FINANCIAL

ACCOUNTING

Tools for Business Decision-Making

CHAPTER
5: WEYGANDT KIESO TRENHOLM IRVINE
KIMMEL
Merchandising Operations

STUDY OBJECTIVES
SO 1: Identify the differences between service
and merchandising companies.
SO 2: Prepare entries for purchases under a
perpetual inventory system.
SO 3: Prepare entries for sales under a
perpetual inventory system.
SO 4: Prepare a single-step and multiple-step
income statement.
SO 5: Calculate the gross profit margin and
profit margin.
SO 6: Prepare entries for purchases and sales
under a periodic inventory system and

Differences Between Service and

Merchandising Companies
Service companies perform services as
their primary source of revenue
Merchandising companies buy and sell
inventory (e.g. Loblaws):
Retailers sell to consumers
Wholesalers sell to retailers
Manufacturers produce goods for sale

Operating Cycle
The time it takes to go from cash to
cash in producing revenues
Longer for a merchandising company
that for a service company:
Merchandise must first be purchased
before it can be sold
Adds an additional step to the cycle

Income Measurement Process

Revenue:
Sales revenue (from the sale of
merchandise): the main source

Expenses are divided into two

categories:
Cost of goods sold: total cost of
merchandise sold in a period
Operating expenses: incurred in the
process of earning sales revenue

Gross profit
= Sales revenue less cost of goods sold

Income Measurement Process for

Merchandiser

Inventory Systems
Flow of costs for a merchandising
company:
Beginning inventory + purchases = cost
of goods available for sale
Once sold, these costs are assigned to
cost of goods sold
Goods left over are ending inventory

One of two systems is used to

account for inventory and cost of
goods sold:
Perpetual inventory system

Perpetual System
Detailed records are kept for the cost of
each product purchased and sold
These records are updated continuously
(perpetually) for purchases and sales
A physical count is done at least once a
year to adjust perpetual records to
actual
This system enables the effective
control of inventory which is an
important asset

Periodic System
Detailed records of merchandise are not
kept throughout the period
Cost of goods sold is only determined at
the end of the accounting period:
Once inventory is counted
Cost of goods sold = Beginning inventory +
cost of purchases less ending inventory

Discussion Question
How do companies decide which
inventory system to use?

Purchases of Merchandise
Purchases are recorded in the
Merchandise Inventory account
Includes all costs to get merchandise
to place of business and ready for
resale:
Includes freight and applicable taxes
Less purchase returns, allowances,
discounts

Credit purchases are supported by a

purchase invoice

Sales Taxes and Freight

GST and HST paid does not form part
of cost of goods (refunded)
Generally no PST on goods
purchased for resale
FOB (Free on Board) refers to where
title or ownership of goods transfers:
FOB destination: buyers place of
business
FOB shipping point: sellers place of
business

FOB Destination
Ownership of the goods does not pass
from the seller to the buyer until the
goods are received by the buyer (i.e.
destination point)

FOB Shipping Point

Ownership of the goods passes from
the seller to the buyer as soon as the
goods are shipped

Discussion Question
Who pays the freightthe seller or the
buyerwhen the shipping terms are
(a) FOB shipping point and (b) FOB
destination?

Purchase Returns and Allowances

A purchaser returns the goods to the
seller and receives a cash refund or
credit
The buyer may choose to keep the
merchandise if the seller is willing to
give an allowance (deduction) from
the purchase price
In both cases, the result is a
decrease to the cost of goods
purchased

Discounts
A quantity discount gives a price
reduction according to the volume of
the purchase:
Not recorded separately discounted
price is recorded as cost of purchase

A purchase discount is offered to

encourage early payment of a
balance due. Example: 2/10, n/30:
Recorded separately when payment
made. Results in a decrease to
Merchandise Inventory account

Summary of Purchase
Transactions

Sales of Merchandise
Recording of sales:
Two entries required: one to record sales
price and one to record cost of sale

