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Chapter 5 Merchandising Operations
© 2016 Pearson Education, Ltd.

© 2016 Pearson Education, Ltd.
Learning Objectives Describe merchandising operations and the two types of merchandise inventory systems Account for the purchase of merchandise inventory using a perpetual inventory system Account for the sale of merchandise inventory using a perpetual inventory system © 2016 Pearson Education, Ltd.

Learning Objectives Adjust and close the accounts of a merchandising business Prepare a merchandiser’s financial statements Use the gross profit percentage to evaluate business performance Account for the purchase and sale of merchandise inventory using a periodic inventory system (Appendix 5A) © 2016 Pearson Education, Ltd.

What Are Merchandising Operations?
A merchandiser is a business that sells merchandise, or goods, to customers. The merchandise that this type of business sells is called merchandise inventory. A wholesaler buys goods from a manufacturer and sells them to retailers. A retailer buys merchandise from manufacturers or a wholesaler and then sells the goods to consumers. A merchandiser is a business that sells merchandise, or goods, to customers. The merchandise that a business sells to customers is called merchandise inventory. Merchandisers are often identified as either wholesalers or retailers. A wholesaler is a type of merchandiser that buys goods from manufacturers and then sells them to retailers. A retailer is a type of merchandiser that buys merchandise either from a manufacturer or a wholesaler and then sells those goods to consumers. © 2016 Pearson Education, Ltd.

The Operating Cycle of a Merchandising Business
The operating cycle begins when the company purchases inventory from a vendor. The company then sells the inventory to customers. The company collects cash from customers. The operating cycle has three main steps: A company purchases inventory from a vendor, the company sells the inventory to a customer, and the company collects cash from customers. A vendor is an individual or a business from whom a company purchases goods. © 2016 Pearson Education, Ltd.

The operating cycle of a merchandiser is presented in Exhibit 5-1. The merchandising process begins when the company purchases inventory from an individual or business, called a vendor. Then the company sells the inventory to a customer. Finally, the company collects cash from customers. © 2016 Pearson Education, Ltd.

The income statement of a merchandiser reports: Sales Revenue rather than Service Revenue The cost of merchandise sold to customers, called Cost of Goods Sold (COGS) Gross profit, which is net Sales Revenue minus Cost of Goods Sold Operating expenses, which are expenses other than Cost of Goods Sold Because the operating cycle of a merchandiser is different from that of a service company, the financial statements differ. On the income statement, a merchandising company reports revenues using an account called Sales Revenue rather than the account Service Revenue. A merchandiser also reports the cost of merchandise inventory that has been sold to customers, or Cost of Goods Sold (COGS). The Cost of Goods Sold is the cost of merchandise inventory that the business has sold to customers. Because COGS is usually a merchandiser’s main expense, an intermediary calculation, gross profit, is determined before calculating net income. Gross profit is the excess of net Sales Revenue over Cost of Goods Sold. After calculating gross profit, expenses are then deducted to determine net income. Operating expenses are expenses, other than Cost of Goods Sold, that are incurred in the entity’s major ongoing operations. © 2016 Pearson Education, Ltd.

Exhibit 5-2 shows how a service entity’s income statement (on the left) differ from a merchandiser’s income statement (on the right). As you can see, merchandisers have some new income statement items. © 2016 Pearson Education, Ltd.

Exhibit 5-2 compares the balance sheet of a service company to a merchandiser. On the balance sheet, a merchandiser includes Merchandise Inventory in the current assets section representing the value of inventory that the business has on hand to sell to customers. Merchandise Inventory is a current asset since it is expected to be sold within the operating cycle. © 2016 Pearson Education, Ltd.

