College Accounting Notes - Chapter 5

Chapter Five                                                                      Page 176

                  Accounting for Merchandising Operations


Objective: To have students demonstrate their knowledge in recording transactions for a merchandising business.  They will record inventory, make adjustments to inventory, use returns and allowances for sales and purchases. They will use both the periodic and perpetual inventory systems and also close out the temporary accounts.  After recording all information they will prepare the F/S which include the Multi-step Income Statement. Finally, they will compute the Gross Margin Ratio to asses profitability.


Topics to be covered:


Accounting for Merchandising Operations


-   Merchandising Activities

o   Reporting Income, Expenses, & Inventory

o   Operating Cycles

o   Cost Flows

o   Inventory Systems – Perpetual vs. Periodic


-   Merchandising Sales and Purchases

o   Net Sales – Sales, Sales Discounts, & Sales Returns and Allowances

o   Purchases – Inventory, Purchase Discounts, Purchases Returns and Allowances, Transportation in costs

o   Gross Profit

o   Closing J/E’s


-   Accounting Cycle

o   Adjusting J/E’s

o   Financial Statements

o   Closing Process


-   Financial Statement Format

o   Single – Step I/S

o   Multi – Step I/S

o   Classified B/S


Merchandising Activities





There are two types of inventory reporting:

Perpetual – Ongoing inventory that is updated constantly at the time of sale (UPC codes)

-   All adjustments to inventory go to the inventory account (asset) on the B/S


Periodic – Updates and adjusts inventory at the end of a period. 

-   Auditors use this method to check inventory at the end of the period (annual)

-   This is a physical count method

-   Can be used to verify perpetual inventory

-   Uses Expense Accounts: (Located in the COGS section)

o   Purchases

o   Purchase Returns & Allowances (Contra COGS Exp Account. cr bal.)

o   Purchase Discounts(Contra COGS Exp Account cr. bal.)

o   Transportation-in

o   Gets you to Net Purchases    


Service companies would report as follows:

                       Revenue less Operating Expenses = Net Income


Merchandising companies would report as follows: (using Periodic System)

                        Sales less Sales Discounts Less Sales Returns & Allowances = Net Sales

                        Net Sales Less COGS = Gross Profit

                        Gross Profit Less Sales Expenses Less General & Administrative expenses

                                    (G & A exp.) = Net Income

                        (Sales discounts and Sales returns and allowances are Contra Revenue Accounts that would have a natural debit balance)

New Income Statement levels include:

                                    Net Sales

                                    COGS (also a new account)

                                    Gross Profit

                                    Total Sales Expense

                                    Total G & A Expense

                                    Total Operating Expenses


New Balance Sheet Accounts:

                                    Merchandise Inventory


Merchandising terms:

-These terms are used in both systems, however they are recorded differently.


List Price – MFG suggested retail price


Trade Discount – Gets list price to intended sale price. Percent off of list. This happens at time of purchase.


Purchase Discounts – Discounts given to inventory purchases made on account or for credit that will be paid later. This is recorded at time of payment.

                        Ie; 2/10,n/30 – two percent discount given if you pay the bill within ten days, otherwise all is due in 30 days.  EOM = end of month.

These are recorded directly into inventory as a reduction to inventory at the time of payment under the perpetual system.


Purchase Returns and Allowances – Return is for a full refund and merchandise is returned to seller and put back into inventory.  Allowance is the reduction in price but the merchandise stays with the buyer. These are generated by a Debit Memo from the buyer to the seller. This is a reduction to inventory under the perpetual system.


Transportation Costs – The point of transfer of ownership.  The term used is “Free on Board” or FOB.  There are two types:

                        FOB – Shipping Point – The buyer pays the freight charge from warehouse

                        FOB – Destination – The seller pays the freight from the warehouse

Always recorded at time of payment and would go to inventory as an increase or debit under the perpetual system, it would go to the I/S Freight acct under periodic.


Shrinkage – The loss or reduction in inventory.  It is found by auditing the inventory. This has no revenue offset. The J/E is:

                        Dr. COGS (I/S)

                                    Cr. Inventory (B/S)


Sales Terms:

-These terms are recorded the same way in both systems.


