Accounting for Merchandising Operations

Accounting for Merchandising Operations

Merchandising Activities

  • Definition: A merchandiser earns net income by buying and selling merchandise.
  • Merchandise: Products that a company acquires to resell to customers.
  • Types of Merchandisers: Identified as either a wholesaler or retailer.

Reporting Income for a Merchandiser

  • Revenue: Referred to as sales for a merchandiser.
  • Expense: The expense associated with the merchandise is referred to as the cost of goods sold (COGS), which represents inventory while the goods are being held for sale.
  • Gross Profit: The difference between sales and COGS, also known as gross margin.

Reporting Inventory for a Merchandiser

  • Merchandise Inventory: Refers to products that a company owns and intends to sell. It includes:
    • Cost incurred to buy the goods.
    • Shipping costs to transport goods to the store.
    • Costs to prepare goods for sale.
  • Classification: Recorded as a current asset on the balance sheet until the merchandise is sold.

Operating Cycle for a Merchandiser

  • Definition: The operating cycle is the time it takes for a company to buy inventory, sell it, and collect cash from the sale.
  • Goal: Companies aim to keep their operating cycles short as assets tied up in inventory and receivables are not productive.

Inventory Systems

  • Types of Inventory Systems:
    1. Perpetual Inventory System: Continuously updates inventory records for purchases and sales.
    2. Periodic Inventory System: Updates inventory records at specific intervals.
  • Inventory Flow:
    • Beginning Inventory
    • Net Purchases
    • Merchandise Available for Sale
    • Ending Inventory
    • Cost of Goods Sold (COGS)

Accounting for Merchandise Purchases

  • Basic Entry:
    • Debit: Merchandise Inventory
    • Credit: Cash (or Accounts Payable)
  • Source Document: The invoice serves as a source document for recording transactions.

Purchase Discounts

  • Definition: Cash discount granted to the purchaser for paying within a specified discount period.
  • Impact on Inventory: When a purchase discount is taken, the Merchandise Inventory account is reduced by the discount amount at the time of payment.

Credit Terms

  • Example:
    • 2/10, n/30: A 2% discount is available if paid within 10 days; otherwise, the full balance is due in 30 days.

Accounting for Merchandise Purchases When Paid and Discount is Taken

  • Basic Entry:
    • Debit: Accounts Payable
    • Credit: Merchandise Inventory (for discount taken)
    • Credit: Cash
  • Method: This is referred to as the gross method for recording purchases.

Purchase Returns and Allowances

  • Purchase Returns: Merchandise that a buyer acquires but returns to the seller.
  • Purchase Allowance: Reduction in cost due to defective or unacceptable merchandise.
  • Debit Memorandum: Issued by the buyer to inform the seller of a debit made to the supplier’s account.

Accounting for Merchandise Purchases When Merchandise is Returned or Allowance Given

  • Basic Entry:
    • Debit: Accounts Payable
    • Credit: Merchandise Inventory

Transportation Costs and Ownership Transfer

  • Agreement: The buyer and seller must agree on freight costs and who bears the risk during transit.
  • FOB (Free on Board) Points:
    • FOB Shipping Point: Buyer accepts ownership when goods depart from the seller; the buyer pays for shipping.
    • FOB Destination: Seller retains ownership until goods arrive at the buyer’s location; the seller pays for shipping.

Accounting for Merchandise Sales

  • Components: Merchandising companies must account for:
    • Sales
    • Sales discounts
    • Sales returns and allowances
    • Cost of Goods Sold (COGS)

Sales of Merchandise

  • Basic Entry:
    • Debit: Accounts Receivable (or Cash)
    • Credit: Sales
    • Debit: Cost of Goods Sold
    • Credit: Merchandise Inventory
  • Explanation: Each sales transaction involves two parts—one for revenue and one for the cost of merchandise sold. Gross profit is calculated as:
    • extGrossProfit=extSales−extCostofGoodsSoldext{Gross Profit} = ext{Sales} - ext{Cost of Goods Sold}
    • This may be stated per unit or in total.

Sales Discounts

  • Definition: A cash discount granted to buyers who pay within the discount period.
  • Recording: Recorded only when the customer pays within the discount period.
  • Account Type: Monitored as a separate contra-revenue account (normal balance is debit) to assess effectiveness and cost of discount policy.

Accounting for Sales Discounts Taken

  • Basic Entry:
    • Debit: Cash
    • Debit: Sales Discounts
    • Credit: Accounts Receivable

Sales Returns and Allowances

  • Sales Returns: Merchandise that customers return to the seller after a sale.
  • Sales Allowances: Reduction in the selling price due to damaged or defective merchandise, where the customer opts to retain the item at a reduced price.

Accounting for Sales Returns and Allowances

  • Basic Entry:
    • Debit: Sales Returns and Allowances
    • Credit: Accounts Receivable
    • Debit: Merchandise Inventory
    • Credit: Cost of Goods Sold (this entry is made only if the returned merchandise is resalable)
  • Documentation: Seller prepares a credit memorandum to inform the buyer of the credit to their account.

Completing the Accounting Cycle

  • Flow of Costs: Understanding the flow of merchandising costs during a period is critical, as it determines where these costs are reported at year-end.
    • Sequence:
    • Period 1: Beginning inventory + Net purchases from suppliers = Merchandise available for sale.
    • Ending inventory to derive Cost of Goods Sold reported
    • Cost of Goods Sold reported in the Income Statement and ending inventory recorded in the Balance Sheet.

Adjusting Entries for a Merchandiser

  • Importance: Adjusting entries remain the same as a service business.
  • Additional Entry: To update the merchandise inventory reflecting any loss including theft and deterioration (shrinkage).
  • Counting: Compare physical count of inventory with recorded quantities to adjust.

Preparing Financial Statements

  • Similarities: Financial statements for a merchandiser are similar to those of service businesses.
  • Income Statement: The main differentiators are the inclusion of COGS and gross profit.
  • Balance Sheet: The major difference is the inclusion of merchandise inventory as part of current assets.

Closing Entries for Merchandisers

  • Process: Similar to a service business, with additional temporary accounts arising such as:
    • Sales Discount
    • Sales Returns and Allowances
    • Cost of Goods Sold
  • Closing Method: These accounts with debit balances are closed with expense accounts to the Income Summary.

Financial Statement Formats

  • Income Statements:
    • Multiple-step Income Statement: Composed of three main parts:
    1. Gross Profit
    2. Income from Operations
    3. Net Income
    • Single-step Income Statement: Includes COGS as an operating expense with one subtotal for expenses to arrive at net income.
  • Balance Sheets: Merchandise inventory is reported as a current asset, following accounts receivable.

Decision Analysis

  • Acid-Test Ratio: A metric used to assess the company’s liquidity or ability to pay current debts, excluding less liquid current assets.
  • Gross Margin Ratio: Utilized to assess a company’s profitability before accounting for operating expenses.