Merchandise Inventory Systems: Perpetual and Periodic Inventory Systems Businesses need to determine the value of merchandise inventory on hand and the value sold. The two inventory accounting systems: A periodic inventory system requires a physical count of inventory to determine inventory on hand. A perpetual inventory system offers continuous computerized record of merchandise inventory. There are two main types of inventory accounting systems used to determine the value of inventory on hand. A periodic inventory system is an inventory system that requires businesses to obtain a physical count of inventory to determine quantities on hand. The system is normally used for relatively inexpensive goods, such as in a small, local store without optical-scanning cash registers that do not keep a running record of every loaf of bread and every key chain that it sells. The perpetual inventory system keeps a running computerized record of merchandise inventory – that is, the number of inventory units and the dollar amounts associated with the inventory are perpetually (constantly) updated. A perpetual inventory system keeps a running computerized record of merchandise inventory. © 2016 Pearson Education, Ltd.

How Are Purchases of Merchandise Inventory Recorded in a Perpetual Inventory System? A merchandising entity begins with the purchase of merchandise inventory. The vendor ships the product to the merchandiser. The seller sends the buyer an invoice that requests payment. The buyer pays the vendor after the merchandise inventory is received. The cycle of a merchandising entity begins with the purchase of merchandise inventory. Continuing with the fictitious company, Smart Touch Learning, which has now decided to discontinue its service business and instead has plans to sell touch screen tablet computers. Smart Touch Learning will purchase these tablets from a vendor. The vendor ships the tablet computers to Smart Touch Learning and sends an invoice the same day. The invoice is the seller’s request for payment from the buyer. An invoice is also called a bill. © 2016 Pearson Education, Ltd.

Exhibit 5-3 is the bill that Smart Touch Learning receives from Southwest Electronics Direct. It shows that Smart Touch Learning acquired $35,000 of inventory on June 1, For Southwest Electronics Direct, the seller, the invoice is called a sales invoice. For Smart Touch Learning, the purchaser, the invoice is called a purchase invoice. © 2016 Pearson Education, Ltd.

Purchase of Merchandise Inventory
Assume that Smart Touch Learning receives the goods on June 3 and makes a payment on that date. Suppose Smart Touch Learning receives the goods on June 3, 2017, and makes payment on that date. Smart Touch Learning will record the purchase by debiting Merchandise Inventory and crediting Cash. The Merchandise Inventory account, an asset, is used only for goods purchased that the business owns and intends to resell to customers. Office Supplies, Equipment, and other assets are recorded in their own accounts. © 2016 Pearson Education, Ltd.

Purchase of Merchandise Inventory
Now assume that on June 3, instead of paying cash, Smart Touch Learning receives the merchandise inventory on account. If the transaction is on account, then Smart Touch Learning will record a debit to Merchandise Inventory and a credit to Accounts Payable for $35,000. © 2016 Pearson Education, Ltd.

Purchase Discounts Many businesses offer a discount for early payment, called a purchase discount. Credit terms are the payment terms of the purchase as stated on the invoice. Credit terms express the following: The discount. The discount time period. The final due date. Many businesses offer purchasers a discount for early payment. This is called a purchase discount from the purchaser’s perspective. Southwest Electronic Direct’s credit terms of “3/15, NET 30 DAYS” means that Smart Touch Learning can deduct 3% from the total bill if the company pays within 15 days of the invoice date. A purchase discount is a discount that businesses offer to purchasers as an incentive for early payment. Credit terms are the payment terms of purchase or sale as stated on the invoice. © 2016 Pearson Education, Ltd.

Purchase Discounts If Smart Touch Learning pays on June 15, which is within the discount period, the cash payment entry would be: If Smart Touch Learning pays on June 15, 2017, which is within the discount period, the cash payment entry would include a debit to Accounts Payable for $35,000, a credit to Merchandise Inventory for the discount of $1,050 ($35,000 x .03) and a credit to Cash for $33,950 ($35,000 – $1,050). Inventory is credited for the amount of the discount in order to follow the cost principle, which stated all assets have to be recorded at the amount paid for them. In this example, we paid $33,950 for the merchandise, so that is the amount that must be recorded in the Merchandise Inventory account. When making payment within a discount period, always debit Accounts Payable for the full amount of the invoice; otherwise there will be a balance remaining in the payable account even though the invoice has been paid in full. © 2016 Pearson Education, Ltd.

