In Chapters 1-4, all text examples were ones involving service businesses. In this lesson, we examine the accounting for merchandising operations -- those that sell products. An example of a merchandising Income Statement appears in Illustration 5-11 on page 198. Youll note that in addition to the operating expenses, there is something called Cost of Goods Sold. Cost of Goods Sold is the cost of the inventory that was sold, and is often the major cost of a merchandising company. The cost of inventory that was not sold would appear as the balance of the inventory account on the Balance Sheet.
A productive approach to Chapter 5 is as follows:
Learn the account names, locations, and how the journal entries work;
Get a fundamental understanding of the Income Statement;
Study the closing entries for a merchandising company;
There are two general methodologies for merchandising accounting:
Chapter 5 concentrates on the perpetual system. The "perpetual" refers to the fact that every purchase of inventory is debited to the Inventory account; likewise, every sale of inventory is credited to the Inventory account. Therefore, unless there has been a theft or unrecorded loss of some units of inventory, the Inventory account should reflect the current cost of inventory on hand.
In the perpetual inventory system, you'll find a new account in the assets section (Merchandise Inventory) and several new accounts in owner's equity that are used for recording sales, subtractions from sales, and cost of goods sold.
As suggested above, the Perpetual method makes use of the Inventory account when Inventory is purchased sold. Here is a summary of the typical journal entries:
When inventory is purchased, a debit is made to the Inventory account and a credit made to Cash or Accounts Payable. Inventory is a current asset.Example: Jones purchases $5,000 of Inventory on account, with terms of 2/10, n/30. The journal entry would be:
As mentioned earlier, the Merchandising Income Statement is illustrated on page 198 in Illustration 5-11. The general format of this statement is as follows:
This is the format for a multiple step income statement. There are two main calculations (the steps), as follows:
Net Sales - Cost of Goods Sold = Gross Profit
Gross Profit - Expenses = Net Income
For simplicity, I've omitted the Other Revenues and Gains, and the Other Expenses and Losses.Your text also illustrates a single step income statement, in which Cost of Goods Sold is simply presented as an ordinary expense. This form of statement appears on page 199 in Illustration 5-12.
Going back to the T-accounts for the Perpetual Inventory method, the closing entries would be journalized as follows:
|Sales Ret. & All.||XXX|
|Cost of Goods Sold||XXX|
An example of the closing entries appears on pages 193-194.
Write out the answers to the following Questions, Exercises, and Problems on pages 210-226.
BE 5-1, BE 5-3, BE 5-4
E5-1, 5-2, 5-6, 5-7
Q5 Cost of Goods Sold is determined at the moment of sale.
Q15 Tricky question: Gross Profit is $39,000
Q16 Operating Expenses = $330,000
BE5-3a. Seller's viewpoint. Debit Accounts Receivable $800,000, credit Sales $800,000; then debit COGS $620,000 and credit Merchandise Inventory $620,000.
BE5-4a.. Buyer's viewpoint. Deebit Merchandise Inventory for $800,000 and credit Accounts Payable for $800,000.
P5-2A c. Net Sales = $12,650; Cost of Goods Sold = $8,800; Gross Profit = $3,850. Check your journal entries here.
Consider the situation in which a person invests money for retirement. How much would you hope to earn in a bank account, mutual fund, or in the stock market? Would 6% be satisfactory to you? Turning to the nature of merchandising businesses, what sort of return do you think they make? There are a couple of interesting measures that you might consider:
1. Gross Profit Percentage = Gross Profit divided by Net Sales
2. Net Income as a Percent of Net Sales = Net Income divided by Net Sales
Choose two merchandising companies and then go to their web sites or home pages, and
see if you can locate the income statement. Calculate the Gross Profit Percentage
and the Net Income as a Percent of Net Sales. On the home page, look for something
like "About Us", "Investor Relations" or "Annual Reports."
You might even be able to find enough detail in the "Financial
Two other items: unlike your textbook, most companies do not calculate the gross profit in the income statement, so grab your calculator before logging in. Also, you may find that Cost of Goods Sold is called "Cost of Sales" and may be combined with other costs. This is ok; just make an approximate calculation. Here are some possibilities for your search:
Chapter 5 Quiz
Revised: December 2004
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