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UNIT 3. ACCOUNTING FOR MERCHANDISING BUSINESSESUNIT 3. ACCOUNTING FOR MERCHANDISING BUSINESSES

ContentsContents

3.0 Aims & Objectives3.0 Aims & Objectives

3.13.1 IntroductionIntroduction3.23.2 Nature of a Merchandising BusinessNature of a Merchandising Business

3.2.13.2.1 What is a Merchandising BusinessWhat is a Merchandising Business

3.2.23.2.2 Comparison of Financial Statements for Merchandising andComparison of Financial Statements for Merchandising and

Service BusinessesService Businesses

3.33.3 The Periodic and the Perpetual Inventory SystemsThe Periodic and the Perpetual Inventory Systems

3.3.13.3.1 The Periodic Inventory SystemThe Periodic Inventory System

3.3.23.3.2 Perpetual Inventory SystemsPerpetual Inventory Systems

3.43.4 Recording Purchase and Sales TransactionsRecording Purchase and Sales Transactions

3.4.13.4.1 Recording SalesRecording Sales

3.4.23.4.2 Recording PurchasesRecording Purchases

3.53.5 Completing the Worksheet for a Merchandising BusinessCompleting the Worksheet for a Merchandising Business

3.63.6 Preparing Financial Statements for Merchandising BusinessesPreparing Financial Statements for Merchandising Businesses

3.73.7 SummarySummary

3.83.8 Answers to Check Your Progress QuestionsAnswers to Check Your Progress Questions

3.93.9 Model Examination QuestionsModel Examination Questions

3.103.10 Glossary of TermsGlossary of Terms

3.0 AIMS & OBJECTIVES3.0 AIMS & OBJECTIVES

After reading this unit, you will be able to:After reading this unit, you will be able to:

-- describe what a merchandising business is and compare it to a service giving business.describe what a merchandising business is and compare it to a service giving business.

-- describe the difference between the two alternative systems of recording inventorydescribe the difference between the two alternative systems of recording inventory

(periodic and the perpetual inventory systems)(periodic and the perpetual inventory systems)

-- record journal entries for merchandising transactions such as the purchase and sale ofrecord journal entries for merchandising transactions such as the purchase and sale of

merchandisemerchandise

-- complete the worksheet of a merchandising business and record adjustment journalcomplete the worksheet of a merchandising business and record adjustment journal

entries related to the Merchandise Inventory accountentries related to the Merchandise Inventory account

-- prepare financial statements for a merchandising businessprepare financial statements for a merchandising business

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3.1 INTRODUCTION3.1 INTRODUCTION

In the previous chapters, you saw how to record transactions of a service business. The stepsIn the previous chapters, you saw how to record transactions of a service business. The steps

that we go through to prepare the financial statements of other types of businesses (such as athat we go through to prepare the financial statements of other types of businesses (such as a

merchandising business) are basically the same. Transactions are first journalized, and thenmerchandising business) are basically the same. Transactions are first journalized, and thenposted to the ledger; a worksheet is prepared and completed. But, there are someposted to the ledger; a worksheet is prepared and completed. But, there are some

transactions in merchandising companies that you dont find in a service giving business, liketransactions in merchandising companies that you dont find in a service giving business, like

the purchase of goods for sale and the sale of those goods. The first section of this chapter,the purchase of goods for sale and the sale of those goods. The first section of this chapter,

therefore, discusses the nature of a merchandising business and how to record merchandisingtherefore, discusses the nature of a merchandising business and how to record merchandising

transactions. The next section discusses about the preparation of financial statements fortransactions. The next section discusses about the preparation of financial statements for

merchandising companies.merchandising companies.

SECTION-ONE:SECTION-ONE: RECORDING MERCHANDISING TRANSACTIONSRECORDING MERCHANDISING TRANSACTIONS

3.2 NATURE OF A MERCHANDISING BUSINESS3.2 NATURE OF A MERCHANDISING BUSINESS

3.2.13.2.1What is a Merchandising BusinessWhat is a Merchandising Business??

A merchandising business buys goods in finished form for resale to customers.A merchandising business buys goods in finished form for resale to customers.

A merchandising business sells tangibleA merchandising business sells tangible goodsgoods to its customers. When we say goods it can beto its customers. When we say goods it can be

anything that has physical characteristics that you can see and touch (i.e., tangible). Theseanything that has physical characteristics that you can see and touch (i.e., tangible). These

can be goods ranging from television sets, cars, office table and chair (furniture), to chewingcan be goods ranging from television sets, cars, office table and chair (furniture), to chewing

gums, toothbrushes and various stationery. These goods that a merchandising company sellsgums, toothbrushes and various stationery. These goods that a merchandising company sells

to its customers are calledto its customers are called merchandise inventorymerchandise inventory. (A customer is an individual or a firm to. (A customer is an individual or a firm to

whom a business sells its products.)whom a business sells its products.)

One final thing that you should know about a merchandising business is that a merchandisingOne final thing that you should know about a merchandising business is that a merchandising

company does not produce the goods that it sells. Instead, it buys these goods fromcompany does not produce the goods that it sells. Instead, it buys these goods from

manufacturersmanufacturers, which produce the goods using raw materials., which produce the goods using raw materials.