Purchase Returns and Allowances
Sellers allow purchasers to return merchandise that is defective, damaged, or unsuitable. Purchase returns exist when sellers allow purchasers to return merchandise. Purchase allowances are granted to purchasers as an incentive to keep goods that are not as ordered. Sellers allow purchasers to return merchandise that is defective, damaged, or otherwise unsuitable. This is called a purchase return from a purchaser’s perspective. A purchase returns is a situation in which sellers allow purchasers to return merchandise that is defective, damaged, or otherwise unsuitable. A purchase allowance is an amount granted to the purchaser as an incentive to keep goods that are not “as ordered.” Together, purchase returns and allowances decrease the buyer’s cost of the merchandise inventory. © 2016 Pearson Education, Ltd.

Purchase Returns and Allowances
Assume Smart Touch Learning returns $7,000 of the June 3 purchase on June 4. Assume that Smart Touch Learning has not yet paid the original bill of June 1. Suppose 20 of the tablets purchased on that invoice were damaged in shipment. On June 4, Smart Touch Learning returns the goods valued at $7,000 to the vendor and records the purchase return. © 2016 Pearson Education, Ltd.

Transportation Costs While goods are in transit, rules are necessary to determine who bears the risk of loss. Either the buyer or the seller must pay the transportation costs of shipping merchandise inventory. The purchase agreement specifies FOB (free on board) terms to determine when title to the goods transfers to the purchaser and who pays the freight. Exhibit 5-4 shows the differences between FOB shipping points and FOB destination. FOB shipping point is a situation in which the buyer takes ownership (title) of the goods after the goods leave the seller’s place of business (shipping point), and the buyer typically pays the freight. FOB destination is a situation in which the buyer takes ownership (title) of the goods at the delivery destination point, and the seller typically pays the freight. When merchandisers are required to pay for shipping costs, those costs are classified as either freight in or freight out. © 2016 Pearson Education, Ltd.

Freight In With FOB shipping point, the freight cost is paid by the buyer and is part of the inventory cost. Assume Smart Touch Learning pays a $60 freight charge on the June 3 purchase. Assume Smart Touch Learning pays a $60 freight charge related to the June 3 purchase. Smart Touch Learning should record a debit to Merchandise Inventory and a credit to Cash. Freight in is transportation cost to ship goods into the purchaser’s warehouse; therefore, it is freight on purchased goods. Freight out is the transportation cost to ship goods out of the seller’s warehouse; therefore, it is freight on goods sold to a customer. © 2016 Pearson Education, Ltd.

Freight In Within Discount Period
If Smart Touch Learning pays within the 15-day period, it gets a 3% discount. Discounts are computed only on the merchandise purchased from the seller. Discounts are not computed on the transportation costs because there is no discount on freight. Under FOB shipping point, the seller sometimes prepays the transportation cost as a convenience and lists this cost on the invoice. If Smart Touch Learning pays within the discount period, the discount will be computed only on the merchandise cost, not the total invoice amount. © 2016 Pearson Education, Ltd.

Cost of Inventory Purchased
Knowing the net cost of inventory allows a business to determine the actual cost of the merchandise purchased. Net cost of inventory is calculated as follows: The net cost of merchandise inventory purchased includes the purchase cost of inventory, less purchase returns and allowances, less purchase discounts, plus freight in. Knowing the net cost of inventory allows a business to determine the actual cost of the merchandise purchased. The calculation of net cost of inventory purchased is determined as follows: Purchase cost of inventory ‒ Purchase returns and allowances ‒ Purchase discounts + Freight in = Net cost of inventory purchased © 2016 Pearson Education, Ltd.

