© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Accounting for Merchandising Operations Chapter 5 5.

© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin

Accounting for Merchandising Operations

Chapter

55


Learning objectiveLearning objective

1. Specialty of merchandising activities2. Accounting for merchandise purchasing3. Accounting for merchandise sales4. Completing Accounting cycle5. Financial statement format6. Decision Analysis:

• Current Ratio• Acid-test ratio• Gross margin ratio

• Case: Walmart & Target


1. Specialties of Merchandising Activities1. Specialties of Merchandising Activities

Merchandising companies Merchandising companies sell goodssell goods to earn revenue. to earn revenue.

Example: supermarketExample: supermarket

Merchandising companies Merchandising companies sell goodssell goods to earn revenue. to earn revenue.

Example: supermarketExample: supermarket

RevenuesRevenues ExpensesExpensesMinus Net

incomeNet

incomeEquals


Manufacturer Wholesaler Retailer Customer

Merchandising CompaniesMerchandising Companies

Merchandising ActivitiesMerchandising Activities


Reporting Income for a MerchandiserReporting Income for a Merchandiser

Merchandising companies sell productsproducts to earn revenue.Examples: sporting goods, clothing, and auto parts

stores

Cost ofGoods Sold

GrossProfit

ExpensesNet

IncomeNet

SalesMinus Equals Minus Equals


Operating Cycle for a MerchandiserOperating Cycle for a MerchandiserBegins with the purchase of merchandise and ends

with the collection of cash from the sale of merchandise.

Purchases

Merchandiseinventory

Credit sales

Accountreceivable

CashcollectionPurchases

Merchandiseinventory

Cashsales

Cash SaleCash SaleCash SaleCash Sale Credit SaleCredit SaleCredit SaleCredit Sale


Inventory SystemsInventory Systems

+

+

BeginninginventoryBeginninginventory

Net cost ofpurchasesNet cost ofpurchases

Merchandiseavailable for sale Merchandiseavailable for sale

Ending InventoryEnding InventoryCost of Goods

SoldCost of Goods

Sold

==


Inventory SystemsInventory Systems

Perpetual inventory system continuously updates accounting records for merchandising transactions — specifically, for those records of inventory available for sale and inventory sold.

Periodic inventory system updates the accounting records for merchandise transactions only at the end of a period. What are the disadvantages of periodic inventory system?


2. Accounting for Merchandise Purchases2. Accounting for Merchandise Purchases

Trade discounts vs. purchase discounts Purchase returns and allowances Transportation costs


Main Source, Inc. Invoice614 Tech Avenue Date NumberNashville, TN 37651 5/4/05 358-BI

Sold To

Name: Barbee, Inc. Attn: Tom Bell Address: One Willow Plaza Cookeville, Tennessee 38501

P.O. 167 Sales: 25 Terms 2/10,n/30 Ship: FedEx PrepaidItem Description Quanity Price AmountAC417 250 Backup System 500 54.00$ 27,000$

Sub Total 27,000 We appreciate your business! Ship Chg. -

Tax - Total 27,000$

Seller Invoice date Purchaser Order numberCredit terms Freight termsGoods Invoice amount

Seller Invoice date Purchaser Order numberCredit terms Freight termsGoods Invoice amount


Accounting for Merchandise PurchasesAccounting for Merchandise Purchases

On November 2, Z-Mart, purchased $1200 of Merchandise Inventory by paying cash.

On November 2, Z-Mart, purchased $1200 of Merchandise Inventory by paying cash.

Nov. 2 Merchandise Inventory . . . . . . . . . 1,200 Cash . . . . . . . . . . . . . . . . 1,200

Purchase merchandise for cash


Trade DiscountsTrade Discounts

Used by manufacturers and wholesalers to offer Used by manufacturers and wholesalers to offer better prices for greater quantities purchased.better prices for greater quantities purchased.

ExampleExampleMatrix, Inc. offers a 30% tradeMatrix, Inc. offers a 30% tradediscount on orders of 1,000discount on orders of 1,000

units or more of their popularunits or more of their popularproduct Racer. Each product Racer. Each

Racer has a list price of $5.25.Racer has a list price of $5.25.

