Lecture #5: Accounting for a Merchandising Concern

  • The accounting records and reports of the Dow Law Practice is a service enterprise.
  • A merchandising company, on the other hand, earns revenue by selling goods or merchandise. The net income results when revenue from sales exceeds the cost of the goods sold (including operating expenses).

Eastside Hardware Store
Condensed Income Statement
For Month Ended July 31, 1990
Revenue from sales $100,000
Less cost of goods sold 60,000
Gross profit from sales $40,000
Less operating expenses 25,000
Net income $15,000
  • Eastside Hardware Store sold goods to customers for $100,000.
  • The cost of the goods are $60,000.
  • The gross profit is $40,000.(The amount by which revenue exceeds the cost of goods sold).

Revenue from Sales

It is reported as the following example.

Iowa Sales, Incorporated
Income Statement
For Year EndedDecember 1, 1990
Revenue from sales
Gross sales $306,200
Less cost of goods sold 1,900
Sales discounts 4,300
Net Sales $300,000

1.Gross Sales

These are the goods that were sold to the customers. The sales are rung up on the cash register.

Nov. 3 Cash $1,205
Sales $1,205
To record the day’s cash sales.
Nov. 3 Accounts Receivable $45
Sales $45
Sold merchandise on credit

2.Sales Returns and Allowances.

In most stores, customers are allowed to return any unsatisfactory merchandise they bought. This is important information for the store managers. This indicates dissatisfied customers, so it deserves its own account.

Nov. 4 Sales Returns and Allowances $20
Accounts Receivable (or Cash) $20
Customer returned unsatisfactory merchandise.

3.Sales Discounts.

When goods are sold on credit, the amount and time of the payment is stated clearly. When credit periods are long, creditors often grant discounts for early payments.

For example, Iowa Sales, Incorporated sold $100 of merchandise to a customer on credit. The terms of the agreement are 2/10, N/60

Nov. 12 Accounts Receivable $100
Cash $100
Sold merchandise, terms 2/10, N/60.

F The customer can pay $98 up to Nov. 22 or the customer can wait and pay the amount on Jan. 11.The customer paid early and received the discount.

Nov. 22 Cash $98
Sales Discounts $2
Accounts Receivable $100
Received payment for the Nov. 12 sale less the discount.

F All sales discounts are recorded in one account. This account is closed at the end of the accounting period. Salesdiscounts reduce revenue from sales.

Periodic and Perpetual Inventory Systems

Stores sell thousands of goods, so when goods are sold, the store does not know the cost of selling that good. Stores usually wait to the end of the accounting period to take an inventory to determine the cost of goods sold. This is called a periodic inventory system. (This is this chapter).

If a business is small and sells a limited number of goods (such as a car dealership), the cost of the goods sold can be recorded, when the good is sold. This is called a perpetual inventory system.

Cost of Goods Sold, Periodic Inventory System

To use a periodic inventory system, you need three pieces of information.

  1. The cost of the merchandise on hand at the beginning of the period.
  2. The cost of the merchandise purchased during the period.
  3. The cost of unsold goods that remain at the end of the period.

Cost of goods on hand at the beginning of the period $19,000
Cost of goods purchased during the period 232,000
Goods available for sale during the period $251,000
Less unsold goods on hand at the period end* 21,000
Cost of goods sold during the period $230,000

*This is determined by inventory count.

1.Merchandise Inventories.

  1. Count the unsold items on the shelves in the store and in the stockroom.
  2. Multiply the total count of each good by its unit cost.
  3. Add all the cost of all the goods together.

2.Cost of Merchandise Purchased.

To determine the cost of merchandise purchased, you must note the invoice price of goods purchased and subtract any discounts, returns, and allowances.

Nov. 5 Purchases $1,000
Accounts Payable $1,000
Purchased merchandise on credit, invoice dated Nov. 2, terms 2/10, N/30

The firm pays for the goods to get the discount.

Nov. 12 Accounts Payable $1,000
Purchase Discount $20
Cash $980
Paid for the purchase of Nov. 5 less the discount.

  • The purchase discount is important account. Many companies pay within the time period to get the discount. A store can save alot of money by using discounts.
  • Another account of important information is the Returns and Allowances account. When the store buys defective merchandise, the store can return the merchandise to the factory.

Nov. 14 Accounts Payable $65
Purchase Returns and Allowances $65
Returned defective merchandise.

Sometimes the store has to pay for the transportation cost of getting the goods from the factory to the store.

Nov. 24 Transportation-in $22
Cash $22
Paid express charges on merchandise purchased.