How Are Sales of Merchandise Inventory Recorded in a Perpetual Inventory System? The amount a business earns from selling merchandise inventory is called Sales Revenue. Two entries are required to record sale transactions: The first entry records Sales Revenue and Cash or Accounts Receivable. The second entry records Cost of Goods Sold and Merchandise Inventory. After a company buys merchandise inventory, the next step is to sell the goods. The amount a business earns from selling merchandise inventory is called Sales Revenue. At the time of sale, two entries must be recorded in the perpetual inventory system. One entry records the Sales Revenue and the Cash (or Accounts Receivable) at the time of sale. The second entry records Cost of Goods Sold (debit the expense) and reduces the Merchandise Inventory (credit the asset). © 2016 Pearson Education, Ltd.

Sale of Merchandise Inventory
Exhibit 5-5 shows the invoice Smart Touch Learning issued to a customer for the purchase of two tablets. A sales invoice is an agreement between buyer and seller. To the seller, a sales invoice is a bill that shows what amount the customer must pay. © 2016 Pearson Education, Ltd.

Smart Touch Learning sold 2 tablets for $1,000 cash. The cost of those tablets was $700. To record the sale by Smart Touch Learning, two journal entries must be recorded. The first journal entry records the sale transaction. A second journal entry must also be made to record the expense and decrease the Merchandise Inventory balance. The first journal entry records the cash sale of $1,000 by debiting Cash and crediting Sales Revenue. The second journal entry would transfer the $700 from the Merchandise Inventory account to the Cost of Goods Sold account. © 2016 Pearson Education, Ltd.

Smart Touch Learning sold 10 tablets for $500 each on account with terms of 2/10, n/30 on June 21. The goods cost $3,500. Smart Touch Learning sold 10 tablets for $500 each, making a $5,000 (10 tablets × $500 per tablet) sale on account with terms 2/10, n/30 on June 21. The goods cost $3,500. Again, two entries are recorded for the transaction. First, we record a debit to Accounts Receivable for $5,000 and a corresponding credit to Sales Revenue for $5,000. Second, we record a reduction to the Merchandise Inventory account of $3,500 ($350 x 10), along with a corresponding debit to Cost of Goods Sold. © 2016 Pearson Education, Ltd.

Sales Discounts A sales discount reduces the amount of cash received from a customer for early payment. Sales Discounts is a contra account to Sales Revenue. Assume the customer that purchased the tablets on June 21 made payment on June 30, within the discount period. Many sellers offer customers a discount for early payment. A sales discount is a reduction in the amount of cash received from a customer for early payment. Sales Discounts is a contra revenue account and has a normal debit balance. Assume the customer that purchased the tablets on June 21 made payment on June 30, within the discount period. Smart Touch Learning will collect $4, the $5,000 amount owed less the 2 percent discount, $100 ($5,000 x 0.02). Smart Touch Learning records a debit to Cash of $4,900, a debit to Sales Discounts for $100, and a credit to Accounts Receivable for $5,000. © 2016 Pearson Education, Ltd.

Sales Returns and Allowances
The return of goods by a customer or the granting of an allowance is called sales returns and allowances. Sales Returns and Allowances is a contra account to Sales Revenue and has a normal debit balance. After making a sale, Smart Touch Learning may have a customer that returns goods, asking for a refund or credit to the customer’s account. Or the company may instead grant a sales allowance to encourage the customer to accept the nonstandard goods. Such an allowance reduces future cash collected from the customer. Sales returns and allowances decrease the seller’s receivable from a customer’s return of merchandise or from granting the customer an allowance from the amount owed to the seller. © 2016 Pearson Education, Ltd.

Sales Return On June 25, a customer returns 3 tablets that were sold for $1,500, with a cost of goods sold of $1,050. Assume that the customer has not yet paid the original bill of June 21. Suppose, on June 25, the customer returns three of the tablets that were sold for $1,500, with a cost of goods sold of $1,050. When recording a return of merchandise, the seller must record two journal entries: one to record the sales return and decrease the receivable and the other to update the Merchandise Inventory account for the cost of the returned merchandise. The first entry will show the reduction in Accounts Receivable with a corresponding entry in Sales Returns and Allowances. The second entry will show the Merchandise Inventory increase to reflect the returned goods, but the Cost of Goods Sold must be decreased because the goods are no longer considered sold. © 2016 Pearson Education, Ltd.