ExampleExampleMatrix, Inc. offers a 30% tradeMatrix, Inc. offers a 30% tradediscount on orders of 1,000discount on orders of 1,000

units or more of their popularunits or more of their popularproduct Racer. Each product Racer. Each

Racer has a list price of $5.25.Racer has a list price of $5.25.


2/10,n/302/10,n/30

Purchase Discounts Credit termPurchase Discounts Credit term

Discount Percent

Discount Percent

Number of Days

Discount Is Available

Number of Days

Discount Is Available

Otherwise, Net (or All)

Is Due

Otherwise, Net (or All)

Is Due CreditPeriod

CreditPeriod


Purchase DiscountsPurchase Discounts

A deduction from the invoice price granted to induce early payment of the amount due.

A deduction from the invoice price granted to induce early payment of the amount due.

Terms

Time

Due

Discount Period

Full amountless discount

Credit Period

Full amount due

Purchase or SalePurchase or Sale



On Nov 2, Z-Mart purchased $1200 of Merchandise Inventory on account, credit

terms are 2/10, n/30.

On Nov 2, Z-Mart purchased $1200 of Merchandise Inventory on account, credit


Nov. 2 Merchandise Inventory 1,200 Accounts Payable 1,200

Purchase merchandise on account



On Nov. 12, Z-Mart paid the amount due on the purchase of Nov. 2.

On Nov. 12, Z-Mart paid the amount due on the purchase of Nov. 2.

$1,200 × 2% = $24 discount



After we post these entries, the accounts involved look like this:

After we post these entries, the accounts involved look like this:

Merchandise Inventory Accounts Payable 11/02 1,200 11/02 1,20011/12 24 11/12 1,200

Bal. 1,176 Bal. 0


Failure to Pay Within the Discount PeriodFailure to Pay Within the Discount Period

If we fail to take a 2/10, n/30 discount, is it really expensive?If we fail to take a 2/10, n/30 discount, is it really expensive?

365 days ÷ 20 days × 2% = 36.5% annual rate 365 days ÷ 20 days × 2% = 36.5% annual rate

Daysin ayear

Daysin ayear

Numberof additionaldays before

payment

Numberof additionaldays before

payment

Percentpaid to keep

money

Percentpaid to keep

money


Purchase Returns and AllowancesPurchase Returns and Allowances

Purchase Return: 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.



On Nov. 9, Z-Mart purchased $20,000 of Merchandise Inventory on account, credit


On Nov. 9, Z-Mart purchased $20,000 of Merchandise Inventory on account, credit


Nov. 9 Merchandise Inventory 20,000 Accounts Payable 20,000

Purchased merchandise on account



On Nov. 10, Z-Mart returned $500 of defective merchandise to the supplier.

On Nov. 10, Z-Mart returned $500 of defective merchandise to the supplier.

Nov 10 Accounts Payable 500 Merchandise Inventory 500

Returned defective merchandise



On Nov. 18, Z-Mart paid the amount owed for the purchase of Nov 9.

On Nov. 18, Z-Mart paid the amount owed for the purchase of Nov 9.

Nov. 18 Accounts Payable 19,500 Cash 19,110 Merchandise Inventory 390

Paid account less discount


Transportation CostsTransportation Costs

FOB shipping point(buyer pays)

FOB destination(seller pays)

Merchandise

Seller Buyer


Transportation CostsTransportation Costs

On Nov. 12, Z-Mart purchased $8,000 of Merchandise Inventory for cash and also paid

$100 transportation costs.

On Nov. 12, Z-Mart purchased $8,000 of Merchandise Inventory for cash and also paid

$100 transportation costs.