The following diagram can help you to better visualize the flow of goods from a manufacturerThe following diagram can help you to better visualize the flow of goods from a manufacturer

to the final consumer:to the final consumer:

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Merchandising companiesMerchandising companies

sellssells

goods goodsgoods goods

AA wholesalerwholesaler is a trader, which buys goods from manufacturers and sells them to a retailer oris a trader, which buys goods from manufacturers and sells them to a retailer or

another wholesaler. It is theanother wholesaler. It is the retailerretailer who sells the goods to the final consumer by buyingwho sells the goods to the final consumer by buying

them from wholesalers (or sometimes from a manufacturer).them from wholesalers (or sometimes from a manufacturer).

When you want to buy a soap to wash your clothes, where do you buy it? Who is theWhen you want to buy a soap to wash your clothes, where do you buy it? Who is the

manufacturer of the soap? Are there any wholesalers of that soap in your area? Can themanufacturer of the soap? Are there any wholesalers of that soap in your area? Can the

wholesaler be taken as the customer of the manufacturer? And finally, can we say the shopwholesaler be taken as the customer of the manufacturer? And finally, can we say the shop

from which you buy the soap is a merchandising business?from which you buy the soap is a merchandising business?

3.2.2 Comparison of Financial Statements for Merchandising and Service3.2.2 Comparison of Financial Statements for Merchandising and Service

BusinessesBusinesses

Income StatementIncome Statement

A model income statement for a merchandising business and another one for a serviceA model income statement for a merchandising business and another one for a service

business are shown below. Compare them carefully.business are shown below. Compare them carefully.

ABC service companyABC service company

Income statementIncome statement

For the year ended Dec.31, 200xFor the year ended Dec.31, 200x

XYZ merchandisingXYZ merchandising


For the year ended Dec.31, 200xFor the year ended Dec.31, 200x

Revenue:Revenue:

Service fee.Birr 23,200Service fee.Birr 23,200

Revenue:Revenue:

Net SalesBirr 360,000Net SalesBirr 360,000

Cost of goods sold.(Cost of goods sold.(256,000256,000))

Gross Profit .104,000Gross Profit .104,000Expenses:Expenses:

Various Operating Expenses (Various Operating Expenses (71207120))

Net IncomeNet Income 1608016080

Various OperatingVarious Operating

Expenses.(Expenses.(79,40079,400))

Net Income ..Net Income ..24,60024,600

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As you can see from the above Income Statements, merchandising companies have to pay toAs you can see from the above Income Statements, merchandising companies have to pay to

buy the goods that they sell. Therefore, they have to deduct this cost of goods sold in additionbuy the goods that they sell. Therefore, they have to deduct this cost of goods sold in addition

to other operating expenses from their sales revenue to determine their net income.to other operating expenses from their sales revenue to determine their net income.

The difference between sales revenue and cost of goods sold is referred to as gross profit.The difference between sales revenue and cost of goods sold is referred to as gross profit.

Why gross? Because other expenses have yet to be deducted to arrive at the net profit or netWhy gross? Because other expenses have yet to be deducted to arrive at the net profit or net

income of the business.income of the business.

Balance SheetBalance Sheet

The Balance Sheet of a service business and that of a merchandising business are similar inThe Balance Sheet of a service business and that of a merchandising business are similar in

every aspect except one thing. The current assets section of the Balance Sheet of aevery aspect except one thing. The current assets section of the Balance Sheet of a

merchandising business includes one asset that service companies do not have. That ismerchandising business includes one asset that service companies do not have. That is

merchandise inventory. Merchandise inventory refers to goods bought by a merchandisingmerchandise inventory. Merchandise inventory refers to goods bought by a merchandising

business for resale to customers. So, if a merchandising business has some unsold goodsbusiness for resale to customers. So, if a merchandising business has some unsold goods

(merchandise) on hand at the end of the year this would be reported as one asset on the(merchandise) on hand at the end of the year this would be reported as one asset on the

Balance Sheet.Balance Sheet.

3.3 THE PERIODIC AND THE PERPETUAL INVENTORY SYSTEMS3.3 THE PERIODIC AND THE PERPETUAL INVENTORY SYSTEMS

The value of goods (merchandise) on hand at the end of the year for resale would be reportedThe value of goods (merchandise) on hand at the end of the year for resale would be reported

on the Balance Sheet as one asset as described above. This means that we need to open aon the Balance Sheet as one asset as described above. This means that we need to open a

separate ledger account in which to record merchandise inventory information.separate ledger account in which to record merchandise inventory information.

The two alternatives in dealing with this account are:The two alternatives in dealing with this account are:

1.1. To up date this account every time goods are bought and sold (continuously =To up date this account every time goods are bought and sold (continuously =

perpetually) orperpetually) or

2.2. To up date this account only at the end of the period (periodically).To up date this account only at the end of the period (periodically).

