Financial Accounting

John J. Wild
Sixth Edition
McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 04

Reporting and Analyzing

Merchandising Operations
 Conceptual Learning Objectives
C1: Describe merchandising activities and
identify income components for a
merchandising company.
C2: Identify and explain the inventory asset
and cost flows of a merchandising
company.

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 Analytical Learning Objectives
A1: Compute the acid-test ratio and
explain its use to assess liquidity.
A2: Compute the gross margin ratio and
explain its use to assess profitability.

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 Procedural Learning Objectives
P1: Analyze and record transactions for
merchandise purchases using a perpetual
system.
P2: Analyze and record transactions for
merchandise sales using a perpetual system.
P3: Prepare adjustments and close accounts for a
merchandising company.
P4: Define and prepare multiple-step and
single-step income statements.
P5: Appendix 4A – Record and compare
merchandising transactions using both
periodic and perpetual inventory systems (see
text for details).
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C1

Merchandising Activities

Service organizations sell time to

earn revenue.
Examples: Accounting firms, law firms,
and plumbing services

Minus Equals Net

Revenues Expenses
income

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C1
Merchandising Activities

Merchandising Companies

Manufacturer Wholesaler Retailer Customer

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C1 Reporting Income for a
Merchandiser
Merchandising companies sell products to earn revenue.
Examples: sporting goods, clothing, and auto parts stores

Net Minus Equals Minus

Cost of Gross Equals Net
sales Expenses
goods sold profit income

Merchandising Company
Income Statement
For Year Ended December 31, 2011

Net sales $ 150,000

Cost of goods sold 80,000
Gross profit $ 70,000
Operating expenses 46,500
Net income $ 23,500
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C2 Operating Cycle for a
Merchandiser
Begins with the purchase of merchandise and ends with
the collection of cash from the sale of merchandise.

Cash Sale Credit Sale

Cash
Purchases collection Purchases

Merchandise
Cash Accounts
inventory
sales receivable

Merchandise
inventory Credit sales
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C3
Inventory Systems

Beginning
inventory + Net
purchases

= Merchandise
available for sale

Ending inventory + Cost of goods

sold
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P1

Merchandise Purchases

On June 20, Jason, Inc. purchased $14,000 of

Merchandise Inventory paying cash.

Dr. Cr.
Jun. 20 Merchandise Inventory 14,000
Cash 14,000
Purchase merchandise for cash

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P1

Trade Discounts

Used by manufacturers and wholesalers

to offer better prices for greater
quantities purchased.

Example
Matrix, Inc. offers a 30% trade Quantity sold 1,000
discount on orders of 1,000 Price per unit $ 5.25
units or more of their popular Total 5,250
product Racer. Each Less 30% discount (1,575)
Racer has a list price of $5.25. Invoice price $ 3,675

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P1 Vendor’s Invoice for
Purchase of Merchandise
Invoice Seller
Invoice date
Main Source, Inc. Invoice Purchaser
614 Tech Avenue Date Number
Nashville, TN 37651 5/4/12 358-BI Order number
S
o
Credit terms
Name: Barbee, Inc.
l
d Attn: Tom Bell Freight terms
Address: One Willow Plaza
T Cookeville, Tennessee Goods
o 38501
Invoice amount
P.O. 167 Sales: 25 Terms 2/10,n/30 Ship: FedEx Prepaid
Item Description Quanity Price Amount
AC417 250 Backup System 500 $ 54.00 $ 27,000

Sub Total 27,000

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

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 P1

Purchase Discounts

A deduction from the invoice price granted to induce

early payment of the amount due.

Discount Period Credit

Terms Period

Time
Due: Invoice Due: Full Invoice
Due price minus Price
discount

Date of
Invoice 4-0
P1
Purchase Discounts

2/10,n/30
Number of
Days Otherwise,
Discount Discount Is Net (or All) Credit
Percent Available Is Due in Period
30 Days
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P1
Purchase Discounts

On May 7, Jason, Inc. purchased $27,000 of

merchandise inventory on account, credit
terms are 2/10, n/30.

Dr. Cr.
Merchandise Inventory 27,000
Accounts Payable 27,000
Purchase merchandise on account

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P1
Purchase Discounts

On May 15, Jason, Inc. paid the amount due

on the purchase of May 7.

Dr. Cr.
May 15 Accounts Payable 27,000
Cash 26,460
Merchandise Inventory* 540
Pai d accounts payabl e i n ful l

*$27,000 × 2% = $540 discount

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P1
Purchase Discounts

After we post these entries, the

accounts involved look like this:

Merchandise Inventory Accounts Payable

5/7 5/15 5/15 5/7
27,000 540 27,000 27,000
Bal. Bal.
26,460 0

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P1

When Discount Is Not Taken

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

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

Days Number Percent

in a of additional paid to
year days before keep
payment money

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P1

Purchase Returns and Allowances

Purchase returns . . .
refer to merchandise a buyer acquires but then
returns to the seller.
Purchase allowance . . .
is a reduction in the cost of defective or
unacceptable merchandise that a buyer
acquires.

