Accounting for

Merchandising Businesses
Chapter 6
 GROUP 4

Cita Tasha Nataniela Farliza Atna Ayu S. Fitri Anggra Eni

20080694041 20080694056 20080694054

Iftah Nahdyatul F. Kamalia Nur Fauziati

20080694071 20080694100
 Learning Objective 1
• Distinguish between the activities and financial statements of service and merchandising businesses.
OBJ 1 • Nature of Merchandising Busines
 • Nature of Merchandising
1 Business

The activities of a service business differ from those of a merchandising business.

These differences are illustrated in the following condensed income statements:

Service Business
Fees earned – Operating expenses = Net Income
 • Nature of Merchandising
1 Business

Merchandising Business
• When merchandise is sold, the revenue is reported as sales, and its cost is
recognized as an expense called cost of merchandise sold.
• The cost of merchandise sold is subtracted from sales to arrive at gross
profit. It is the profit before deducting operating expenses.

Sales – Cost of merchandise sold = Gross profit

Gross Profit – Opetaring expenses = Net Income

• Merchandise on hand (not sold) at the end of an accounting period is called

merchandise inventory.
1 • Operating Cycle

Operating Cycle (1)

• The operating cycle is the process by wich a company spends cash, generates
revenues, and receives cash either at the time the revenues are generated or later
by collecting an account receivable
• The operating cycle of a service and merchandising busines differs in that a
merchandising busniness must purchase merchandise for sale to customers.
1 • Operating Cycle

Operating Cycle (2)

• The time in days to complete an operating cycle differs significantly among
meehandise businesses.

• For example, many groceries items, such as milk, must be sold wthin their
expiration dates for a week or two

• In contrst, jewelry stores often carry expensive items that are often displayed
months before being sold to customers
 Learning Objective 2
• Distinguish between the activities and financial statements of service and merchandising businesses.
• Nature of Merchandising Busines
OBJ 1

• Describe and illustrate the accounting for merchandise transactions.

• Merchandising Transactions
OBJ 2
2 • Purchase Transaction
Purchase Transaction
There are two systems for accounting for merchandise transactions : perpetual and periodic

• In a Perpetual inventory system, each purchase and sale of merchandise is reccorded in the
inventory account and related subsidiary ledger

• In this way, the amount of merchandise available for sale and the amount sold are continuosly
(perpetually) updated in inventory record

• In Periodic inventory system, Inteasd, a listing of inventory on hand, called a physical

inventory, is prepared at the end of the accounting period

• This Physical inventory is used to determine the cost of merchandise on hand at the end of the
period and the cost of merchandise sold during the period
2 • Purchase Transaction

Under the perpetual inventory system, cash purchases of merchandise

are recorded as follows:

Purchases of merchandise on account are recorded as follows:

 • Purchase Transaction
2 • Purchase Discount

Purchase Discount
A buyer may receive a discount from the seller (sales discount) for early
payment of the amount owed. From the buyer’s perspective, such
discounts are called purchases discounts.
 • Purchase Transaction
2 • Purchase Discount

Assume that NetSolutions places an order from Alpha Technologies on jauary 5 with terms
of 2/10, n /30. In order to pay the invoice on January 15, NetSolutions borrows $2,940, which
is $3,000 less the discount of $60 ($3,000 × 2%). If an annual interest rate of 6% and a 360-
day year is also assumed, the interest on the loan of $2,940 for the remaining 20 days of
the credit period is $9.80 ($2,940 × 6% × 20/360).

The net savings to NetSolutions of taking the discount is $50.20, computed as follows:

If NetSolutions does not take the discount, it pays an estimated interest rate of 36% for
using the $2,940 for the remaining 20 days of the credit period.
 • Purchase Transaction
2 • Purchase Discount

Under the perpetual inventory system, the buyer initially debits Merchandise Inventory for the
amount of the invoice. When paying the invoice within the discount period, the buyer credits
Merchandise Inventory for the amount of the discount. In this way, Merchandise Inventory shows
the net cost to the buyer

To illustrate, NetSolutions would record the Alpha Technologies invoice and its payment at the
end of the discount period as follows:

Assume that NetSolutions does not take the discount, but instead pays the invoice on February 4.
In this case, NetSolutions would record the payment as follows:
2 • Purchase Transaction

Invoice

• The terms of purchases on account are normally indicated on the invoice

or bill that the seller sends the buyer.

