Chapter Three

Accounting for
Merchandising Business
(Haron Abraham-PhD)
 INTRODUCTION
 Merchandising enterprise are
companies that buy goods in
finished form for resale.
Merchandising enterprises
acquire merchandise for resale
to customers. It is the selling
of merchandise, instead of a
service, that makes the
activities of merchandising
CONT..

Service Company
Income Statement
For the Year Ended December 31,
xxx
 Revenues…………………………………..
………………..xxxx
 Less:
Expenses………………………………….
………. (xxx)
 Net Income (Net Loss)
CONT..
Merchandising Company
Income Statement
For the Year Ended December 31, xxx
 Revenues……………………………………………………..xxx
x
 Less: Cost of Goods Sold…………………….……… (xxx)
 Gross Profit…………………..…………………………….. xxx
 Less: Expenses………………………………..………….
(xxx)
 Net Income (Net Loss)……………………..………….. xxx
CONT..
The income statement of a
merchandising company has three
main divisions:
 Sales revenues - result from the

sale of goods by the company;

 Cost of goods sold - indicates how

much the goods that were sold

cost the company;
 Expenses- are the company`s
expenses in running the business
 ACCOUNTING FOR PURCHASES (RECORDING PURCHASES
OF MERCHANDISE)

 When merchandise is purchased for

resale to customers, the temporary
account, merchandise purchases, or
simply purchases, is debited for the cost
of the goods. However, not all purchases
are debited to purchases. Purchases of
assets acquired for use and not for
resale, such as supplies, equipment and
similar items, should be debited to
specific asset accounts rather than to
purchases.
CONT..
 Purchases of merchandise are
usually identified in the ledger as
purchases. A more exact account
title, such as “purchases of
merchandise”, could be used.
Thus, a merchandising enterprise
can accumulate in the purchases
account the cost of all
merchandise purchased for resale
during the accounting period.
CONT..
 Purchases may be made for cash
or on account (credit).

When purchases are made for cash,

the transaction could be recorded
as follows:
Purchases
xxx
Cash
xxx
CONT..

Most purchases of merchandise are

made on account and could be
recorded as follows:
Purchases
xxx
Accounts Payable
xxx
 PURCHASE DISCOUNTS

 Merchandise is often purchased under

credit terms that permit the buyer to
deduct a stated discount if the invoice is
paid within a specified period of time.
 Purchase discounts- are discounts taken
by the buyer for early payment of an
invoice.
 Credit terms- are the arrangements
agreed upon by the buyer and the seller
as to when payments for merchandise
are to be made.
CONT..

Cash discount terms are often

stated as follows:
 2/10, n/30 - means a discount of

2% of the gross invoice price of the

merchandise may be deducted if
payment is made within 10 days
following the invoice date (date of
sale). The gross invoice price is
due 30 days from the invoice date.
CONT..
 A purchase discount is based on the invoice
cost less returns and allowances, if any.
Purchase discounts are credited for
discounts that are taken.
 Purchase discounts represent a reduction
in the cost of goods purchased for resale.
Purchase discounts are a contra
(offsetting) account to purchases. Its
normal balance is a credit. Purchase
discounts are reported in the income
statement as a deduction from purchases.
 PURCHASE RETURNS AND ALLOWANCES

 Purchase returns occur when a

buyer returns merchandise to
a seller. When a buyer receives
an allowance (or reduction in
the price of goods shipped), a
purchase allowance results.
The purchaser initiates the
request for a reduction of the
balance due through the
issuance of a debit
 A DEBIT MEMORANDUM
 A convenient medium for informing the
seller (creditor) of the amount the buyer
proposes to debit to the accounts
payable account , or
 A document issued by the buyer to
inform a seller that a debit has been
made to the seller`s account. It also
states the reasons for the return or
request for a price reduction.
 The original copy of the memorandum is
sent to the seller and one copy is
retained by the purchaser.
 CONT..