Sales Allowance On June 28, Smart Touch Learning grants a $100 sales allowance for goods damaged in transit. When a seller grants a sales allowance, there are no returned goods from the customer. Therefore, there is no second entry to adjust the Merchandise Inventory account. Suppose that on June 28 Smart Touch Learning grants a $100 sales allowance for goods damaged in transit. The journal entry includes a debit to Sales Returns and Allowances and a credit to Accounts Receivable. © 2016 Pearson Education, Ltd.

Sales Returns and Allowances Within Discount Period
The discount is calculated net of the allowances and returns. On June 30, Smart Touch Learning receives payment on the receivable. If sales returns and allowances occur before the discount period has expired, any discount allowed would be calculated net of the returns and allowances. © 2016 Pearson Education, Ltd.

Transportation Costs—Freight Out
Smart Touch Learning paid $30 to ship goods to a customer on June 21. Remember: Freight out is a selling expense. Remember that a freight out expense is one in which the seller pays freight charge to ship goods to customers. Freight out is a delivery expense to the seller. Delivery expense is an operating expense and is debited to the Delivery Expense account. For example, assume Smart Touch Learning paid $30 to ship goods to a customer on June 21. The entry includes a debit to Delivery Expense and a credit to Cash. © 2016 Pearson Education, Ltd.

Net Sales Revenue and Gross Profit
Net Sales Revenue is the amount a company has earned on sales of merchandise after returns, allowances, and discounts have been taken out. Net Sales Revenue is determined using the following formula: Net Sales Revenue is calculated as Sales Revenue less Sales Returns and Allowances and Sales Discounts. Net Sales Revenue is the amount a company has earned on sales of merchandise inventory after returns, allowances, and discounts have been taken out. © 2016 Pearson Education, Ltd.

For the year, Smart Touch Learning sells $297,500 of merchandise inventory, receives $11,200 of sales returns and allowances, and accepts $5,600 of early payment discounts. Smart Touch Learning sells $297,500 of merchandise inventory, receives $11,200 of sales returns and allowances, and accepts $5,600 of early payment discounts. As such, Smart Touch Learning’s net sales revenue is $280,700. © 2016 Pearson Education, Ltd.

Gross profit is a measure of a business’s success. After determining net sales revenue, Smart Touch Learning can then calculate its gross profit. Gross profit is the markup on the merchandise inventory and is calculated as net sales minus cost of goods sold. Gross profit, along with net income, is a measure of a business’s success. A sufficiently high gross profit is vital to a merchandiser. The gross profit is reported on the merchandiser's income statement and is the sum of the gross profits on all merchandise sold. The gross profit must cover the company’s operating expenses for the company to survive. It indicates the amount available to cover operating expenses. © 2016 Pearson Education, Ltd.

What Are the Adjusting and Closing Entries for a Merchandiser?
Actual inventory on hand may differ from what the books show. Inventory shrinkage is loss of inventory occurring from theft, damage, and errors. An adjustment is made to Merchandise Inventory based on the physical count of goods on hand. A merchandiser adjusts and closes accounts the same way a service entity does. The Merchandise Inventory account should stay current at all times in a perpetual inventory system. However, actual inventory on hand may differ from what the books show. This can occur because of theft, damage, and errors and is referred to as inventory shrinkage. Inventory shrinkage is the loss of inventory that occurs because of theft, damage, or errors. For this reason, businesses take a physical count of inventory at least once a year. The most common time to count inventory is at the end of the fiscal year. The business then adjusts the Merchandise Inventory account based on the physical count. © 2016 Pearson Education, Ltd.