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P1

Purchase Returns and Allowances

On May 9, Matrix, Inc. purchased $20,000

of merchandise inventory on account,
credit terms are 2/10, n/30.

May 9 Merchandise Inventory 20,000

Accounts Payable 20,000
Purchase merchandise on account

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P1

Purchase Returns and Allowances

On May 10, Matrix, Inc. returned $500 of

defective merchandise to the supplier.

Dr. Cr.
May 10 Accounts Payable 500
Merchandise Inventory 500
Returned defective merchandise

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P1

Purchase Returns and Allowances

On May 18, Matrix, Inc. paid the amount
owed for the purchase of May 9.
Dr. Cr.
May 18 Accounts Payable 19,500
Cash 19,110
Merchandise Inventory 390
Pa i d a ccount i n ful l

Purchase $ 20,000
Returns (500)
Amount Due 19,500
Discount (390)
Cash Paid $ 19,110
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P1
Transportation Costs
Buye
Selle
r
r

FOB
FOB shipping Merchandise destination
point (seller pays)
(buyer pays)
Ownership transfers
to buyer when goods Transportation
Terms are passed to costs paid by
FOB shipping point Carrier Buyer
FOB destination Buyer Seller
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P1

Transportation Costs

On May 12, Jason, Inc. purchased $8,000 of

merchandise inventory for cash and also
paid $100 transportation costs.
Dr.Dr. Cr.
May 12 Merchandise Inventory 8,100
Cash 8,100
Paid for merchandise and transportation

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P1
Quick Check

On July 6, 2011, Seller Co. sold $7,500 of merchandise to

Buyer, Co. on account; 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 $7,500
b. Credit Purchase Discounts $150
c. Debit Merchandise Inventory $7,600
d. Debit Accounts Payable $7,450

FOB shipping point indicates the buyer ultimately

pays the freight. This is recorded with
a debit to Merchandise Inventory.

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P1

Cost of Merchandise Purchased

MATRIX, INC.
Itemized Cost of Merchandise Purchases
For Year Ended May 31, 2011
Invoice cost of merchandise purchases $ 692,500
Less:
Purchase discounts (10,388)
Purchase returns and allowances (4,275)
Add:
Cost of transportation-in 4,895
Total cost of merchandise purchases $ 682,732

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P2

Accounting for Merchandise Sales

MATRIX, INC.
Computation of Gross Profit
For Year Ended May 31, 2011

Sales $ 2,451,000
Less:
Sales discounts $ 29,412
Sales returns and allowances 18,500 47,912
Net sales $ 2,403,088
Cost of goods sold (1,928,600)
Gross profit $ 474,488

Sales discounts and returns and allowances are contra revenue accounts.
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P2

Sales of Merchandise

On March 18, Diamond Store sold $25,000 of

merchandise on account. The merchandise was carried
in inventory at a cost of $18,000.

Dr. Cr.
Mar. 18 Accounts Receivable 25,000
Sales 25,000
Sa l es of mercha ndi se on credi t

Cost of Goods Sold 18,000

Merchandise Inventory 18,000
To record cost of sa l es

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P2

Sales Discounts

On June 8, Barton Co. sold merchandise costing $3,500

for $6,000 on account. Credit terms were 2/10, n/30. Let’s
prepare the journal entries.

Dr. Cr.
Jun. 8 Accounts Receivable 6,000
Sales 6,000
Sales of merchandise on credit

Cost of Goods Sold 3,500

Merchandise Inventory 3,500
To record cost of sales
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P2

Sales Discounts

On June 17, Barton Co. received a check for $5,880

in full payment of the June 8 sale.

Jun 17 Cash 5,880

Sales Discounts 120
Accounts Receivable 6,000
Received payment less discount

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P2

Sales Returns and Allowances

On June 12, Barton Co. sold merchandise

costing $4,000 for $7,500 on account. The
credit terms were 2/10, n/30.

Dr. Cr.
Jun. 12 Accounts Receivable 7,500
Sales 7,500
Sales of merchandise on credit

Cost of Goods Sold 4,000

Merchandise Inventory 4,000
To record cost of sales

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P2

Sales Returns and Allowances

On June 14, merchandise with a sales price of $800 and a

cost of $470 was returned to Barton. The return is related
to the June 12 sale.