Nov. 12 Merchandise Inventory 8,100 Cash 8,100

Paid for merchandise and transportation


Quick Check Quick Check

On July 6, 2005 Seller Co. sold $7,500 of merchandise to Buyer, Co.; terms of 2/10,n/30. The

shipping terms were FOB shipping point. The shipping cost was $100. Which of the following will

be part of Buyer’s July 6 journal entry?

a. Credit Sales $7,500b. Credit Purchase Discounts $150c. Debit Merchandise Inventory $100d. Debit Accounts Payable $7,450

On July 6, 2005 Seller Co. sold $7,500 of merchandise to Buyer, Co.; terms of 2/10,n/30. The

shipping terms were FOB shipping point. The shipping cost was $100. Which of the following will

be part of Buyer’s July 6 journal entry?

a. Credit Sales $7,500b. Credit Purchase Discounts $150c. Debit Merchandise Inventory $100d. Debit Accounts Payable $7,450

FOB shipping point indicates the buyer ultimately pays the freight. This is recorded with

a debit to Merchandise Inventory.


Itemized Cost of Merchandise PurchasedItemized Cost of Merchandise Purchased

Invoice cost of merchandise purchases 235,800$ Less: Purchase discounts (4,200) Purchase returns and allowances (1,500) Add: Cost of transportation-in 2,300 Total cost of merchandise purchases 232,400$

Z-Mart.Total Cost of Merchandise Purchases

For Year Ended Dec 31, 2005Invoice cost of merchandise purchases 235,800$ Less: Purchase discounts (4,200) Purchase returns and allowances (1,500) Add: Cost of transportation-in 2,300 Total cost of merchandise purchases 232,400$

Z-Mart.Total Cost of Merchandise Purchases

For Year Ended Dec 31, 2005


3. Accounting for Merchandise Sales3. Accounting for Merchandise Sales

Sales of merchandise Sales discounts Sales returns and allowances


Accounting for Merchandise SalesAccounting for Merchandise Sales

Sales discounts and returns and allowances are Contra Revenue accounts.Sales discounts and returns and allowances are Contra Revenue accounts.


Sales of MerchandiseSales of MerchandiseOn Nov. 3, Z-Mart sold $2,400 of merchandise on

credit. The merchandise was carried in inventory at a cost of $1,600.

On Nov. 3, Z-Mart sold $2,400 of merchandise on credit. The merchandise was carried in inventory

at a cost of $1,600.

Nov. 3 Accounts Receivable 2,400 Sales 2,400

Sales of merchandise on credit

Cost of Goods Sold 1,600 Merchandise Inventory 1,600

To record cost of sales


Sales DiscountsSales Discounts

On Nov. 12, Z-Mart sold merchandise costing On Nov. 12, Z-Mart sold merchandise costing $600 for $1,000 on account. Credit terms were $600 for $1,000 on account. Credit terms were

2/10, n/60. Let’s prepare the journal entries.2/10, n/60. Let’s prepare the journal entries.

On Nov. 12, Z-Mart sold merchandise costing On Nov. 12, Z-Mart sold merchandise costing $600 for $1,000 on account. Credit terms were $600 for $1,000 on account. Credit terms were

2/10, n/60. Let’s prepare the journal entries.2/10, n/60. Let’s prepare the journal entries.

Nov. 12 Accounts Receivable 1,000 Sales 1,000


Cost of Goods Sold 600 Merchandise Inventory 600



Sales DiscountsSales Discounts

On Nov. 22, Z-Mart received a check for $980 in full payment of the Nov. 12 sale.

On Nov. 22, Z-Mart received a check for $980 in full payment of the Nov. 12 sale.

Nov.22 Cash 980 Sales Discount 20

Accounts Receivable 1,000 Received payment less discount

Contra Revenue Account


Sales Returns and AllowancesSales Returns and Allowances

On Nov. 3, Z-Mart sold merchandise costing $4,000 for $7,500 on account The credit

terms were 2/10, n/30.

On Nov. 3, Z-Mart sold merchandise costing $4,000 for $7,500 on account The credit

terms were 2/10, n/30.

Nov.3 Accounts Receivable 7,500 Sales 7,500


Cost of Goods Sold 4,000 Merchandise Inventory 4,000



Sales Returns and AllowancesSales Returns and Allowances

On Nov. 6, customer returns merchandises with a sales price of $800 and a cost of $600. The

return is related to the Nov. 3 sale.

On Nov. 6, customer returns merchandises with a sales price of $800 and a cost of $600. The

return is related to the Nov. 3 sale.