Adjusting Merchandise Inventory Based on a Physical Count
Smart Touch Learning’s Merchandise Inventory account shows an unadjusted balance of $31,530. But on December 31, the inventory on hand is $31,290. The entry to record the $240 difference is: The Merchandise Inventory account should stay current at all times in a perpetual inventory system. However, the actual amount of inventory on hand may differ from what the books show. An adjusting entry is required to adjust the Merchandise Inventory account to equal the physical count. Smart Touch Learning’s Merchandise Inventory account shows an unadjusted balance of $31,530. With no shrinkage – due to theft or error – the business should have inventory costing $31,530. But on December 31, Smart Touch Learning counts the inventory on hand, and the total cost comes to only $31,290. The entry to record the $240 ($31,530 - $31,290) difference includes a debit to Cost of Goods Sold and a credit to Merchandise Inventory. This entry brings Merchandise Inventory to its correct balance of $31,290. © 2016 Pearson Education, Ltd.

Closing the Accounts of a Merchandiser
Exhibit 5-6 presents Smart Touch Learning’s adjusted trial balance and closing entries for the year, which are similar to those you have already learned, except for the new accounts (highlighted in blue). Closing still means to zero out all temporary accounts. The new accounts introduced in this chapter are Merchandise Inventory, Sales Revenue, Sales Returns and Allowances, Sales Discounts, Cost of Goods Sold, and Delivery Expense. Merchandise Inventory is a permanent account. The income statement accounts are temporary accounts and closed at the end of the period.

Closing the Accounts of a Merchandiser
Close revenues via the Income Summary. Close expenses and contra revenues via the Income Summary. Close Income Summary via Owner, Capital. Close Owner, Withdrawals via Owner, Capital. The four-step closing process for a merchandising company includes making the revenue and expense accounts equal to zero via the Income Summary, zeroing out the Owner, Capital account, and zeroing out the Owner, Withdrawal account. © 2016 Pearson Education, Ltd.

How Are a Merchandiser’s Financial Statements Prepared?
There are two formats for income statement: The single-step income statement presents revenues and expenses with no subtotals. The multi-step income statement presents revenues and expenses with subtotals to highlight significant relationships. The income statement can appear in two formats: the single-step format and the multi-step format. The single-step income statement is the income statement format that groups all revenues together and all expenses together without calculating subtotals. A multi-step income statement lists several important subtotals. In addition to net income (the bottom line), it also reports subtotals for gross profit and operating income. © 2016 Pearson Education, Ltd.

Single-Step Income Statement
Exhibit 5-7 shows a single-step income statement for Smart Touch Learning. The single-step format clearly distinguishes revenues from expenses and works well for service entities because they have no gross profit to report. © 2016 Pearson Education, Ltd.

Multi-Step Income Statement
Exhibit 5-8 shows the multi-step income statement for Smart Touch Learning. In addition to net income (the bottom line), it also reports subtotals for gross profit and operating income (also called income from operations). The income statement begins with net sales revenue, cost of goods sold, and gross profit. Next, the operating expenses, those expenses other than the cost of goods sold, are listed. © 2016 Pearson Education, Ltd.

Operating expenses are reported in two categories: Selling expenses are related to marketing and selling the company’s goods and services. Administrative expenses include expenses not related to marketing the company’s goods and services. Gross profit minus operating expenses equals operating income. Companies report operating expenses in two categories: selling expenses and administrative expenses. Selling expenses are expenses related to marketing and selling the company’s goods and services. Administrative expenses include expenses not related to marketing the company’s goods and services. Gross profit minus operating expenses equals operating income. Operating income measures the results of the entity’s major ongoing activities (normal operations). © 2016 Pearson Education, Ltd.

After determining operating income, the next section of the income statement reports other revenues and expenses. Examples include: Interest Revenue. Interest Expense. Gains and losses on the sale of plant assets. The last section of the income statement is other revenues and expenses. Other revenues and expenses are revenues or expenses that are outside the normal, day-to-day operations of a business, such as a gain or loss on the sale of plant assets or interest expense. © 2016 Pearson Education, Ltd.