When there are transportation charges, the buyer and seller must agree to which party pays for it.

Income Statement
Purchases $235,800
Less: Purchase returns and allowances 1,200
Purchase discounts 4,100
Net purchases $230,500
Add transportation-in 1,500
Cost of goods purchased $232,000

3.Cost of Goods Sold.

The last example was the cost of the merchandise purchased. You have to add in the beginning and ending inventories.

Cost of goods sold:
Merchandise inventory,December 31, 1989 $19,000
Purchases $235,800
Less: Purchase returns and allowances 1,200
Purchase discounts 4,100
Net purchases $230,500
Add transportation-in 1,500
Cost of goods purchased $232,000
Goods available for sale $251,000
Merchandise inventory,December 31, 1990 21,000
Cost of goods sold $230,000

Inventory Losses

Stores lose merchandise in a variety of ways, such as shrinkage, spoilage, and shoplifting. When you use a periodic inventory system, these lost items are hidden in the cost of goods sold figure.

Income Statement of a Merchandising Company

A classified income statement for a store has:

1. A revenue section.

2. A cost of goods section.

3. An operating expenses section. This section is broken-down into two parts.

(i) Selling expense - The expense for storing and preparing goods for sale, advertising, delivering goods, etc.

(ii) General and administrative expense - These expenses are for the overall management of a business, which includes departments: Central office, accounting, personnel, and collections office.

Iowa Sales, Incorporated
Income Statement
For Year Ended December 31, 1990
Revenue from sales:
Gross sales $306,200
Less :Sales returns and allowances 1,900
Sales discounts 4,300 6,200
Net sales $300,000
Cost of goods sold:
Merchandise inventory,December 31, 1989 $19,000
Purchases $235,800
Less: Purchase returns and allowances 1,200
Purchase discounts 4,100
Net purchases $230,500
Add transportation-in 1,500
Cost of goods purchased $232,000
Goods available for sale $251,000
Merchandise inventory, December 31, 1990 21,000
Cost of goods sold $230,000
Gross profit from sales $70,000
Operating expenses:
Selling expenses:
Sales salaries expense
Rent expense, selling expense
Advertising expense
Store supplies expense
Depreciation expense, store equipment
Total selling expense $30,700
General and administrative expenses:
Office salaries expense
Rent expense, office space
Insurance expense
Office supplies expense
Depreciation expense, office equipment
Total general and administrative expenses 28,200
Total operating expenses 58,900
Income from operations $11,100
Less income taxes expense 1,700
Net Income $9,400

Work Sheet of a Merchandising Company

The account period is 1 year.

1. List all the accounts in the ledger and their balances.

2. You make the adjustments. In the U.S., the corporations have to pay taxes periodically. The corporations do not know what their net income is, so they have to estimate it. The corporations pay taxes on this estimated income periodically, such as once amonth. Each tax payment is recorded as an expense.

Iowa Sales, Incorporated
Work Sheet for Year EndedDecember 31, 1990
Unadjusted Trial Balance Adjustments Income Statement Balance Sheet
Debit Credit Debit Credit Debit Credit Debit Credit
Cash 8,200 8,200
Accounts receivable 11,200 11,200
Merchandise inventory 19,000 19,000 21,00 21,000
Prepaid insurance 900 600 300
Store supplies 600 400 200
Office supplies 300 200 100
Store equipment 29,100 29,100
Accum. depr. store equipment 2,500 3,000 5,500
Office equipment 4,400 4,400
Accum. depr. office equipment 600 700 1,300
Accounts payable 3,600 3,600
Income taxes payable 100 100
Common stock 50,000 50,000
Retained earnings 8,600 8,600
Dividends declared 4,000 4,000
Sales 306,200 306,200
Sales returns and allowances 1,900 1,900
Sales discounts 4,300 4,300
Purchases 235,800 235,800
Pur. returns and allowances 1,200 1,200
Purchases discounts 4,100 4,100
Transportation-in 1,500 1,500
Sales salaries expense 18,500 18,500
Rent expense, selling space 8,100 8,100
Advertising expense 700 700
Store supplies expense 400 400
Depr. expense, store equipment 3,000 3,000
Office salaries expense 25,800 25,800
Rent expense, office space 900 900
Insurance expense 600 600
Office supplies expense 200 200
Depr. expense, office equipment 700 700
Income taxes expense 1,600 100 1,700
376,800 376,800 5,000 5,000 323,100 332,500 78,500 69,100
Net Income 9,400 9,400
Total 332,500 332,500 78,500 78,500

However, at the end of the year, the corporation knows its net income. Usually the corporation underestimated its taxes, so it makes an adjustment at the end of the year to pay the correct amount of taxes (lines 12 and 33). The business owes $100 to the government.

