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Accounting for Merchandising Operations

Chapter 4: Accounting for Merchandising Operations

Learning Objectives

  • C1: Describe merchandising activities and cost flows.

  • A1: Compute and analyze the acid-test and gross margin ratios.

  • P1: Analyze and record transactions for merchandise purchases (perpetual system).

  • P2: Analyze and record transactions for merchandise sales (perpetual system).

  • P3: Prepare adjustments and close accounts for a merchandising company.

  • P4: Define and prepare multiple-step and single-step income statements.

  • P5: Record and compare merchandising transactions (periodic vs. perpetual systems).

  • P6: Prepare adjustments for discounts, returns, and allowances (revenue recognition rules).

  • P7: Record and compare transactions using gross vs. net methods.

Key Concepts

  • Merchandising Activities: Involve the sale of products to earn revenue.

  • Cost Flows: Begin with purchases and end with cash collection from sales.

Inventory Systems

  • Perpetual System: Updates records with each inventory transaction.

  • Periodic System: Updates records at end of period only.

Handling Purchases

  • Without Cash Discounts: Record purchases at full invoice amount.

  • With Cash Discounts: Recognize discounts if paid within discount period (e.g., 2/10, n/30).

  • Returns & Allowances: Adjust purchases for any defective merchandise (purchase returns or allowances).

  • Transportation Costs: Add costs to inventory when purchases are FOB shipping point.

Handling Sales

  • Sales Transactions: Record sales revenue and cost of goods sold.

  • Sales Discounts: Offer discounts to encourage early payment.

  • Sales Returns: Acknowledge returns and adjust inventory accordingly.

Financial Reporting

  • Income Statements: Can be multiple-step or single-step showing revenues, expenses, and net income.

  • Gross Margin: Represents sales after deducting the cost of goods sold, important for coverage of operating expenses.

Adjustments & Closing Entries

  • Adjustments: Include estimates for discounts, returns, and allowances based on revenue recognition.

  • Closing Entries: Transfer balances from temporary to permanent accounts to reflect income.

Ratios

  • Acid-Test Ratio: Indicates short-term liquidity; aim for at least 1.0.

  • Gross Margin Ratio: Measures percentage of sales available to cover expenses and profit needs.

Transactions Comparison

  • Gross vs. Net Method: Record purchases or sales either at full price (gross) or after discounts (net).