3. 3.1 The Periodic Inventory System3. 3.1 The Periodic Inventory System

Under this system, as the name periodic suggests, the inventory account is updated onlyUnder this system, as the name periodic suggests, the inventory account is updated only

periodically i.e., only at the end of a period.periodically i.e., only at the end of a period.

When goods are bought, a temporaryWhen goods are bought, a temporary purchasespurchasesaccount is debited instead of the inventoryaccount is debited instead of the inventory

account itself. Likewise, when goods are sold revenue is recorded, but the fact that there is aaccount itself. Likewise, when goods are sold revenue is recorded, but the fact that there is a

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reduction in merchandise inventory is not recognized. This is because the Merchandisereduction in merchandise inventory is not recognized. This is because the Merchandise

Inventory account is not credited every time goods are sold.Inventory account is not credited every time goods are sold.

Therefore, if one wants to know the cost of goods on hand, it is a must that a physicalTherefore, if one wants to know the cost of goods on hand, it is a must that a physical

inventory be conducted first. The account doesnt reflect the value of goods on hand becauseinventory be conducted first. The account doesnt reflect the value of goods on hand because

it was not up dated when merchandise was bought and sold.it was not up dated when merchandise was bought and sold. Physical inventoryPhysical inventory meansmeans

counting the quantity of goods on hand. Once the quantity of goods on hand has beencounting the quantity of goods on hand. Once the quantity of goods on hand has been

determined, it is multiplied by the unit price of those goods to determine the cost of goods ondetermined, it is multiplied by the unit price of those goods to determine the cost of goods on

hand.hand.

In conclusion, under the periodic system, since the merchandise inventory account is notIn conclusion, under the periodic system, since the merchandise inventory account is not

continually updated, the cost of merchandise on hand is determined only at the end of thecontinually updated, the cost of merchandise on hand is determined only at the end of the

period after carrying out a physical inventory.period after carrying out a physical inventory.

Companies such as department stores or super markets, which sell small items, use periodicCompanies such as department stores or super markets, which sell small items, use periodic

systems.systems.

3.3.23.3.2 Perpetual Inventory SystemsPerpetual Inventory Systems

A perpetual inventory system continuously records the amount of inventory on handA perpetual inventory system continuously records the amount of inventory on hand

(perpetual =continuous). Under this system, the merchandise inventory account is debited or(perpetual =continuous). Under this system, the merchandise inventory account is debited or

credited every time (goods) are bought or sold. When an item is sold, its cost is recorded in acredited every time (goods) are bought or sold. When an item is sold, its cost is recorded in aseparate cost of goods sold account in addition to recording sales.separate cost of goods sold account in addition to recording sales.

The cost of merchandise on hand can be looked up from the merchandise Inventory accountThe cost of merchandise on hand can be looked up from the merchandise Inventory account

any time, without conducting a physical inventory.any time, without conducting a physical inventory.

Check Your Progress Exercise-1Check Your Progress Exercise-1

If you have a supermarket business, would you use the perpetual or periodic system? What ifIf you have a supermarket business, would you use the perpetual or periodic system? What if

your system is computerized? Explain.your system is computerized? Explain.

3.4 RECORDING PURCHASES AND SALES TRANSACTIONS3.4 RECORDING PURCHASES AND SALES TRANSACTIONS

The following discussions in the remainder of this chapter all assume the use of a periodicThe following discussions in the remainder of this chapter all assume the use of a periodic

inventory system. The perpetual system will be discussed in part two of this course.inventory system. The perpetual system will be discussed in part two of this course.

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3.4.1 Recording Sales3.4.1 Recording Sales

When a merchandising company transfers goods to the buyer, in exchange for cash or aWhen a merchandising company transfers goods to the buyer, in exchange for cash or a

promise top at a later date, revenue is produced to the company. This revenue is recorded in apromise top at a later date, revenue is produced to the company. This revenue is recorded in a

SalesSales account. However, the sales revenue, which is reported on the Income Statement isaccount. However, the sales revenue, which is reported on the Income Statement is NetNet

SalesSales. That is,. That is,

Net Sales = Gross Sales Sales Discounts- Sales Returns and AllowancesNet Sales = Gross Sales Sales Discounts- Sales Returns and Allowances

Recording Gross SalesRecording Gross Sales

The gross sales amount is obtained from sales invoices. AnThe gross sales amount is obtained from sales invoices. An invoiceinvoice is a document, preparedis a document, prepared

by the seller of merchandise to notify to the buyer the details of the sale. These details canby the seller of merchandise to notify to the buyer the details of the sale. These details can

include number of items sold, unit price of items, total price, terms of sale and manner ofinclude number of items sold, unit price of items, total price, terms of sale and manner of

shipment. When goods are delivered to the customer, the Sales account is credited becauseshipment. When goods are delivered to the customer, the Sales account is credited because

revenues are increased by credits.revenues are increased by credits.

A company can sell goods either for cash or on account.A company can sell goods either for cash or on account.

Recording Cash SalesRecording Cash Sales

When merchandise is sold on cash, the Cash account is debited and the revenue account SalesWhen merchandise is sold on cash, the Cash account is debited and the revenue account Sales

is credited.is credited.

