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MERCHANDISING OPERATIONS AND THE MULTI-STEP
INCOME STATEMENT
LO 1: Describe merchandising operations and inventory systems.
• Primary source of revenue for merchandisers like Walmart that buy and sell goods is referred to as
sales revenue.
• Cost of goods sold is the total cost of merchandise sold during the period.
o It is an EXPENSE that is directly related to the revenue recognized from the sale of goods.
Ex: Company C, a retailer, bought chairs from a wholesaler for $15 each. Company C then sold the
chairs to their customers for $20 each.
• The $20 represents Company C’s sales revenue for each chair.
• The $15 that Company C spent on each chair represents Company C’s cost of goods sold and
is recognized when each chair is sold to customers.
***Key Formula: Sales Revenue – Cost of Goods Sold = Gross Profit
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FLOW OF COSTS
• Companies use either a perpetual inventory system or a periodic inventory system to account for
inventory.
1. Perpetual: CONTINUOUSLY updates accounting records for merchandising transactions –
SPECIFICALLY reduction of inventory and increasing cost of goods sold.
• Advantages of perpetual inventory system.
1. Traditionally used for merchandise with high unit values.
2. Shows the quantity and cost of the inventory that should be on hand at any time.
3. Provides better control over inventories than a periodic system.
2. Periodic: updates the accounting records for merchandise transactions at the END OF A PERIOD.
• Cost of goods sold determined by count at the end of the accounting period.
***Key Formula… Cost of Goods Sold = Beginning Inventory + Net Purchases – Ending Inventory
Beginning Inventory
200,000$
Add: Purchases, net
900,000$
Goods available for sale 1,100,000$
Less: Ending Inventory 400,000$
Cost of Goods Sold 700,000$
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LO 2: Record purchases under a perpetual inventory system.
FREIGHT COSTS
Shipping Terms Ownership Transfers when goods passed to Freight cost paid by
PURCHASE DISCOUNTS
• Buyer receives a cash discount for prompt payment.
• Saves the buyer money and helps the seller collect money faster.
What does this mean?
*The buyer can deduct 2% of the invoice amount if
payment is made within 10 days of the invoice
date, otherwise full payment is due within a
30-day credit period.
*Simply…The buyer gets a 2% discount if they pay
within 10 days, otherwise the full amount is due in
30 days.
1. FOB (Free on Board)
Shipping Point: GOODS
ARE BUYERS AS SOON AS
CARRIER GETS THEM.
2. FOB (Free on Board)
Destination: GOODS ARE
SELLERS UNTIL THEY REACH
BUYER.
1. CARRIER
2. BUYER
1. BUYER
Inventory xxx
Cash xxx
2. SELLER
Freight-Out xxx
Cash xxx
Del
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PURCHASE DISCOUNTS (Cont.)
PURCHASE RETURNS AND ALLOWANCES
• Purchase Returns: Return goods for credit if the sale was made on credit, or for a cash refund if the
purchase was for cash.
• Purchase Allowances: May choose to keep the merchandise if the seller will grant a reduction of
the purchase price.
1% discount if paid within first 10 days of next month.
Net amount due within the first 10 days of the next month.
DEBIT CREDIT
Inventory xxx
Accounts Payable xxx
Inventory xxx
Cash xxx
Inventory xxx
Cash xxx
Accounts Payable xxx
Inventory (For purchase discount) xxx
Cash xxx
Accounts Payable xxx
Cash xxx
Cash or Accounts Payable xxx
Inventory xxx
2. Purchase inventory for CASH.
Summary of Purchasing Journal Entries- Perpetual
B
U
Y
E
R
1. Purchase inventory ON ACCOUNT.
3. Paying freight costs on purchases (FOB Shipping Point)
4. Paying WITHIN discount period.
5. Paying OUTSIDE discount period.
6. Recording Purchase Returns and Allowances.
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Example Journal Entries
Jay Company bought inventory from Z Company on January 1 for $10,000 under the credit terms 3/15,
n/60. On January 10, Jay Company returned goods costing $1,000 to Z Company. Jay Company paid Z
Company for the remaining goods on Jan. 12.
What are the journal entries that need to be recorded in January for Jay Company?
Date
Debit
Credit
Inventory
Jan. 1
10,000
Accounts Payable- Z Company
10,000
Accounts Payable- Z Company
Jan. 10
1,000
Inventory
1,000
Accounts Payable- Z Company (10,000 – 1,000)
Jan. 12
9,000
Inventory (9,000 × 3% = $270)
270
Cash
8,730
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LO 3: Record sales under a perpetual inventory system.
SALES RETURNS AND ALLOWANCES
• Used when the seller either accepts goods back from a purchaser (a return) or grants a reduction in
the purchase price (an allowance) so that the buyer will keep the goods.