Sale of Merchandise – This is recorded at the final agreed price at the time of title transfer. It is recorded at gross value. When a sale is made a COGS entry is required to move the cost of the goods sold out of inventory.  The entries are as follows:

                        Dr. A/R (B/S)

                                    Cr. Sales  (I/S)

                        Dr. COGS (I/S)

                                    Cr. Merchandise Inventory (B/S)



Sales Discounts – This is recorded at the time of receipt of the total payment. When a sale is made the terms are agreed upon and taken in the form of 2/10, n/30. This is a contra revenue account that will have a debit balance in the revenue section. This will reduce sales. The degree of discount is dependent upon suppliers and demand. The entry to record it is:

                        Dr. Cash

                        Dr. Sales Discount

                                    Cr. A/R (for the whole gross amount)






Sales Returns and Allowances – Sales returns are when a product is returned in full and put back into inventory.  An allowance is when a price adjustment happens after the goods have been delivered and the buyer keeps the merchandise. This is a contra revenue account with a debit balance in the revenue section. It reduces sales at the time of the seller issuing a credit memo.

            For a Sales Return:                                     For an Allowance:

Dr. Sales Return and Allowances                        Dr. Sales Return and Allowances

                                    Cr. A/R                                               Cr. A/R

            Dr. Inventory

                                    Cr. COGS


Sales Expense – any cost incurred in making a sales or delivering the product.


General and Administrative Expense – Department costs that support the operations of a company.  The are: Accounting, Legal, H/R, MIS, ect.



Closing Entries for a manufacturing concern

  1. Group the like revenue and expense accounts into debit and credit balances
  2. Close sales to income summary
  3. Close debit balance accounts to income summary that would include COGS, Sales Adjustments, and Expenses.
  4. Close Income Summary to Capital
  5. Close Withdrawal to Capital



Reversing Entries

-   These are J/E made in the current period that will auto matically reverse itsel in the next period:

Period 1               Dr Advertising Exp.              Cr A/R

Period 2               Dr. A/R                                   Cr. Advertising Exp.

                        (the period 2 J/E will automatically happen)

(page 190 reviews the journal entries)


Financial Statements

There are two types of Income Statements:

-   Single Step – shows only subtotals with expenses grouped together

o   This is a top level report  without a lot of detail

-Multi Step – shows net sales components, COGS, Gross Profit, and separates expenses into Sales and General and Administrative.



Gross Margin Ratio

-Shows the profit on each dollar before operating expenses

                                    Net Sales – COGS

                                                Net Sales



                        Demo Problem pg 194-196

  Quick Study, Exercises, and Problems


1. Do QS:       5-1 – Recording purchases – Perpetual system pg 206

                        5-9 – Recording purchases – Periodic system (use 5-1) pg 207


            Ex. 5-1 – Record J/E’s for merchandise for buyer and seller  pg 207

            Ex. 5-2 – Buyer and seller transactions  pg 207

            Ex. 5-6 -  Buyer and seller transactions pg 208



2. Do QS:       5-2 – Recording sales – Perpetual system pg 206

                        5-10 – Recording sales – Periodic system (use 5-2)pg 207


            Ex. 5-4 – Sales Returns & Allowances pg 207-208

            Ex. 5-5 – Purchase Returns & Allowances (use 5-4) pg 208



3. Do Ex:        5-8 – Compute Revenue, Expense, & N/I pg 208


            QS. 5-3 – Gross Margin Calc.  pg 206

           Ex. 5-13 – Perpetual Inventory J/E’s pg 209



4. Do QS:     5-4 – Shrinkage J/E’s pg 206

          5-5 – Closing J/E pg 206


Prob.:  5-1  J/E’s for merchandising activities pg 210    



5. Do Problem 5-4 Merchandising amounts and Multi-step I/S pg 212 





Problem 5-2 J/E’s for Merchandising activities pg 210-211

                5-3 Adjusting J/E’s & I/S pg 211