ExampleExampleIka Company based in Bahir Dar, buys and sells used commodities. On JanuaryIka Company based in Bahir Dar, buys and sells used commodities. On January

14. 2001. Ika sold goods for Birr 20,000. Record the transaction.14. 2001. Ika sold goods for Birr 20,000. Record the transaction.

Answer:Answer:

January 14, Dr. Cash..20,000.00January 14, Dr. Cash..20,000.00

Cr. Sales20,000.00Cr. Sales20,000.00

Recording Credit SalesRecording Credit Sales

The Accounts Receivable account is debited when goods are sold on account (for credit).The Accounts Receivable account is debited when goods are sold on account (for credit).

Example -Example -

Ika sold goods worth Birr 35,000 on account on January 15, 2001. Record the transaction.Ika sold goods worth Birr 35,000 on account on January 15, 2001. Record the transaction.

SolutionSolution

January 15. Accounts Receivable..35,000.00January 15. Accounts Receivable..35,000.00

Sales35,000.00Sales35,000.00

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Determining Gross Sales when there are trade discountsDetermining Gross Sales when there are trade discounts

A trade discount isA trade discount is a percentage deduction from the specified list price or catalogue price ofa percentage deduction from the specified list price or catalogue price of

merchandise.merchandise.

Trade discounts allow us:Trade discounts allow us:

-- To avoid publishing a new catalogues every time prices change.To avoid publishing a new catalogues every time prices change.

-- To grant quantity discountsTo grant quantity discounts

-- Quotation of different prices to different types of customers.Quotation of different prices to different types of customers.

Trade discounts are not recorded in the sellers accounting records; they are only used toTrade discounts are not recorded in the sellers accounting records; they are only used to

calculate the gross selling price.calculate the gross selling price.

ExampleExample: IKA sold 500 T.V. sets, each with a list price of Birr 80, on January 17, 2001 for: IKA sold 500 T.V. sets, each with a list price of Birr 80, on January 17, 2001 for

cash. It gave the customer a 30% trade discount, as the customer was a very loyal one.cash. It gave the customer a 30% trade discount, as the customer was a very loyal one.

Record the sale.Record the sale.

Answer:Answer:

List price of goods ( 80 X 500) Birr 40,000List price of goods ( 80 X 500) Birr 40,000

Less: Trade discount (30 % of 40,000)Less: Trade discount (30 % of 40,000) (12,000(12,000))

Invoice priceInvoice price 28,00028,000

Journal entry:Journal entry:

Cash..28,000Cash..28,000

Sale28,000Sale28,000

Check Your Progress Exercise 2Check Your Progress Exercise 2

1. Record the journal entry if IKa Company above sold goods with a list price of BirrRecord the journal entry if IKa Company above sold goods with a list price of Birr

52,000 to a customer on account. Ika offered the customer a trade discount of 20% for52,000 to a customer on account. Ika offered the customer a trade discount of 20% for

purchasespurchases aboveabove Birr 40,000 as it usually does.Birr 40,000 as it usually does.

Recording Deductions from Gross SalesRecording Deductions from Gross Sales

Go back to illustration 1- and have a look at the model Income Statement of a merchandisingGo back to illustration 1- and have a look at the model Income Statement of a merchandising

company. You will see that the sales reported on the income statement iscompany. You will see that the sales reported on the income statement is net salesnet sales, i.e., after, i.e., after

deduction of sales discounts and sales returns and allowances.deduction of sales discounts and sales returns and allowances.

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Gross sales (from invoice)..XXXGross sales (from invoice)..XXX

Less: Sales discounts.(XX)Less: Sales discounts.(XX)

Sales returns and allowances ...(Sales returns and allowances ...(XX)XX)

Net sales.Net sales.XXXX

Sales DiscountsSales Discounts

Sales Discounts are deductions from invoice price to customers who pay early when goodsSales Discounts are deductions from invoice price to customers who pay early when goods

are sold on credit.are sold on credit.

As a seller, you would usually want to be paid as soon as possible. This is because, as youAs a seller, you would usually want to be paid as soon as possible. This is because, as you

can imagine, you can use the money for various purposes once you have been paid. If youcan imagine, you can use the money for various purposes once you have been paid. If you

want your customers to pay you early the customary practice is to offer them a (deduction)want your customers to pay you early the customary practice is to offer them a (deduction)

discount from the invoice price if they pay early.discount from the invoice price if they pay early.

How much discount is given usually depends on theHow much discount is given usually depends on the credit tercredit terms. These terms (agreements)ms. These terms (agreements)

are usually stated on the invoice. The most frequently used terms are stated below:are usually stated on the invoice. The most frequently used terms are stated below:

-- n/30 or Net 30 means there is no discount even if the customer pays before then/30 or Net 30 means there is no discount even if the customer pays before the

payment date.payment date.

-- 2/10, n/30 means the due date of the payment is after 30 days of the sale. But if the2/10, n/30 means the due date of the payment is after 30 days of the sale. But if the

customer pays with in 10 days she will get a 2% discount.customer pays with in 10 days she will get a 2% discount.