The entry to record the return of

merchandise identified in the debit
memorandum would be:
Accounts Payable
xxx
Purchase returns and
allowances xxx
CONT..
When both purchase discounts and purchase
returns and allowances are deducted from
purchases, the result is called net
purchases.
Gross purchases
xxx
Less: Purchase discount xx
Purchase returns and allowances xx
(xx)
Net purchases
xx
 ACCOUNTING FOR SALES (RECORDING
SALES OF MERCHANDISE)

 Merchandise sales are usually

identified in the ledger as sales. A
more exact title, such as “sales of
merchandise”, could be used. The
sales account is credited only for
sales of goods held for resale. Sales
of assets not held for resale, such
as equipment or land, are credited
directly to the asset account.
CONT..
 Sales may be made on credit or
for cash. Every sales
transaction should be
supported by a business
document that provides
written evidence of the sale.
CONT..

When a sale is for cash, the entry

would be:
Cash xxx
Sales xxx
When a sale is on account (credit),
the entry would be:
Accounts Receivable xxx
Sales
xxx
RECORDING DEDUCTIONS FROM GROSS SALES

Two common deductions from gross

sales are:
 Sales discounts and

 Sales returns and allowances

These deductions are recorded in

contra accounts to the sales
account. Contra accounts have
normal balances that are opposite
the balance of the account they
reduce.
 SALES DISCOUNTS

 The terms of a credit sale may

include an offer of a cash
discount, called a sales
discount, to the customer for
prompt payment of the balance
due. This incentive offers
advantages to both parties:
the purchaser saves money,
and the seller is able to
 SALES RETURNS AND ALLOWANCES

 A customer may be dissatisfied with the

merchandise received because the goods are
damaged or defective, of inferior quality, or
not in accord with the customer`s
specifications. In such cases, the customer
may return the goods to the seller for credit if
the sale was made on credit, or for cash
refund if the sale was originally for cash. This
transaction is known as a sales return.
Alternatively, the customer may choose to
keep the merchandise if the seller is willing to
grant an allowance (deduction) from the
selling price. This transaction is known as a
sales allowance.
CONT..
The seller`s entry to record a credit
memorandum involves:
Sales Returns and Allowances xxx
Accounts Receivable
xxx
For a sales return or allowance on a cash sale, a
cash refund is normally made. In such case,
Sales Returns and Allowances
xxx
Cash
xxx
 CONT…
 Because sales returns and allowances are viewed
as reductions of the amount initially recorded in
sales, the sales returns and allowances account
is a contra (or offsetting) account to sales. The
normal balance of sales returns and allowances
is a debit. A contra account is used, instead of
debiting sales, to disclose the amount of sales
returns and allowances in the accounts and in
the income statement. Disclosure of this
information is important to management:
Excessive returns and allowances suggest
inferior merchandise, inefficiencies in filling
orders, errors in billing customers, and mistakes
in delivery or shipment of the goods.
 TRADE DISCOUNTS

 In some industries it is customary

to bill customers a gross price
subject to one or more trade
discounts. The gross price usually
is the suggested price for resale,
and the trade discount represents
the difference between gross
(list) price and the price to the
purchaser before cash discounts.
 TRANSPORTATION COSTS (FREIGHT COSTS)
The terms of the agreement between buyer and
seller include provisions concerning:
When the ownership (title) of the merchandise
passes to the buyer? and
Which party is to bear the cost of delivering the
merchandise to the buyer’s place of business?
Shipping terms (freight terms) are expressed as
either:
1. FOB shipping point
2. FOB destination
If the ownership passes to the buyer when the
seller delivers the merchandise to the shipper,
the buyer is to absorb the transportation costs
and the terms are said to be FOB shipping point.
FOB SHIPPING POINT (FREE ON BOARD AT SHIPPING POINT)

