ACCO 2023

LECTURE NOTES – Accounting for Merchandising Operations

A merchandising company earns profits by buying and selling goods. Merchandise represents
goods or items intended for sale by a merchandiser in the normal course of business operations

The two accounting system used for inventories are

1. Perpetual Inventory System

2. Periodic Inventory System

Sales

Invoice is a document prepared by the seller of the merchandise. The seller calls it a sales
invoice. A copy is given to the buyer of the merchandise and it is called purchase invoice.

Net sales

The largest source of revenue for a merchandiser is sales. Usually the largest expense for a
merchandiser is cost of goods sold, also known as cost of sales. Sales can be reduced by sales
discounts and sales returns. Sales, less sales discounts and sales returns, are called net sales. The
difference between net sales and cost of goods sold is gross profit. Gross profit is often called
gross margin.

Trade Discount

Catalog/List prices is where the goods are listed with their prices. A trade discount is a
percentage reduction to the published list price which is granted to customers who buys
frequently and in large quantities.

The Invoice price is the basis for recording and invoicing.

Accounts used by merchandising companies

Name of Normal Purpose of account

account Balance
Sales CR Sales is a revenue account that records the sales of merchandise
Sales returns DR This account is a contra-revenue account that tracks returns or
and allowances allowances granted to customers. It is a contra-revenue account.

Sales discounts DR This account is also a contra-revenue account. It tracks the

amount of discounts that customers take due to early-payment
discounts offered by the seller.
Cost of Goods DR Cost of Goods Sold is an expense. It is debited for the cost of the
Sold merchandise that was sold to the customer.
Purchase DR Account used for purchases of merchandise for sale.

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Purchase returns CR This account is a contra-expense account that tracks returns or
and allowances allowances for purchase merchandise.

Purchase CR Credited by the buyer when he avails of the cash discount

Discount
Freight In DR Account used to record freight costs incurred by the buyer in
acquiring the merchandise. It is an adjunct account.
Freight Out DR Account used to record shipping costs shouldered by the seller for
sales of the merchandise. Also known as Delivery Expense

Freight costs

Freight terms are important. FOB or Free on Board determines who pays for transportation and
when title passes.

 FOB Shipping Point: legal title to the goods passes to the BUYER when the goods are
shipped. The BUYER shoulder all the transportation cost. BUYER receives title to goods
at the shipping point.
 FOB Destination: The SELLER shoulders all the transportation costs from the point of
shipment up to the point of destination.
 Discounts for prompt payment cannot be taken on freight.
 Freight prepaid- when the SELLER pays the transportation costs at the time of shipment.
 Freight collect- when the BUYER pays the transportation cost upon the receipt of the
goods at the place of destination.

Journal entries using the perpetual system: seller’s books

Sales of Merchandise: Two entries are recorded: one for the sale and another for the cost of the
goods sold.

Dr. Accounts Receivable

Cr. Sales

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Dr. Cost of Goods Sold (COGS)

Cr. Merchandise inventory

Payments Received from Customers, with early payment discount:

Dr. Cash

Dr. Sales Discounts

Cr. Accounts Receivable

Sales returns from customers. Two entries are recorded: the sales return and the receipt of the
goods from the customer.

Dr. Sales returns and Allowances

Cr. Accounts Receivable

Dr. Merchandise Inventory

Cr. COGS

An adjusting entry for inventory shrinkage:

Dr. COGS

Cr. Merchandise Inventory

Closing Entries

Closing entries were covered in ACCT 100. See page 165 for a review of closing entries.

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 A review of the Multiple-Step Income Statement

Revenue from Sales

Sales

Less Sales Discounts

Gross profit
Less Sales Returns and Allowances computation
Net Sales

- Cost of Goods Sold

=Gross Profit

Operating Expenses:

Selling Expenses Income from

Operations
General and Administrative Expenses
computation
Total Operating Expenses

Income from Operations*

Add: Other Revenues

Nonoperating
Less: Other Expenses activities
computation
Net Income

*Gross profit less total operating expenses

Ratio Analysis

The acid-test ratio is a stricter, more conservative version of the current ratio. The formula for the
acid-test ratio follows.

Acid Test Ratio = Cash and cash equivalents + Short Term Investments + A/R
Current Liabilities

The gross margin ratio calculates the gross profit earned on each dollar of sales. The formula for
the gross margin ratio is below.

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Gross Margin Ratio = Gross profit (Net Sales – COGS)
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Net Sales