Nov. 6 Sales Returns and Allowances 800 Accounts Receivable 800

Customer returned merchandise

Merchandise Inventory 600 Cost of Goods Sold 600

Returned goods placed in inventory


Sales Returns and AllowancesSales Returns and AllowancesAssume that $800 of merchandise Z-Mart sold on Nov.

3 is defective but the buyer decides to keep it because Z-Mart offers a $100 price reduction.

Assume that $800 of merchandise Z-Mart sold on Nov. 3 is defective but the buyer decides to keep it because Z-Mart offers a $100 price reduction.

Nov. 6 Sales Returns and Allowances 100 Accounts Receivable 100

To record sales allowance on Nov. 3 sale.


4. Completing accounting cycle4. Completing accounting cycle

Prepare adjustments and close accounts for a merchandising company.


ShrinkageShrinkage

Compare a physical count of inventory with recorded amounts.

Z-Mart’s Merchandise Inventory account at the end of year 2005 has a balance of $21,250, but a physical count reveals that only $21,000 of inventory exists. The adjusting entry is:

12/31/2005 Dr. Cost of goods sold 250

Cr. Merchandise inventory 250

To adjust for $250 shrinkage.


Let’s complete the accounting cycle by preparing theclosing entriesclosing entries for

Z-Mart.

Completing the accounting cycleCompleting the accounting cycle


Step 1:Step 1: Close Credit Balances in Temporary Accounts to Income Summary.Step 1:Step 1: Close Credit Balances in Temporary Accounts to Income Summary.

Dec. 31 Sales . . . . . . . . . . . . . . . . . . . . 321,000 Income summary . . . . . . 321,000

To close credit balance in temporary accounts


Step 2:Step 2: Close Debit Balances in Temporary Accounts to Income Summary.Step 2:Step 2: Close Debit Balances in Temporary Accounts to Income Summary.

Dec. 31 Income Summary 308,100

Sales Discounts 4,300

Sales Returns and Allowances 2,000

Cost of Goods Sold 230,400

Depreciation Expense-Store Eq 3,000

Depreciation Expense-Office Eq 700

Office Salaries Expense 25,300

Sales Salaries Expense 18,500

Insurance Expense 600

Rent Expense - Office Space 900

Rent Expense - Selling Space 8,100

Office Supplies Expense 1,800

Store Supplies Expense 1,200

Advertising Expense 11,300

To close debit balances in temporary accounts



Step 3:Step 3: Close Income Summary to Owner’s CapitalStep 3:Step 3: Close Income Summary to Owner’s Capital

Dec. 31 Income Summary 12,900 K. Mart, Capital 12,900

To close Income Summary account


Step 4:Step 4: Close Withdrawals Account to Owner’s Capital.Step 4:Step 4: Close Withdrawals Account to Owner’s Capital.

Dec. 31 K Mart, Capital 4,000 K Mart, Withdrawals 4,000

To close the withdrawals account


5. Financial statement format5. Financial statement format

Define and prepare multiple-step and single-step income statements.


Income Statement FormatsIncome Statement Formats

Multiple-StepMultiple-Step

Single-StepSingle-Step

Multiple-StepMultiple-Step

Single-StepSingle-Step


Multiple-Step Income Statement

Multiple-Step Income Statement


Operating expensesOperating expenses

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, HR management, and financial management.


Single-Step Income StatementSingle-Step Income Statement


Multiple-Step vs. Single-Step Income statementMultiple-Step vs. Single-Step Income statementMultiple-Step vs. Single-Step Income statementMultiple-Step vs. Single-Step Income statement

A multiple-step income statement format shows detailed computations of net sales and other costs and expenses, and report subtotals for various classes of items. Gross profit Income from operations Net income

A single-step income statement lists revenues and expenses with very few categories.