-- 2/EOM, n/60- means the normal due date is with in 60 days of the sale but the2/EOM, n/60- means the normal due date is with in 60 days of the sale but the

customer will get a 2% discount if she pays before the end of month of sale.customer will get a 2% discount if she pays before the end of month of sale.

Check Your Progress Exercise -3Check Your Progress Exercise -3

1. What do the credit terms 1/15,n/60; 2/10, n/EOM; and n/60 mean?1. What do the credit terms 1/15,n/60; 2/10, n/EOM; and n/60 mean?

Sales discounts are purchase discounts from the side of the buyer. Sales discounts andSales discounts are purchase discounts from the side of the buyer. Sales discounts and

purchase discounts are the same thing seen from different sides. They are generally calledpurchase discounts are the same thing seen from different sides. They are generally called

cash discountscash discountstogether. A cash discount is, therefore, deduction from original invoice pricetogether. A cash discount is, therefore, deduction from original invoice price

for early payment when goods are sold on credit (on account).for early payment when goods are sold on credit (on account).

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Example:Example:

On January 21, 2001 IKA Company sold merchandise for birr 20,000 on account. The creditOn January 21, 2001 IKA Company sold merchandise for birr 20,000 on account. The credit

terms are 2/30, n/30. The customer paid on January 31, (10 days after invoice date).terms are 2/30, n/30. The customer paid on January 31, (10 days after invoice date).

A.A. How much would IKA Company collect from this sale?How much would IKA Company collect from this sale?

B.B. Record the necessary journal entries on January 21 and January 31.Record the necessary journal entries on January 21 and January 31.

Solution:Solution:

A-A- Since the customer paid with in the discount period, i.e., with in 10 days, she will get aSince the customer paid with in the discount period, i.e., with in 10 days, she will get a

2% discount. Therefore,2% discount. Therefore,

Invoice price..20,000Invoice price..20,000Less: Sales Discount (2% X 20,000)(Less: Sales Discount (2% X 20,000)(400)400)

Cash collected .Cash collected . 19,60019,600

B-B- Journal Entries:Journal Entries:

January 21 A/R..20,000January 21 A/R..20,000

Sales..20,000Sales..20,000

January 31, Cash.19600January 31, Cash.19600

Sales Discounts ...400Sales Discounts ...400

A/R..20,000A/R..20,000

You might initially have thought of debiting the Sales account for Birr 400 on January 31,You might initially have thought of debiting the Sales account for Birr 400 on January 31,

since the actual cash collected from the sales of those goods is birr 400 less than what wassince the actual cash collected from the sales of those goods is birr 400 less than what was

recorded as Sales on January 21. But it is better to record the reduction in sales in a separaterecorded as Sales on January 21. But it is better to record the reduction in sales in a separate

contra Sales account. Acontra Sales account. A contracontra account reduces another account. In this case, the amount inaccount reduces another account. In this case, the amount in

the Sales Discount account will be deducted from (Gross) Sales on the income statement. Thatthe Sales Discount account will be deducted from (Gross) Sales on the income statement. That

way, we can disclose how much sales discount was offered and taken during the year on theway, we can disclose how much sales discount was offered and taken during the year on the

income statement, separately.income statement, separately.

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Check Your Progress Exercise - 4Check Your Progress Exercise - 4

IKA Company sold goods worth Birr 120,000 on account to Gizu company terms 1/10, n/60IKA Company sold goods worth Birr 120,000 on account to Gizu company terms 1/10, n/60

on January 18, 2001. Gizu Company paid on January 28, 2001.on January 18, 2001. Gizu Company paid on January 28, 2001.

A-A- How much would IKA Company collect from this sale?How much would IKA Company collect from this sale?

B-B- Record the necessary journal entries on January 18 and on January 28.Record the necessary journal entries on January 18 and on January 28.

Sales Returns and AllowancesSales Returns and Allowances

Customers can return merchandise they have bought if they find it to be defective or of theCustomers can return merchandise they have bought if they find it to be defective or of the

wrong model, or unsatisfactory for a variety of reasons. A sales return is merchandisewrong model, or unsatisfactory for a variety of reasons. A sales return is merchandise

returned by a buyer. The buyer would be paid back her money if she has already paid.returned by a buyer. The buyer would be paid back her money if she has already paid.

AA sales allowancesales allowance is a deduction from the original invoice price when the customer keeps theis a deduction from the original invoice price when the customer keeps the

merchandise but is dissatisfied. If, for example, a customer buys an item worth birr 100 andmerchandise but is dissatisfied. If, for example, a customer buys an item worth birr 100 and

finds it to be of the wrong color after receiving it, she may still want to retain the item even iffinds it to be of the wrong color after receiving it, she may still want to retain the item even if

she is dissatisfied with its color. In that case the seller may let her pay only, say, Birr 95 byshe is dissatisfied with its color. In that case the seller may let her pay only, say, Birr 95 by

giving her an allowance of Birr 5.giving her an allowance of Birr 5.