 FOB shipping point means that the seller

places the merchandise “free on board”
at the shipping point and the buyer is
responsible for the transportation costs
beyond that point. In other words, FOB
shipping point means the buyer incurs all
transportation costs after the
merchandise is loaded on a railroad car or
truck at the point of shipment. Thus, the
buyer is responsible for paying the freight
charges.
FOB DESTINATION (FREE ON BOARD AT DESTINATION)

 FOB destination means goods are

shipped to their destination
without charge to the buyer. Thus,
the seller is responsible for paying
the freight charges. In other
words, FOB destination means that
the seller places the merchandise
“free on board” to its destination
by paying the delivery costs.
 FOB FOB
Shipping Destinatio
Point n
Ownership Delivered Delivered
(title) to shipper to buyer
passes to
the buyer
when
merchandi
se is…
Transporta Buyer Seller
tion costs
are borne
by…
 INCOME STATEMENT

Two forms of the income statement

are widely used by merchandising
companies: these income
statements are:
1. Multiple-step income statement
2. Single-step income statement
 MULTIPLE-STEP INCOME STATEMENT

 The multiple-step income

statement is so named
because- it shows the
numerous steps in determining
net income (or net loss)-of its
many sections, sub-sections,
and intermediate balances.
CONT..
The various sections of a multiple-step
income statement are:
1. Revenue from Sale
 The total of all charges to customers

for merchandise sold, both for cash

and on account, is reported in this
section
 Sales returns and allowances and sales

discounts are deducted from the gross

amount to yield net sales
Net Sales = Gross Sales – Sales Discount
– Sales Returns and Allowances
CONT.
2. Cost of merchandise sold
 Other descriptive terms frequently employed

are cost of goods sold and cost of sales.

 Is the total cost of merchandise sold during

the period
 CGS = BI + Cost of Merchandise Purchased –

EI
 Cost of Merchandise Purchased = Net

Purchase + Freight-In
Net Purchase = Gross Purchase – Purchase
Discounts – Purchase Returns and Allowances
CONT..
3. Gross profit
 The excess of the net revenue from sales

over the cost of merchandise sold is called

gross profit, gross profit on sales, or gross
margin. It is called gross because operating
expenses must be deducted from it.
4. Operating expenses
 Operating expenses can be subdivided into

two categories:
 Selling expense

 Administrative (General) expense

 SINGLE-STEP INCOME STATEMENT

 The statement is so named because only

one step, subtracting total expenses from
total revenues, is required in determining
net income (or net loss). In a single-step
statement, all data are classified under
two categories:
 Revenues- which includes both operating
revenues and other revenues and gains, or
 Expenses- which include cost of goods
sold, operating expenses and other
expenses and losses.
CONT..
 The single-step form has the
advantages of being simple
and it emphases total
revenues and total expenses
as the factors that determine
net income. An objection to the
single-step form is that such
relationships as gross profit to
sales and income from
operations to sales are not as
 CLOSING ENTRIES

 The closing entries are recorded in

the journal immediately following
the adjusting entries. All of the
temporary owner`s equity
accounts are cleared of their
balances, reducing them to zero.
The final effect of closing out such
balances is a net increase or a net
decrease in the retained earnings
account.
CONT..
Four entries are required in order to close the
temporary accounts:
1. The first entry closes all income statement
accounts with credit balances by transferring
the total to the credit side of Income
Summary.
Sales xx
Purchases returns and allowances xx
Purchase discounts xx
Income Summary
xxx
CONT..
2.The second entry closes all income statement
accounts with debit balances by transferring the
total to the debit side of the Income Summary.
Income Summary xxx
Sales returns and allowances
xx
Sales discounts
xx
Transportation-in
xx
Selling expenses
xx
Administrative expenses
xx
CONT
3. The third entry closes Income Summary by
transferring its balance, the net income for
the year, to Retained Earnings. (Debit and
credit are reversed if there a net loss).
Income Summary xx
Retained Earnings
xx
4. The fourth entry closes Dividends by
transferring its balance to Retained Earnings.
Retained Earnings xx
Dividends
xx