After you make all other adjustments, you place the new balances on its appropriate section (Income or Balance Sheetsections).

3. The income statement should include revenue, cost of goods sold, and expense items.

4. The beginning inventory amount. The $19,000 inventory balance is recorded as a debt on the income statement, because it is a positive element in the calculation of cost of goods sold. Then you add purchases of goods to this amount.

5. The Ending Inventory Amount.

At the end of the year (i.e. accounting period), you have to take an inventory count. This is $21,000.This appears as a credit on the Income Statement, because you have to subtract this off from the cost of goods sold (i.e. it was not sold). The store has this inventory, so it is an debit item on the balance sheet (i.e. asset).

Completing the Work Sheet and Preparing the Financial Statements

After completing the work sheet and sorting the accounts to the proper columns for the income statement and balance sheet, you can prepare the financial statements.

1. Income Statement.

See income statement of Iowa Sale, Inc.

2. The second statement is the retained earnings statement. This is equivalent to changes in owner’s equity, but this is a corporation. This information is found on the last two columns on the worksheet.

Iowa Sales, Incorporated
Retained Earnings Statement
For Year Ended December 1, 1990
Retained earnings, December 31, 1989 $8,600
Add 1990 net income $9,400
Total $18,000
Deduct dividends earned $4,000
Retained earnings,December 31, 1990 $14,000

3. Then finally you prepare the balance sheet. The $14,000 retained earnings is placed on the balance sheet statement.

Iowa Sales, Incorporated
Balance Sheet
December 31, 1990
Current assets:
Accounts receivables
Merchandise inventory
Prepaid expenses
Total current assets $41,000
Plant and equipment:
Store equipment
Less accumulated depreciation
Office equipment
Less accumulated depreciation
Total plant and equipment 26,700
Total Assets $67,700
Current liabilities:
Accounts payable
Income taxes payable
Total liabilities $3,700
Stockholders’ Equity
Common stock, $5 par value, 10,000 shares authorized and outstanding
Retained earnings
Total stockholders’ equity
Total liabilities and stockholders’ equity $67,700

Adjusting and Closing Entries

From the worksheet, you have the necessary journal entries. Then you close the temporary accounts into the Income Summary and also the other accounts.

Closing Entries and the Inventory

Before closing entries, the merchandise inventory account had a balance of $19,000 from the beginning of the accounting cycle. When the first closing is posted, this account goes to zero. When you post the second closing entry, this account goes to $21,000. This balance will remain throughout the succeeding year.

1990 Adjusting Entries
Dec. 31 Insurance Expense $600
Prepaid Insurance $600
31 Store Supplies Expense $400
Store Supplies $400
31 Office Supplies Expense $200
Office Supplies $200
31 Depreciation Expense, Store Equipment $3,000
Accumulated Depreciation, Store Equipment $3,000
31 Depreciation Expense, Office Equipment $700
Accumulated Depreciation, Office Equipment $700
31 Income Taxes Expense $100
Income Taxes Payable $100
Closing Entries
31 Income Summary $323,100
Merchandise Inventory
Sales Returns and Allowances
Sales Discounts
Sales Salaries Expense
Rent Expense, Selling Space
Advertising Expense
Store Supplies Expense
Office Salaries Expense
Rent Expense, Office Space
Insurance Expense
Office Supplies Expense
Depreciation Expense, Office Equipment
Income Taxes Expense
31 Merchandise Inventory
Purchases Returns and Allowances
Purchase Discounts
Income Summary $332,500
31 Income Summary $9,400
Retained Earnings $9,400
31 Retained Earnings $4,000
Dividends Declared $4,000

Multiple-Step and Single-Step Income Statements

The first income statement shows all major groups of the cost of goods sold and the expenses. Corporations usually simplify their income statements to their shareholders, investors, etc., which is called a single-step income statement. The multi-step income statement is the first income statement you saw for this lecture. Then corporations will simplify their financial statements further by combining the single-step income statement with the Retained Earnings Statement.

Iowa Sales, Incorporated
Statement of Income and Retained Earnings
For Year Ended December 31, 1990
Revenue from sales $300,000
Cost of goods sold $230,000
Selling expenses 30,700
General and administrative expenses 28,200
Income taxes expense 1,700
Total expenses $290,600
Net income $9,400
Add retained earnings, December 31, 1989 $8,600
Total $18,000
Deduct dividends declared 4,000
Retained earnings,December 31, 1990 $14,00

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