Example:Example:

IKA Company sold merchandise worth Birr 15, 000 on February 3, 2001 on account termsIKA Company sold merchandise worth Birr 15, 000 on February 3, 2001 on account terms

2/10, n/30. On February 5, the buyer returned a portion of the goods worth Birr 5,000 as they2/10, n/30. On February 5, the buyer returned a portion of the goods worth Birr 5,000 as they

were found to be of the wrong model. The buyer then paid on February 13, 2001.were found to be of the wrong model. The buyer then paid on February 13, 2001.

Record the necessary journal entries on February 3,5 and 13.Record the necessary journal entries on February 3,5 and 13.

Solution:Solution:

February 3February 3 A/R.15,000A/R.15,000

Sales .15,000Sales .15,000

February 5February 5 Sales Returns and Allowances 5,000Sales Returns and Allowances 5,000

A/R.5,000A/R.5,000

February 13February 13 Cash..9800Cash..9800

Sales Discount .. 200Sales Discount .. 200

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A/R10,000A/R10,000

Here, the buyer paid with in the discount period. Therefore, the amount that would beHere, the buyer paid with in the discount period. Therefore, the amount that would be

collected is:collected is:

15,000 5,000 = 10,00015,000 5,000 = 10,000

DeductDeduct: 2% Cash discount: 2% Cash discount (200)(200)

Cash collectedCash collected 98009800


Assume the customer in the above example returned the goods on February 15 instead ofAssume the customer in the above example returned the goods on February 15 instead of

February 5, after paying with in the discount period on February 13. Record the relevantFebruary 5, after paying with in the discount period on February 13. Record the relevant

Journal entries on February 3, 13 and 15.Journal entries on February 3, 13 and 15.

Go back to illustration (1) once again on page and you will see that we have so far beenGo back to illustration (1) once again on page and you will see that we have so far been

dealing with what net sales is composed of. You should by now be able to figure out how thedealing with what net sales is composed of. You should by now be able to figure out how the

net sales figure on the income statement is arrived at.net sales figure on the income statement is arrived at.

In the following section, we will see how to record purchase transactions. Keep in mind that aIn the following section, we will see how to record purchase transactions. Keep in mind that a

merchandising company bothmerchandising company both buysbuys andand sellssells goods.goods.

3.4.2 Recording Purchases3.4.2 Recording Purchases

Under the periodic inventory system a merchandising company uses the Purchases account toUnder the periodic inventory system a merchandising company uses the Purchases account to

record the cost of goodsrecord the cost of goods boughtbought for resale to customers.for resale to customers.

Example:Example:

IKA Company bought goods worth Birr 43,000 from Saba Co., which is based in AddisIKA Company bought goods worth Birr 43,000 from Saba Co., which is based in Addis

Ababa, on account on January 4, 2001, terms 20/10, n/30. Record the transaction.Ababa, on account on January 4, 2001, terms 20/10, n/30. Record the transaction.

Solution:Solution:

January 4 Purchases ..43,000January 4 Purchases ..43,000

Accounts payable..43,000Accounts payable..43,000

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Record the same transaction for IKA Company if the merchandise were bought for cash.Record the same transaction for IKA Company if the merchandise were bought for cash.

..

Deductions from PurchasesDeductions from Purchases

Purchase DiscountsPurchase Discounts

A merchandising company can buy goods under credit terms that permit it to get a discount ifA merchandising company can buy goods under credit terms that permit it to get a discount if

it pays with in a specified period of time. The deduction from the original purchase price isit pays with in a specified period of time. The deduction from the original purchase price is

recorded in a separate contra Purchase account called Purchase Discounts.recorded in a separate contra Purchase account called Purchase Discounts.

Example:Example:

IKA Company bought goods worth Birr 50,000 from Gibir Company on account on JanuaryIKA Company bought goods worth Birr 50,000 from Gibir Company on account on January

14, 2001, terms 1/10,n/60. Ika Company paid on January 24, 2001. Record the transactions14, 2001, terms 1/10,n/60. Ika Company paid on January 24, 2001. Record the transactions

on both dates.on both dates.

Solution:Solution:

Jan. 14.Jan. 14. Purchases..50,000Purchases..50,000

A/P50,000A/P50,000

Jan. 24.Jan. 24. A/P 50,000A/P 50,000

Purchase Discounts .......500Purchase Discounts .......500

Cash.. 49,500Cash.. 49,500

Check your Progress Exercise -7Check your Progress Exercise -7

1. What would Gibir Company record on January 14, and January 24?1. What would Gibir Company record on January 14, and January 24?

Purchase Returns and allowancesPurchase Returns and allowances

A purchase return occurs when a buyer returns merchandise to a seller.A purchase return occurs when a buyer returns merchandise to a seller.

A purchase allowance is a reduction on the price of goods bought for dissatisfaction on theA purchase allowance is a reduction on the price of goods bought for dissatisfaction on the

side of the buyer.side of the buyer.

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Both purchase returns and purchase allowances are recorded in a contra purchase accountBoth purchase returns and purchase allowances are recorded in a contra purchase account

called Purchase Returns and Allowances.called Purchase Returns and Allowances.

