.
Sales returns refer to merchandise that customers return to the seller after a sale.
Sales allowances refer to reductions in the selling price of merchandise sold to customers.
Sales returns refer to merchandise that customers return to the seller after a sale. Many companies allow customers to return merchandise for a full refund. Sales allowances refer to reductions in the selling price of merchandise sold to customers. This can occur with damaged or defective merchandise that a customer is willing to purchase with a decrease in selling price. Sales returns and allowances usually involve dissatisfied customers and the possibility of lost future sales, and managers monitor information about returns and allowances.

13. Merchandising Cost Flow in the Accounting CycleP2
Beginning inventory
Net purchases
Merchandise available for sale
Ending inventory
Cost of goods sold
To Income Statement
To Balance Sheet
Period 1
Period 2
This slide shows the flow of merchandise costs during a period and where these costs are reported at period-end. Specifically, beginning inventory plus net cost of purchases is the merchandise available for sale. As inventory is sold, its cost is recorded in cost of goods sold on the income statement; what remains is ending inventory on the balance sheet. A period’s ending inventory becomes the next period’s beginning inventory.

14. Closing Entries for MerchandisersP3
Closing entries are similar for service companies and merchandising companies using a perpetual system. The difference is that we must close some new temporary accounts that arise from merchandising activities.
Z-Mart has several temporary accounts unique to merchandisers: Sales (of goods), Sales Discounts, Sales Returns and Allowances, and Cost of Goods Sold.
Their existence in the ledger means that the first two closing entries for a merchandiser are slightly different from the ones described in the prior chapter for a service company. These differences are set in red boldface in the closing entries on this slide.

15. P4
A multiple-step income statement format shows detailed computations of net sales and other
costs and expenses, and reports subtotals for various classes of items.
Generally accepted accounting principles do not require companies to use any one presentation format for financial statements so we see many different formats in practice. A multiple-step income statement format shows detailed computations of net sales and other costs and expenses, and reports subtotals for various classes of items. The graphic on this slide shows a multiple-step income statement for Z-Mart. The statement has three main parts: (1) gross profit, determined by net sales less cost of goods sold, (2) income from operations, determined by gross profit less operating expenses, and (3) net income, determined by income from operations adjusted for nonoperating items.
Operating expenses are classified into two sections. Selling expenses include the expenses of promoting sales by displaying and advertising merchandise, making sales, and delivering goods to customers. General and administrative expenses support a company’s overall operations and include expenses related to accounting, human resource management, and financial management. Nonoperating activities consist of other expenses, revenues, losses, and gains that are unrelated to a company’s operations. Other revenues and gains commonly include interest revenue, dividend revenue, rent revenue, and gains from asset disposals. Other expenses and losses commonly include interest expense, losses from asset disposals, and casualty losses. When a company has no reportable nonoperating activities, its income from operations is simply labeled net income.

16. Single-Step Income Statement
A single-step income statement is another widely used format, and is shown on this slide for Z-Mart. It lists cost of goods sold as another expense and shows only one subtotal for total expenses. Expenses are grouped into very few, if any, categories. Many companies use formats that combine features of both the single- and multiple-step statements. Provided that income statement items are shown sensibly, management can choose the format.
As you can see, the Net Income is the same whether the multi-step or the single-step is used. The only difference is in the amount of detail that is provided on the income statement.

17. Classified Balance SheetP4
Highly Liquid
The merchandiser’s classified balance sheet reports merchandise inventory as a current asset, usually after accounts receivable according to an asset’s nearness to liquidity. Inventory is usually less liquid than accounts receivable because inventory must first be sold before cash can be
received; but it is more liquid than supplies and prepaid expenses. This slide shows the current asset section of Z-Mart’s classified balance sheet (other sections are as shown in Chapter 4).
Less Liquid

18. End of Chapter 5
End of Chapter 5.