• The term for when payments for merchandise are tp be made are called
the Credit terms.
 Credit Terms

To encourage the buyer

to pay before the end of
the credit period, the
seller may offer a
discount. Credit terms of
2/10, n/30 are
summarized
 • Purchase Transaction
2 • Purchase Returns and Allowances

Purchase Returns and Allowance

A purchases return involves actually returning merchandise that is
damaged or does not meet the specifications of the order. From a
buyer’s perspective, such returns are called purchases returns and
allowances.
2 • Debit memo

A debit memorandum, often called a debit memo, informs the seller of the amount the buyer
proposes to debit to the account payable due the seller.
● NetSolutions receives a delivery from Maxim Systems and determines that $900 of the
items are not the merchandise ordered. Debit memorandum #18 is issued to Maxim
Systems.
Debit
memo
NetSolutions records the return of the merchandise
indicated in the debit memo :
To illustrate, assume the following data concerning a purchase of merchandise by NetSolutions on
May 2:
May 2. Purchased $5,000 of merchandise on account from Delta Data Link, terms 2/10, n/30.
4. Returned $3,000 of the merchandise purchased on May 2.
12. Paid for the purchase of May 2 less the return and discount.

NetSolutions would record these transactions as follows:

2 • Sales Transaction

Sales Transaction
Revenue from merchandise sales is usually recorded as Sales.
To illustrate, assume that on March 3, NetSolutions sells merchandise for $1,800. These cash sales
are recorded as follows:

Using the perpetual inventory system, the cost of merchandise sold and the
decrease in merchandise inventory are also recorded. In this way, the merchandise
inventory account indicates the amount of merchandise on hand (not sold).
2 • Sales Transaction

Sales may be made to customers using credit cards such as MasterCard or VISA. Such sales are
recorded as cash sales..If customers use MasterCards to pay for their purchases, the sales would be
recorded exactly as shown in the March 3 entry at the top of the page. Any processing fees charged
by the clearinghouse or issuing bank are periodically recorded as an expense. This expense is
normally reported on the income statement as an administrative expense.

To illustrate, assume that NetSolutions paid credit card processing fees of $4,150 on March 31.
These fees would be recordedas follows:
 • Sales Transaction
2 • Sales on Account

Sales on Account
A business may sell merchandise on account. The seller records such sales
as a debit to Accounts Receivable and a credit to Sales. An example of an
entry for a NetSolutions sale on account of $18,000 follows. The cost of
merchandise sold was $10,800.
 • Sales Transaction
2 • Sales Discount

Sales Discount
Sales discounts reduce sales revenue. To reduce sales revenue, the
sales account could be debited. However, managers usually want to
know the amount of the sales discounts for a period. For this
reason, sales discounts are recorded in a separate sales discounts
account, which is a contra (or offsetting) account to Sales.
 • Sales Transaction
2 • Sales Discount

To illustrate, assume that NetSolutions sold $18,000 of merchandise to Digital Technologies

on March 10 with credit terms 2/10, n/30. Under the credit terms, Digital Technologies has until
March 20 (March 10 plus 10 days) to pay within the discount period. Assume that Digital
Technologies pays the invoice on March 19. Since the invoice is paid within the discount period
(10 days), Digital Technologies would deduct $360 ($18,000 × 2%) from the invoice amount of
$18,000 and pay $17,640. NetSolutions would record the receipt of the cash as follows:
 • Sales Transaction
2 • Sales Return and Allowed

Sales Return and Allowances

Merchandise sold may be returned to the seller (sales return). From a seller’s
perspective, such returns and allowances are called sales returns and
allowances. If the return or allowance is for a sale on account, the seller
usually issues the buyer a credit memorandum, often called a credit memo.
A credit memo authorizes a credit (decrease) to the buyer’s account
receivable. A credit memo indicates the amount and reason for the credit.
 • Sales Transaction
2 • Sales Return and Allowed

Like sales discounts, sales returns and allowances reduce sales revenue. Also, returns often result in
additional shipping and handling expenses. For this reason, sales returns and allowances are recorded
in a separate sales returns and allowances account, which is a contra (or offsetting) account to Sales.
The seller debits Sales Returns and Allowances for the amount of the return or allowance. If the sale
was on account, the seller credits Accounts Receivable. Using a perpetual inventory system, the seller
must also debit (increase) Merchandise Inventory and decrease (credit) Cost of Merchandise Sold for
the cost of the returned merchandise.