Sales taxes are not recorded as revenue

When freight is FOB destination, seller
records cost of freight as an expense
Sales returns and allowances are a
contra revenue account to Sales
Sales discounts are also a contra
revenue account to Sales

Summary of Sales Transactions

Recording Inventory Sales

Income Statement Presentation

Two different forms of income
statement:
Single-step
All data classified into two categories: revenues
and expenses

Multiple-step
Shows several steps in determining profit or loss

Net sales
Gross profit
Profit from operations
Non operating revenues and expenses
Profit

Single-Step Income Statement

Revenues
Net sales
Interest revenue
Total revenues
Expenses
Cost of goods sold
Operating expenses
Interest expense
Loss on sale of equipment
Total expenses
Profit before income tax
Income tax expense
Profit

$460,000
3,400
463,400
316,000
114,000
1,800
200
432,000
31,600
6,300
$ 25,300

Multiple-Step Income Statement

Sales revenues
Sales
Less: Sales returns and allowances
Sales discounts
Net sales
Cost of goods sold
Gross profit
Operating expenses
Salaries expense
Rent expense
Utilities expense
Advertising expense
Depreciation expense
Freight out
Loss on sale of equipment
Total operating expenses
Profit from operations

$480,000
$12,000
8,000

20,000
460,000
316,000
144,000

$45,000
19,000
17,000
16,000
8,000
9,000
200
114,200
29,800

Multiple-Step Income Statement

(continued)
Profit from operations
(continued)
Other revenues and gains
Interest revenue
Other expenses and losses
Interest expense
Profit before income tax
Income tax expense
Profit

$ 29,800
$3,400
1,600

1,800
31,600
6,300
$ 25,300

Evaluating Profitability:
Gross Profit Margin
Measures the gross profit expressed as
a percentage of net sales
Gross profit margin = Gross profit
Net sales

Higher is generally
better

Evaluating Profitability:
Profit Margin
Measures the percentage of each
dollar of sales that results in profit

Profit margin
=
Net sales

Profit

Higher is generally
better

Discussion Question
Why would food stores (e.g. Sobeys),
generally experience lower gross profit
and profit margins than businesses such
as computer services (e.g., Microsoft)?

Appendix 5A:
Periodic Inventory System
Compare to perpetual inventory
system:
Differences in recording purchases
Differences in recording sales
Cost of goods sold is calculated only at
the end of a period, using ending
inventory count

Comparison of Entries for

Inventory Purchases

Comparison of Entries for Sales

Calculating Cost of Goods Sold

Three steps are required:
1. Calculate cost of goods purchased
2. Determine ending inventory
3. Calculate the cost of goods sold

Multiple-Step Income Statement

Sales revenue
Sales
Less: Sales returns and
allowances
Sales discounts
Net sales
Cost of goods sold
Inventory, January 1
Purchases
Less: Purchase returns
Purchase discounts
Net purchases
Add: Freight in
Cost of goods purchased
Cost of goods available for
sale
Inventory, December 31
Cost of goods sold
Gross profit

$12,000

$480,00
0

8,000
$325,00
0
10,400

20,000
460,000
$
36,000

6,800
307,800
12,200

320,000
356,000
40,000
316,000
144,000

Multiple-Step Income Statement

(continued)
Gross profit (continued)
Operating expenses
Salaries expense
Rent expense
Utilities expense
Advertising expense
Depreciation expense
Freight out
Insurance expense
Loss on sale of equipment
Total operating expenses
Profit from operations

$144,000
$45,000
19,000
17,000
16,000
8,000
7,000
2,000
200
114,200
29,800

Multiple-Step Income Statement

(continued)
Profit from operations
(continued)
Other revenues and gains
Interest revenue
Other expenses and losses
Interest expense
Profit before income tax
Income tax expense
Profit

$ 29,800
$3,400
1,600
1,800
31,600
6,300
$ 25,300

Comparing IFRS and ASPE

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