Example:Example:

In the previous example for IKA Company, a portion of the goods worth birr 5,000 bought onIn the previous example for IKA Company, a portion of the goods worth birr 5,000 bought on

January 14 from Gibir Company were of the wrong size. Gibir Company acknowledged thisJanuary 14 from Gibir Company were of the wrong size. Gibir Company acknowledged this

and gave IKa Company a 5% price allowance on January 17.and gave IKa Company a 5% price allowance on January 17.

What should IKA Company record on January 17?What should IKA Company record on January 17?

Solution:Solution:

January 17 A/P250January 17 A/P250

Purchase Returnes and Allowance250Purchase Returnes and Allowance250

Check your Progress Exercise - 8Check your Progress Exercise - 8

1. What would Gibir Co. record on January 17?1. What would Gibir Co. record on January 17?

When both purchase discounts and purchase returns and allowances are deducted fromWhen both purchase discounts and purchase returns and allowances are deducted from

purchases what is obtained is called Net purchase. That is,purchases what is obtained is called Net purchase. That is,

Gross PurchaseXXGross PurchaseXX

LessLess: Purchase discounts.(XX): Purchase discounts.(XX)

Purchase returns and allowancesPurchase returns and allowances(XX)(XX)

Net Purchases.Net Purchases.XXXX

Transportation costsTransportation costs

Once merchandise has been bought it has to be moved from the sellers place to the buyersOnce merchandise has been bought it has to be moved from the sellers place to the buyers

place. A third party comes in to the scene here: theplace. A third party comes in to the scene here: the transportation companytransportation company who moves thewho moves the

goods between the two places.goods between the two places.

That is:That is:

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SellerSeller GoodsGoods goodsgoods goodsgoods BuyerBuyer

FreighterFreighter

So, the question is, who is going to pay to the freighter (transportation) company. Who coversSo, the question is, who is going to pay to the freighter (transportation) company. Who covers

the transportation costs depends, as you might have guessed, on the agreement between thethe transportation costs depends, as you might have guessed, on the agreement between the

buyer and seller. The agreements are usually stated in the either of these two terms:buyer and seller. The agreements are usually stated in the either of these two terms:

- FOB DestinationFOB Destination means free on board at destination . That is, since the means free on board at destination . That is, since the

destination of the goods is the buyers place, it is free at destination meansdestination of the goods is the buyers place, it is free at destination means

transportation cost is paid when the goods are loaded. It simplytransportation cost is paid when the goods are loaded. It simply means the seller paysmeans the sellerpays

transportation cost.transportation cost. FOB Destination means goods are shipped to their destination (toFOB Destination means goods are shipped to their destination (to

the buyer) with out transportation charge to the buyer.the buyer) with out transportation charge to the buyer.

- FOB shipping Point FOB shipping Point means free on board at shipping point. That is, goods aremeans free on board at shipping point. That is, goods are

loaded (on a truck or train) or shipped free of charge. It is, therefore, the buyer, whichloaded (on a truck or train) or shipped free of charge. It is, therefore, the buyer, which

pays to the transportation company when the goods reach the buyer (their destination)pays to the transportation company when the goods reach the buyer (their destination)

Briefly, when the terms areBriefly, when the terms are FOB Shipping Point the buyer pays transportation costs.FOB Shipping Point the buyer pays transportation costs.

Transportation costs paid by a buyer of merchandise increase the cost of merchandise. TheyTransportation costs paid by a buyer of merchandise increase the cost of merchandise. They

are recorded in a separate Transportation-In account that is used to record freight costsare recorded in a separate Transportation-In account that is used to record freight costs

incurred in the acquisition of merchandise.incurred in the acquisition of merchandise.

ExampleExample

IKA Company bought goods worth Birr 85,000 on account, terms 2/10,n/60 FOB shippingIKA Company bought goods worth Birr 85,000 on account, terms 2/10,n/60 FOB shipping

point on March 2, 2001.Transportoin cost of Birr 1,500 was paid on March 2. Ika Companypoint on March 2, 2001.Transportoin cost of Birr 1,500 was paid on March 2. Ika Company

paid on March 31, 2001. Record the necessary journal entriespaid on March 31, 2001. Record the necessary journal entries

Solution:Solution:

Here, since the terms are FOB Shipping Point, the buyer (Ika) pays transportation.Here, since the terms are FOB Shipping Point, the buyer (Ika) pays transportation.

March 2March 2 -Purchase..85,000-Purchase..85,000

A/P..85,000A/P..85,000

-Transportation In.....1500-Transportation In.....1500

Cash1500Cash1500

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March 31March 31 A/P85,000A/P85,000

Cash..85,000Cash..85,000


1. What would have been recorded by IKA, if it paid on March 12, 2001? What if the terms1. What would have been recorded by IKA, if it paid on March 12, 2001? What if the terms

were FOB destination?were FOB destination?

Example:Example:

IKA Company sold goods worth Birr 135,000 terms 1/15, n/EOM on February 1, 2001. FOBIKA Company sold goods worth Birr 135,000 terms 1/15, n/EOM on February 1, 2001. FOB

Destination. It also paid transportation costs of Birr 800 on Feb. 1. The customer paid IKA onDestination. It also paid transportation costs of Birr 800 on Feb. 1. The customer paid IKA on

February 16, 2001. Record the relevant Journal entries.February 16, 2001. Record the relevant Journal entries.