A buyer may pay for merchandise and then later return it. In this case, the seller may do one of
the following:
1. Issue a credit that is applied against the buyer’s other receivables.
2. Issue a cash refund.
If the credit is applied against the buyer’s other receivables, the seller records the credit with
entries similar to those shown above. If cash is refunded, the seller debits Sales Returns and
Allowances and credits Cash.
2 • Freight

Freight
• The ownership of the merchandise may pass to the buyer when the
seller delivers the merchandise to the freight carrier.
• In this case, the terms are said to be FOB (free on board) shipping point.
• This term means that the buyer pays the freight costs from the shipping
point to the final destination.
2 • Freight

To illustrate, assume that on June 10, Net Solutions purchased merchandise as follows:
June 10. Purchased merchandise from Magna Data, $900, terms FOB shipping point. 10. Paid feight
of $50 on June 10 purchase from Magna Data.

The ownership of the merchandise may pass to the buyer when the buyer receives the
merchandise. In this case, the terms are said to be FOB (free on board) destination. This term
means that the seller pays the freight costs from the shipping point to the buyer’s final
destination.
2 • Freight
To illustrate, assume that NetSolutions sells merchandise as follows:
June 15. Sold merchandise to Kranz Company on account, $700, terms FOB destination.
The cost of the merchandise sold is $480.
15. NetSolutions pays freight of $40 on the sale of June 15.
NetSolutions records the sale, the cost of the sale, and the freight cost as follows:
2 • Summary

Summary : Recording Merchandise Inventory Transactions

Recording merchandise inventory transactions under the perpetual inventory systemhas been
described and illustrated in the preceding sections. These transactions involvedpurchases,
purchases discounts, purchases returns and allowances, freight,sales, and sales returns from
customers. Exhibit 6 summarizes how these transactions are recorded in T account form.
2 • Dual Nature

Dual Nature Merchandise

Transaction
Each merchandising transaction
affects a buyer and a seller. In
the following illustration, the
same transactions for a seller
and buyer are recorded. In this
example, the seller is Scully
Company and the buyer is
Burton Co.
2 • Dual Nature
2 • Dual Nature
 • Chart of Accounts for a
2 Merchandising Businesses

Chart of Accounts for a

Merchandising Businesses
The chart of accounts for a
merchandising business should
reflect the types of merchandise
transactions described and
illustrated earlier in this chapter. The
chart of accounts for NetSolutions is
shown in Exhibit 7. The accounts
related to merchandising
transactions are shown in color.
 • Chart of Accounts for a
2 Merchandising Businesses

Chart of accounts consists of three-digit account numbers. The first digit

indicates the major financial statement classification (1 for assets, 2 for
liabilities, and so on). The second digit indicates the subclassification (e.g., 11
for current assets, 12 for noncurrent assets, etc.). The third digit identifies
the specific account (e.g., 110 for Cash, 123 for Store Equipment, etc.). Using a
threedigit numbering system makes it easier to add new accounts as they
are needed.
 Sales Taxes and Trade Discount
Sales Taxes Almost all states levy a tax on sales of merchandise. The liability for the sales tax is
incurred when the sale is made. At the time of a cash sale, the seller collects the sales tax. When a
sale is made on account, the seller charges the tax to the buyer by debiting Accounts Receivable.
The seller credits the sales account for the amount of the sale and credits the tax to Sales Tax
Payable. For example, the seller would record a sale of $100 on account,subject to a tax of 6%, as
follows:
On a regular basis, the seller pays to the taxing authority (state) the amount of the sales
tax collected. The seller records such a payment as follows:
 Trade Discount
Wholesalers are companies that sell merchandise to other businesses rather than to
the public. Many wholesalers publish sales catalogs. Rather than updating their
catalogs, wholesalers may publish price updates. These updates may include large
discounts from the catalog list prices. In addition, wholesalers often offer special
discounts to government agencies or businesses that order large quantities. Such
discounts are called trade discounts. Sellers and buyers do not normally record the
list prices of merchandise and trade discounts in their accounts. For example, assume
that an item has a list price of $1,000 and a 40% trade discount. The seller records the
sale of the item at $600 [$1,000 less the trade discount of $400 ($1,000 × 40%)].
Likewise, the buyer records the purchase at $600.
 Learning Objective 3
• Distinguish between the activities and financial statements of service and merchandising businesses.

OBJ 1 • Nature of Merchandising Busines

• Describe and illustrate the accounting for merchandise transactions.

OBJ 2 • Merchandising Transactions

• Describe and illustrate the financial statements of a merchandising business.