Dr. Cr.
Jun. 14 Sales Returns and Allowances 800
Accounts Receivable 800
Customer returned merchandise

Merchandise Inventory 470

Cost of Goods Sold 470
Returned goods placed in inventory

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P2

Sales Returns and Allowances

On June 20, Barton received the amount owed to it from

the sale of June 12.
Dr. Cr.
Jun. 20 Cash 6,566
Sales Discount 134
Accounts Receivable 6,700
Recei ved pa yment l ess di scount

Sale $ 7,500
Return (800)
Amount due $ 6,700
Discount (134)
Cash received $ 6,566
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P3 Completing the
Accounting Cycle
BARTON COMPANY
Adjusted Trial Balance
December 31, 2011

Cash $ 7,700
Accounts receivable 11,200 Next, let’s complete
Merchandise inventory
Supplies
14,300
1,300
the accounting cycle
Equipment 41,200 by preparing the
Accum. depr.- Equip. $ 7,000
Accounts payable 16,400 closing entries for
Salaries payable
Common Stock
1,000
42,400
Barton Company.
Retained Earnings
Dividends 4,000
Sales 323,800
Sales discounts 4,300
Sales returns 2,000
Cost of goods sold 233,200
Admin. salaries expense 18,200
Sales salaries expense 29,600
Insurance expense 1,200
Rent expense 8,100
Supplies expense 1,000
Advertising expense 13,300
$ 390,600 $ 390,600
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P3 Step 1: Close Credit Balances in Temporary
Accounts to Income Summary

Dr. Cr.
Dec. 31 Sales 323,800
Income Summary 323,800
To close credit balances
in temporary accounts
BARTON COMPANY
Adjusted Trial Balance (partial)
December 31, 2011

Salaries payable 1,000

Common Stock 42,400
Dividends 4,000
Sales 323,800
Income Summary
Sales discounts 4,300 323,800
Sales returns 2,000
Cost of goods sold 233,200
Admin. salaries expense 18,200
Sales salaries expense 29,600
Insurance expense 1,200
Rent expense 8,100
Supplies expense 1,000
Advertising expense 13,300
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P3 Step 2: Close Debit Balances in Temporary
Accounts to Income Summary
Dr. Cr.
De c. 31 Incom e Sum m ary 310,900
Sale s Dis counts 4,300
Sale s Re turns 2,000
Cos t of Goods Sold 233,200
Adm . Salarie s Expe ns e 18,200
Sale s Salarie s Expe ns e 29,600
Ins urance Expe ns e 1,200
Re nt Expe ns e 8,100
Supplie s Expe ns e 1,000
Adve rtis ing Expe ns e 13,300
To cl ose debi t ba l a nces i n tempora ry a ccounts

Income Summary
310,900 323,800
12,900
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P3 Step 3: Close Income Summary to
Retained Earnings

Dr. Cr.
Dec. 31 Income Summary 12,900
Retained Earnings 12,900
To close Income Summary account

Income Summary
310,900 323,800
12,900
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P3
Step 4: Close Dividends to
Retained Earnings

Dr. Cr.
Dec. 31 Retained Earnings 4,000
Dividends 4,000
To cl ose the di vi dends a ccount

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P4
Multiple-Step Income Statement
BARTON COMPANY
Income Statement
For Year Ended December 31, 2011
Sales $ 323,800
Less: Sales discounts $ 4,300
Sales returns 2,000 6,300
Net sales $ 317,500
Cost of goods sold 233,200
Gross profit $ 84,300
Operating expenses:
Selling expenses:
Salaries expense $ 29,600
Advertising expense 13,300 $ 42,900
General and administrative expenses:
Adm. salaries expense $ 18,200
Insurance expense 1,200
Rent expense 8,100
Supplies expense 1,000 28,500
Total operating expenses 71,400
Net income $ 12,900
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P4
Single-Step Income Statement

BARTON COMPANY
Income Statement
For Year Ended December 31, 2011
Net sales $ 317,500
Cost of goods sold $ 233,200
Operating expenses 71,400
Total expenses 304,600
Net income $ 12,900

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P4

Balance Sheet
BARTON COMPANY
Balance Sheet
December 31, 2011
Assets:
Cash $ 7,700
Accounts receivable 11,200
Merchandise inventory 14,300
Supplies 1,300
Equipment 41,200
Accum. depr.- Equip. (7,000)
Total assets $ 68,700
Liabilities
Accounts payable 16,400
Salaries payable 1,000
Total liabilities 17,400
Equity
Common stock 42,400
Retained earnings 8,900
Total liabilities $ 51,300
Total liabilities & equity $ 68,700

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A1
Acid-Test Ratio

Acid-test Quick assets

=
ratio Current liabilities

Acid-test Cash + S/T investments + receivables

=
ratio Current liabilities

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.
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A2
Gross Margin Ratio

Gross
Net sales - Cost of goods sold
margin =
Net sales
ratio

Percentage of dollar sales available to

cover expenses and provide a profit.

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End of Chapter 04

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