Statement of Owner’s Equity and the Balance Sheet
The statements of owner’s equity for merchandisers and service businesses are similar. The balance sheet for a merchandiser reports Merchandise Inventory. A merchandiser’s statement of owner’s equity looks exactly like that of a service business. The balance sheet will also look the same as for a service business, except merchandisers have an additional current asset, Merchandise Inventory. Service businesses do not have merchandise inventory. © 2016 Pearson Education, Ltd.

How Do We Use the Gross Profit Percentage to Evaluate Business Performance? The gross profit percentage measures the profitability of each sales dollar above the cost of goods sold and is calculated as Gross profit / net sales revenue. The gross profit percentage is one of the most carefully watched measures of profitability. The gross profit earned on merchandise inventory must be high enough to cover the remaining operating expenses and to earn net income. A small increase in the gross profit percentage from last year to this year may signal an important rise in income. Conversely, a small decrease from last year to this year may signal trouble. In general, a high gross profit percentage is desired. The gross profit percentage measures the profitability of each sales dollar above the cost of goods sold. A high gross profit percentage is desired. © 2016 Pearson Education, Ltd.

How Are Merchandise Inventory Transactions Recorded in a Periodic Inventory System? Perpetual inventory systems are too expensive for smaller businesses. Periodic inventory systems require physical counts of inventory to determine quantities on hand. Merchandise Inventory is updated at the end of the period, during the closing process. Some smaller businesses find it too expensive to invest in a perpetual inventory system. These businesses use a periodic inventory system. In a periodic inventory system, businesses must obtain a physical count of inventory to determine quantities on hand. In a periodic inventory system, purchases, purchase discounts, purchase returns and allowances, and freight in costs are recorded in separate accounts during the year and then the Merchandise Inventory account is updated in the closing process. © 2016 Pearson Education, Ltd.

Purchases of Merchandise Inventory
The entry to record the receipt of goods on account on June 3 and payment on June 15 using the periodic inventory system is as follows: In this invoice example, Smart Touch Learning is being billed for the purchase of 100 touch screen tablet computers, at an amount of $350 each. The invoice has sales terms stated as 3/15, NET 30 DAYS. In a periodic system, Smart Touch Learning will still credit Accounts Payable. However, the debit will go to an account called Purchases (an expense account). Likewise, when Smart Touch Learning makes payment for the merchandise, the purchase discount is recorded in a separate account called Purchase Discounts (a contra expense account). At the end of the period, the Purchases and the Purchase Discount accounts will be closed via the Income Summary. © 2016 Pearson Education, Ltd.

Recording Purchase Returns and Allowances
Prior to payment, on June 4, Smart Touch Learning returned 20 tablets, costing $7,000, to the vendor. When we return goods to the seller, we reduce Accounts Payable. In addition, we record the amount of the return or allowance in a contra expense account called Purchase Returns and Allowances. This account will be closed via the Income Summary at the end of the period. © 2016 Pearson Education, Ltd.

Recording Purchase Returns and Allowances
A business records the cost of all inventory bought in the Purchases account. Net Purchases is the sum of Purchases less Purchase Returns and Allowances and Purchase Discounts. In the periodic inventory system, instead of recording the return to Merchandise Inventory, a separate account, Purchase Returns and Allowances, is used. Both Purchase Discounts and Purchase Returns and Allowances are contra expense accounts. The balance of Purchases is a gross amount because it does not include subtractions for discounts, returns, or allowances. Net purchases are Purchases less Purchase Returns and Allowances less Purchase Discounts. © 2016 Pearson Education, Ltd.

Recording Transportation Costs
On June 3, Smart Touch Learning paid a freight charge. Under the periodic inventory system, freight in is debited to a separate Freight In account (an expense account) as opposed to debiting the Merchandise Inventory account. Smart Touch Learning debits Freight In and credits Cash for $60 to record the freight charge. © 2016 Pearson Education, Ltd.