• Financial Statements for a Merchandising Business
OBJ 3
Financial Statement for Merchandising Businesses
Although merchandising transactions affect the balance sheet in
reporting inventory, they primarily affect the income statement. An
income statement for a merchandising business is normally
prepared using either a multiple- step or single-step format.
 Multiple step income statement
Revenue from Sales
This section of the multiple-step income statement consists of sales, sales returns and
allowances, sales discounts, and net sales. The total amount of sales to customers for cash and on
account is reported in this section. From this total, sales returns and allowances and sales
discounts are deducted to yield net sales. Some companies only report net sales in the income
statement, and report sales, sales returns and allowances, and sales discounts in a note to the
financial statements.
 Componen of Revenue from Sales

1. Sales is the total amount charged customers for merchandise sold, including cash sales and
sales on account.
2. Sales returns and allowances are granted by the seller to customers for damaged or
defective merchandise.
3. Sales discounts are granted by the seller to customers for early payment of amounts owed.
4. Net sales is determined by subtracting sales returns and allowances and sales discounts
from sales.
 Cost of Merchandise Sold
This amount is the cost of merchandise sold to customers. Cost of merchandise
sold may also be reported as cost of goods sold or cost of sales.

The buyer may return merchandise to the seller (purchase return), or the buyer
may receive a reduction in the initial price at which the merchandise was
purchased (purchase allowance).

You have seen that sellers may offer customers sales discounts for early
payment of their bills. From the buyer’s perspective, such discounts are referred
to as purchase discounts.
 Gross Profit
The excess of net sales over cost of merchandise sold is gross profit. As shown
in Exhibit 8, NetSolutions reported gross profit of $182,950 in 2015.
Gross Profit
 Income from Operation
Income from operations, sometimes called operating income, is determined by
subtracting operating expenses from gross profit. Operating Expenses are normally
classified as either selling expenses or administrative expenses. Selling expenses are
incurred directly in the selling of merchandise. Examples of selling expenses include
sales salaries, store supplies used, depreciation of store equipment, delivery expense,
and advertising. Administrative expenses, sometimes called general expenses, are
incurred in the administration or general operations of the business. Examples of
administrative expenses include office salaries, depreciation of office equipment,
and office supplies used.
 Other Income and Expenses
Other income and expense items are not related to the primary operations of the
business. Other income is revenue from sources other than the primary operating
activity of a business. Examples of other income include income from interest, rent,
and gains resulting from the sale of fixed assets. Other expense is an Expense that
cannot be traced directly to the normal operations of the business. Examples of
other expenses include interest expense and losses from disposing of fixed assets.
Other income and other expense are offset against each other on the income
statement.
 Single Step Income Statement
The single-step form emphasizes total revenues and total expenses in
determining net income. A criticism of the single-step form is that gross profit
and income from operations are not reported.
Statement of Owner’s Equity
 Balance Sheet
The balance sheet may be presented with assets on the left-hand side and
the Liabilities and owner’s equity on the right-hand side. This form of the
balance sheet is called the account form. The balance sheet may also be
presented in a downward sequence in three sections. This form of balance
sheet is called the report form.
 Learning Objective 4
• Distinguish between the activities and financial statements of service and merchandising businesses.
OBJ 1 • Nature of Merchandising Busines

• Describe and illustrate the accounting for merchandise transactions.

OBJ 2 • Merchandising Transactions

• Describe and illustrate the financial statements of a merchandising business.

OBJ 3 • Financial Statements for a Merchandising Business

• Describe the adjusting and closing process for a merchandising business.

• The Adjusting and Closing Process
OBJ 4
 The Adjusting and Closing Process
• Thus far, the recording of transactions, chart of accounts, and financial statements for a
merchandising business (NetSolutions) have been described and illustrated.
• In the remainder of this chapter, the adjusting and closing process for a merchandising
business will be described.
• In this discussion, the focus will be on the elements of the accounting cycle that differ from
those of a service business.
 Adjusting Entry for Inventory Shrinkage
Under the perpetual inventory system, the merchandise inventory account is con-tinually
updated for purchase and sales transactions. As a result, the balance of the merchandise
inventory account is the amount of merchandise available for sale at that point in time.
Inventory. This difference is called inventory shrinkage or inventory shortage.

To illustrate, NetSolutions’ inventory records indicate the following on December

31, 2015:
Dec. 31, 2015
At the end of the accounting period, inventory shrinkage is recorded by the following adjusting
entry:
Example
PE-6A Inventory Shrinkage
Modern Furnishings Company’s perpetual inventory records indicate that $890,000 of
merchandise should be on hand on April 30, 2014. The physical inventory indicates that
$876,250 of merchandise is actually on hand. Journalize the adjusting entry for the in-
ventory shrinkage for Modern Furnishings Company for the year ended April 30, 2014.
Assume that the inventory shrinkage is a normal amount.
PE 6-6B Inventory shrinkage
Hahn Flooring Company’s perpetual inventory records indicate that $1,333,150 of merchandise
should be on hand on December 31, 2014. The physical inventory indicates that $1,309,900 of
merchandise is actually on hand. Journalize the adjusting entry for the inventory shrinkage for
Hahn Flooring Company for the year ended December 31, 2014.
Assume that the inventory shrinkage is a normal amount.
 Closing Entries
1. Debit each temporary account with a credit balance, such as Sales, for its balance and credit
Income Summary.
2. Credit each temporary account with a debit balance, such as the various expenses, and debit
Income Summary.
3. Debit Income Summary for the amount of its balance (net income) and credit the owner’s
capital account. The accounts debited and credited are reversed if there is a net loss.