Classified Balance SheetClassified Balance Sheet

Cash 10,200$ Accounts payable 1,200$ Merchandise Inventory 1,200 Notes payable 4,000 Equipment 16,000 Total liabilities 5,200$

Equity 22,200 Total assets 27,400$ Total liabilities and equity 27,400$

Assets Liabilities

Merchandising CompanyBalance Sheet

December 31, 2005

Cash 10,200$ Accounts payable 1,200$ Merchandise Inventory 1,200 Notes payable 4,000 Equipment 16,000 Total liabilities 5,200$

Equity 22,200 Total assets 27,400$ Total liabilities and equity 27,400$

Assets Liabilities

Merchandising CompanyBalance Sheet

December 31, 2005


6. Decision Analysis - Current Ratio & Acid-Test Ratio6. Decision Analysis - Current Ratio & Acid-Test Ratio

Helps assess the company’s ability to pay its debts in the near futureLiquidity measure


6. Decision Analysis - Acid-Test Ratio6. Decision Analysis - Acid-Test Ratio

A common rule of thumb is the acid-test ratio should have a value of at least 1.0 to conclude a company is unlikely to

face liquidity problems in the near future.

A common rule of thumb is the acid-test ratio should have a value of at least 1.0 to conclude a company is unlikely to

face liquidity problems in the near future.

= Quick AssetsQuick Assets Current LiabilitiesCurrent Liabilities

Acid-TestAcid-TestRatioRatio

Acid-TestAcid-TestRatioRatio ==

Cash + S-T Investments + Receivables Cash + S-T Investments + Receivables Current LiabilitiesCurrent Liabilities


6. Decision Analysis - Gross Margin Ratio6. Decision Analysis - Gross Margin Ratio

Percentage of dollar sales available to cover expenses and provide a profit.

GrossMarginRatio

Net Sales - Cost of Goods Sold

Net Sales

=

Indicate the company’s pricing capability of its products


6. Decision Analysis - Supermarket6. Decision Analysis - Supermarket

1. Industry Characteristics High volume, Low profit margin Chain of stores

2. Key success factors Inventory control Store location decision

3. Companies for analysis Walmart Target


6. Walmat & Target - Current Ratio6. Walmat & Target - Current Ratio

CR 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995

WMT 0.90 0.90 0.90 0.90 1.00 0.90 0.90 1.20 1.30 1.70 1.50

Target 1.50 1.69 1.55 1.59 1.37 1.16

Current Ratio

0.80

0.90

1.00

1.10

1.20

1.30

1.40

1.50

1.60

1.70

1.80

1994 1996 1998 2000 2002 2004 2006

Year

Cu

rre

nt

Ra

tio

WMT Target


6. Walmat & Target - Acid-test Ratio6. Walmat & Target - Acid-test Ratio

ATR 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995

WMT 0.19 0.17 0.17 0.13 0.15 0.13

Target 0.76 0.89 0.78 0.84 0.61 0.36

Acid-test Ratio

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

1.00

1994 1996 1998 2000 2002 2004 2006

Year

Ac

id-t

es

t R

ati

o

WMT Target


6. Walmat & Target - Gross Profit Margin6. Walmat & Target - Gross Profit Margin

GPM 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995

WMT 23.06% 22.94% 22.46% 22.35% 22.02% 22.16% 22.03% 21.48% 21.29% 20.81% 20.85%

Target 33.62% 32.87% 32.45% 21.79% 17.80% 15.22% 31.67% 31.23% 31.08%

Gross Profit M argin

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

40.00%

1994 1996 1998 2000 2002 2004 2006

Year

Gro

ss

Pro

fit

Ma

rgin

WMT Target


6. Walmat & Target - Profit Margin6. Walmat & Target - Profit Margin

Profit Margin

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

4.00%

4.50%

5.00%

1994 1996 1998 2000 2002 2004 2006

Year

Pro

fit

Ma

rgin

WMT Target

PM 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995

WMT 3.59% 3.60% 3.53% 3.46% 3.23% 3.45% 3.41% 3.37% 3.13% 3.05% 3.07%

Target 4.58% 4.02% 3.85% 3.68% 3.33% 3.23% 3.39% 3.05% 2.73%

Industry 3.50% 3.37% 3.71%

© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin Accounting for Merchandising Operations Chapter 5 5.

Documents

mcgrawhill companies

mcgrawhillirwin accounting

sale of merchandise

merchandise sales

inventory cost of goods

purchase of merchandise

merchandise transactions

records of inventory