No running record of merchandise inventory is maintained. There is no need to record an entry to Merchandise Inventory and Cost of Goods Sold. Accounting for sales discount and sales return and allowances is the same as under the perpetual inventory system. Recording sales of merchandise inventory is streamlined in the periodic inventory system. With no running record of merchandise inventory to maintain, there is no need to record an entry to Merchandise Inventory and Cost of Goods Sold. Instead, a sale of inventory involves recording only the Sales Revenue portion. © 2016 Pearson Education, Ltd.

Adjusting and Closing Entries
No adjustment is required for inventory shrinkage. Temporary accounts are closed via the Income Summary: Purchase Returns and Allowances Purchase Discounts Purchases Freight In When using the periodic inventory system, there is no need to record an adjusting entry for inventory shrinkage. This is because there is no perpetual running balance of the Merchandise Inventory account. Instead, the business determines the ending Merchandise Inventory amount by taking a physical count of inventory. © 2016 Pearson Education, Ltd.

Smart Touch Learning’s adjusted trial balance and closing entries for the year under the periodic inventory system is shown in Exhibit 5A-1. The accounts that are used in the periodic inventory system are highlighted in blue.

The four-step closing process under the periodic inventory system is similar to the perpetual inventory system. Using the periodic inventory system, Sales Revenue is still closed with a debit via the Income Summary account, but in addition, all other temporary accounts with credit balances (Purchase Returns and Allowances and Purchase Discounts) are also closed. The ending Merchandise Inventory (determined from the physical count) is recorded as a debit. Expense accounts and other temporary accounts with debit balances are still closed via the Income Summary account. In addition, the beginning Merchandise Inventory, Purchases, and Freight In are also closed via the Income Summary account.

Preparing Financial Statements
The financial statements under the perpetual and periodic inventory systems are similar. However, the periodic inventory system requires an additional calculation: the cost of goods sold. The multi-step income statement for Smart Touch Learning is presented in Exhibit 5A-2.

Comparing Perpetual & Periodic Journal Entries
Exhibit 5A-3 provides a side-by-side comparison of periodic and perpetual inventory system journal entries for the same company’s transactions. © 2016 Pearson Education, Ltd.

P5-32A Journalizing purchase and sale transactions Learning Objectives 1, 2, 3 Nov. 14 Merch. Inv. $40 Journalize the following transactions that occurred in November 2016 for May’s Adventure Park. No explanations are needed. Identify each accounts payable and accounts receivable with the vendor or customer name. © 2016 Pearson Education, Ltd.

P5-33A Preparing a multi-step income statement, journalizing closing entries, and preparing a post-closing trial balance The adjusted trial balance of Big Rita’s Music Company at June 30, 2016, follows: © 2016 Pearson Education, Ltd.

Requirements Prepare Big Rita’s multi-step income statement for the year ended June 30, 2016. Journalize Big Rita’s closing entries. Prepare a post-closing trial balance as of June 30, 2016. P5-34A Journalizing adjusting entries, preparing adjusted trial balance, and preparing financial statements The unadjusted trial balance for Travis Electronics Company at March 31, 2016, follows: © 2016 Pearson Education, Ltd.

Requirements Journalize the adjusting entries using the following data: Interest revenue accrued, $450. Salaries (Selling) accrued, $2,500. Depreciation expense—Equipment (Administrative), $1,330. Interest expense accrued, $1,100. A physical count of inventory was completed. The ending Merchandise Inventory should have a balance of $44,600. Prepare Travis Electronics’s adjusted trial balance as of March 31, 2016. Prepare Travis Electronics’s multi-step income statement for year ended March 31, 2016. Prepare Travis Electronics’s statement of owner’s equity for year ended March 31, Assume Travis made no additional contributions during the year. Prepare Travis Electronics’s classified balance sheet in report form as of March 31, 2016. © 2016 Pearson Education, Ltd.

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