4. Debit the owner’s capital account for the balance of the drawing account and credit
the drawing account.
NetSolutions’ income summary account after the closing entries have been posted is as follows:
 Learning Objective 5
• Distinguish between the activities and financial statements of service and merchandising businesses.
OBJ 1 • Nature of Merchandising Busines

• Describe and illustrate the accounting for merchandise transactions.

OBJ 2 • Merchandising Transactions

• Describe and illustrate the financial statements of a merchandising business.

OBJ 3 • Financial Statements for a Merchandising Business

• Describe the adjusting and closing process for a merchandising business.

OBJ 4 • The Adjusting and Closing Process

• Describe and illustrate the use of the ratio of net sales to assets in evaluating a company’s operating performance.
•Financial Analysis and Interpretation: Ratio of Net Sales to Assets
OBJ 5
 Financial Analysis and interpretation:
Ratio of Net Sales to Assets

• The ratio of net sales to assets measures how effectively a business is using its assets to
generate sales.
• The assets used in computing the ratio may be the total assets at the end of the year, the aver-
age of the total assets at the beginning and end of the year, or the average of the monthly
assets.
 The Periodic inventory System
• Throughout this chapter, the perpetual inventory system was used to
record pur-chases and sales of merchandise.
• Not all merchandise businesses, however, use the perpetual inventory
system.
 Cost of Merchandise Sold using the
Periodic Inventory System
In the periodic inventory system, sales are recorded in the same manner as
in the perpetual inventory system
Chart of Accounts under the Periodic Inventory System
 Recording Merchandise transactions under the Periodic
Inventory System

• Using the periodic inventory system, purchases of inventory are not recorded in
the merchandise inventory account.
• In addition, the sales of merchandise are not recorded in the inventory account.
• Purchases Purchases of inventory are recorded in a purchases account rather
than in the merchandise inventory account
• Purchases DiscountsPurchases discounts are normally recorded in a separate pur-
chases discounts account. The balance of the purchases discounts account is
reported as a deduction from Purchases for the period.
• Purchases returns and AllowancesPurchases returns and allowances are
recorded in a similar manner as purchases discounts. A separate purchases
returns and allowances account is used to record returns and allowances.
• Freight InWhen merchandise is purchased FOB shipping point, the buyer pays
for the freight.
 Adjusting Process under the Periodic Inventory System

• Under the perpetual inventory system, the ending inventory physical count is compared to the
balance of Merchandise Inventory. The difference is the amount of inventory shrinkage
• Under the periodic inventory system, the merchandise inventory account is not kept up to
date for purchases and sales.
• As a result, the inventory shrinkage cannot be directly determined.
 Financial Statements under the Periodic Inventory System

• The financial statements are similar under the perpetual and periodic
inventory systems.
• When the multiple-step format of income statement is used, the cost of
merchandise sold may be reported as shown in Exhibit 12.
 Closing Entries under the Periodic Inventory System

• The closing entries differ in the periodic inventory system in that there is no cost of
merchandise sold account to close to Income Summary.
• Instead, the purchases, purchases discounts, purchases returns and allowances, and freight in
accounts are closed to Income Summary
• The four closing entries under the periodic inventory system are as follows:
1. Debit each temporary account with a credit balance, such as Sales, for its balance and credit
Income Summary.
2. Credit each temporary account with a debit balance, such as the various expenses, and debit
Income Summary.
3. Debit Income Summary for the amount of its balance (net income) and credit the owner’s
capital account
4. Debit the owner’s capital account for the balance of the drawing account and credit the
drawing account.
 Closing Entries under the Periodic Inventory
System (2)

• The four closing entries for NetSolutions under the periodic inventory system are
shown on the next page.
• In the preceding closing entries, the periodic accounts are highlighted in color.
• Under the perpetual inventory system, the highlighted periodic inventory
accounts are replaced by the cost of merchandise sold account.
Thank You!
@Group 4