• Contra-revenue account on the income statement and has a Debit balance.
SALES DISCOUNTS
• Issued by the seller to obtain their money from the customer faster.
• Contra-revenue account on the income statement and has a Debit balance.
Sales Revenue – Sales Returns and Allowances – Sales Discounts = Net Sales
Net Sales – Cost of Goods Sold = Gross Profit
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Example Journal Entries
• Jay Company sold goods costing $6,000 to X Company for $10,000 on March 1 under the terms
2/10, net 30. On March 5, X Company returned goods to Jay Company with a selling price of $3,000
and a cost of $1,800. On March 10, Jay Company received payment from X Company for the
remainder of the goods.
What are the journal entries that need to be recorded on in March for Jay Company?
Date
Debit
Credit
Accounts Receivable- X Company
Mar. 1
10,000
Sales Revenue
10,000
Cost of Goods Sold
Mar. 1
6,000
Inventory
6,000
Sales Returns and Allowances
Mar. 5
3,000
Accounts Receivable- X Company
3,000
Inventory
Mar. 5
1,800
Cost of Goods Sold
1,800
Cash
Mar. 10
6,860
Sales Discounts (7,000 × 2% = $140)
140
Accounts Receivable- X Company (10,000 -3,000)
7,000
LO 5: Apply the steps in the accounting cycle to a merchandising company.
Each of the required steps described in Chapter 4 for service companies applies to
merchandising companies.
Adjusting Entries
A merchandising company generally has the same types of adjusting entries as a service
company. However, a merchandiser using a perpetual system will require one additional
adjustment to make the records agree with the actual inventory on hand. Here’s why: At the end
of each period, for control purposes, a merchandising company that uses a perpetual system will
take a physical count of its goods on hand.
The company’s unadjusted balance in Inventory usually does not agree with the actual amount of
inventory on hand. The perpetual inventory records may be incorrect due to recording errors,
theft, or waste. Thus, the company needs to adjust the perpetual records to make the recorded
inventory amount agree with the inventory on hand.
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• This adjustment impacts Inventory and Cost of Goods Sold.
For example, suppose that PW Audio Supply, Inc. has an unadjusted balance of $40,500 in
Inventory.
Through a physical count, PW Audio Supply determines that its actual merchandise inventory at
December 31 is $40,000. The company would make an adjusting entry as follows.
Dec. 31
Cost of Goods Sold
500
Inventory ($40,500 – $40,000)
500
(To adjust inventory to physical count)
Closing Entries
A merchandising company, like a service company, closes to Income Summary all accounts that
affect net income. In journalizing, the company credits all temporary accounts with debit
balances, and debits all temporary accounts with credit balances. It also closes both Income
Summary and Dividends to Retained Earnings. (Hint – R.E.D – temporary accounts are
Revenue, Expense, and Dividends)
The following are the closing entries for PW Audio Supply using assumed amounts from its
year-end adjusted trial balance.
• Cost of Goods Sold is an expense account with a normal debit balance,
• Sales Returns and Allowances and Sales Discounts are contra revenue accounts with
normal debit balances
The easiest way to prepare the first two closing entries is to identify the temporary
accounts by their balances and then prepare one entry for the credits and one for the
debits.
Dec.31
Sales Revenue
480,000
Income Summary
480,000
(To close income statement accounts with credit
balances)
31
Income Summary
450,000
Sales Returns and Allowances
12,000
Sales Discounts
8,000
Cost of Goods Sold
316,000
Salaries and Wages Expense
64,000
Freight-Out
7,000
Advertising Expense
16,000
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Utilities Expense
17,000
Depreciation Expense
8,000
Insurance Expense
2,000
(To close income statement accounts with debit
balances)
31
Income Summary
30,000
Retained Earnings
30,000
(To close net income to retained earnings)
31
Retained Earnings
15,000
Dividends
15,000
(To close dividends to retained earnings)
After PW Audio Supply has posted the closing entries, all temporary accounts have zero
balances. Also, Retained Earnings has a balance that is carried over to the next period
LO 5: Prepare a multi-step income statement
SINGLE-STEP INCOME STATEMENT
• Subtract total expenses from total revenues
• Two reasons for using the single-step format:
1. Company does not realize any type of profit or income until total revenues exceed total
expenses.
2. Form is simple and easy to read.
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MULTI-STEP INCOME STATEMENT
• Highlights the components of net income.
• Three important line items:
1. Gross profit
2. Income from Operations
3. Net Income
•
***ALL OF THESE ITEMS ARE PART OF NONOPERATING
ACTIVITIES AND ARE ADDED OR DEDUCTED FROM INCOME
FROM OPERATIONS TO GET INCOME BEFORE TAXES.
