Chapter 5

-Merchandising Operations and the Multiple-step Income Statement

Merchandising Operations
-Buy and sell goods, primary source of revenues is sales revenues
-Sales Rev- Cost of Goods sold=gross profit- operating expenses= net
income/loss
Operating Cycles
o Operating cycle of a merchandising company is ordinarily
longer than that of a service company
Flow of costs- perpetual and periodic inventory systems
o Perpetual System
Maintains detailed records of the cost of each
inventory purchase and sale
Records continuously show inventory that should be
on hand for each item
Company determines cost of goods sold each time a
sale occurs
Advantages
Used for merchandise with high unit values
Quantity and cost of inventory on hand at any
time
Better control over inventories
o Periodic System
Do not keep detailed records of goods on hand
Cost of goods sold determined by count at the end of
the accounting period
Calculation of cost of goods sold:
Recording Purchases of merchandise
-Cash or credit
-Purchase invoice should support each credit purchase
-Perpetual Purchase- Debit- inventory / Credit- Accounts payable
Freight costs
o Is an operating expense
o When buyer pays freight charges
Debit- inventory / Credit- cash
o When seller pays freight
Debit- freight out / Credit- cash
Purchase returns and allowances
o Return on cash or credit
For byer returning for credit
Debit- accounts payable / Credit- inventory
For cash debit- cash / Credit- inventory

o Or Allowance can keep merchandise if seller grants a

reduction on purchase price
Purchase discounts
o Credit terms permits buyer to claim a cash discount
o Purchaser saves money
o Seller shortens the operating cycle by converting the
accounts receivable into cash earlier
o Recording purchase with discount
Debit- accounts payable / credit- inventory (disc.
Price) and cash
If fail to take discount, must pay full payment
Summary of purchasing transactions
o Debit- purchase and freight-in (if byer pays freight) / creditreturns and discountsbalance falls under outstanding
Recording sales of merchandise
-Sales revenue, like service, is recorded when the performance
obligation is satisfied, which occurs when goods are transferred from
seller to buyer.
-Two journal entries for seller
-Debit- cash or accounts receivable / debit- sales revenue AND
debit- cost of goods sold / credit- inventory
Sales returns and allowances
o Contra-revenue account to sales revenue (debit)
o Flip side of purchase returns and allowances
o Sales are not reduced (debited)
o Two journal entries- if NOT DEFECTIVE
Debit- sales returns and allowances / credit- accounts
receivable
Debit- inventory / credit- cost of goods sold
o IF DEFECTIVE
Only change cost entry for the scrap value of
merchandise
Debit- inventory / credit- cost of goods sold for $50
rather than $150 (value stated in question)
Sales discounts- used to promote prompt payment of balance
due
o Contra-revenue account (debit) to sales revenue
o Debit- cash and sales discounts / credit- accounts
receivable
Income statement presentation
- Single-step income statement
-Total revenues total expenses

-Multiple-step income statement

-Highlights components of net income
-Three important line items
1. Gross profit
2. Income from operations
3. Net income

(Sales revenue - sales returns and allowances - sales discount =

net sales)
Gross profit =(net sales- cost of goods sold)
(Total operating expenses gross profit = income from
operations)
Non-operating activities (are other revenues and gains and other
expenses and loses)
Determining cost of goods sold- periodic system

Evaluating Profitability
Gross profit rate
o Gross profit (net sales COGS) / net sales
o Measures the margin by which selling price exceed cost of
goods sold
Profit margin
o Net income / net sales
o Measure the extent by which selling price covers all
expenses (including cost of goods sold)
Quality of earnings ratio
o Net cash provided by operating activities / net income
Less than 1= more aggressive and accelerating
income
Greater than 1= conservative accounting delaying
income
Periodic Inventory system
-Record revenues when sales are made, not on sale date
-Record purchases in purchases account
-Purchase returns and allowances. Purchase discounts, and freight
costs are recorded in separate accounts
o Recording purchases
Debit- purchases / Credit- accounts payable
o Freight costs
Debit- freight in (if buyer pays) / credit- cash
o Purchase returns and allowances
Debit- accounts payable / credit- purchase returns
and allowances

o Purchase Discounts
Debit- accounts payable / credit- purchase discounts
and cash
o Recording sales
Debit- accounts receivable / credit- sales revenue
No entry for cost of goods sold at time of sale
o Sales returns and allowances
Debit- sales returns and allowances / credit- accounts
receivable
o Sales discounts
Debit- cash and sales discounts / credit- accounts
receivable