Answers:Answers:

Feb 1 A/R..135,000Feb 1 A/R..135,000

Sales..135,000Sales..135,000

Feb 16Feb 16 Sales discount .1,350Sales discount .1,350Cash.133,650Cash.133,650

A/R135,000A/R135,000

Delivery Expense800Delivery Expense800

Cash800Cash800

TheThe Delivery ExpenseDelivery Expense account shows how much was incurred to deliver goods sold toaccount shows how much was incurred to deliver goods sold to

customers. It is, therefore, shown on the income statement as a selling expense.customers. It is, therefore, shown on the income statement as a selling expense.


1.1. What would the customer (buyer) recorded, in the above example, on February 1, andWhat would the customer (buyer) recorded, in the above example, on February 1, and

13, 2001?13, 2001?

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Sometimes, the seller prepays the freight as a convenience to the buyer and later collects it onSometimes, the seller prepays the freight as a convenience to the buyer and later collects it on

the due date of the invoice even though the terms are FOB shipping Point.the due date of the invoice even though the terms are FOB shipping Point.

ExampleExample

Raey Co. sold goods worth Birr 40,000 on April 1, 2001 to IKA company terms 2/10, n/30Raey Co. sold goods worth Birr 40,000 on April 1, 2001 to IKA company terms 2/10, n/30

FOB Shipping Point. It also paid Birr 2,500 to Ergib Movers for transporting the goods andFOB Shipping Point. It also paid Birr 2,500 to Ergib Movers for transporting the goods and

added the amount to the invoice. What would each of these companies record assuming IKAadded the amount to the invoice. What would each of these companies record assuming IKA

paid on April 31, 2001paid on April 31, 2001

Raey Co. (seller)Raey Co. (seller)

April 1- A/R.40,000April 1- A/R.40,000

Sales40,000Sales40,000

A/R.2500A/R.2500

Cash.2500Cash.2500

April 31-Cash42,500April 31-Cash42,500

A/R42500A/R42500

IKa Co (Buyer)IKa Co (Buyer)

April 1-Purchases 40,000April 1-Purchases 40,000

A/P.40,000A/P.40,000

Transport-in 2500Transport-in 2500

A/P2500A/P2500

April 31- A/P42,500April 31- A/P42,500

Cash42,500Cash42,500

Check Your Progress Exercise 11Check Your Progress Exercise 11

1. What would have been recorded on the above dates if IKa Co. Paid on April 11, 2001?1. What would have been recorded on the above dates if IKa Co. Paid on April 11, 2001?

If the buyer pays the transportation costs for the seller (when the terms are FOB Destination)If the buyer pays the transportation costs for the seller (when the terms are FOB Destination)

the buyer simply deducts the freight paid from the amount to be paid to the seller.the buyer simply deducts the freight paid from the amount to be paid to the seller.

Example:Example:

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X Company bought merchandise worth Birr 14,000 terms FOB destination from Y Co. onX Company bought merchandise worth Birr 14,000 terms FOB destination from Y Co. on

account. It paid Birr 350 transportation costs. What would be recorded on the books of theaccount. It paid Birr 350 transportation costs. What would be recorded on the books of the

buyer and seller on the date of the sale?buyer and seller on the date of the sale?

Buyer (X Co)Buyer (X Co) Seller Y Co.Seller Y Co.

-Purchase.14,000-Purchase.14,000 -. A/R.14,000-. A/R.14,000

-A/P14,000-A/P14,000 Sales.14,000Sales.14,000

-A/P350 -Delivery exp.350-A/P350 -Delivery exp.350

Cash..350Cash..350 A/R350A/R350

Transfer of TitleTransfer of Title

Shipping terms determine not only determine who pays for transportation. They alsoShipping terms determine not only determine who pays for transportation. They also

determine at what point ownership title of the goods sold transfers to the buyer. Put briefly,determine at what point ownership title of the goods sold transfers to the buyer. Put briefly,

whose property is it when merchandise is in transit?whose property is it when merchandise is in transit?

1. When terms are FOB Destination we have seen that the seller covers transportation costs.1. When terms are FOB Destination we have seen that the seller covers transportation costs.

By implication the seller takes the responsibility of safely moving and delivering the goods toBy implication the seller takes the responsibility of safely moving and delivering the goods to

the buyer. The buyer is not responsible for any damage that can happen to these goods inthe buyer. The buyer is not responsible for any damage that can happen to these goods in

transit. Therefore, the goods become the buyers property only when they are delivered totransit. Therefore, the goods become the buyers property only when they are delivered to

him /her.him /her.

Conclusion:Conclusion: Ownership title of the goods transfers to the buyer at destination when the termsOwnership title of the goods transfers to the buyer at destination when the terms

are FOB destination.are FOB destination.

2. When the terms are FOB shipping point the buyer pays freight costs. The buyer takes the2. When the terms are FOB shipping point the buyer pays freight costs. The buyer takes the

responsibility of safely moving these goods to his /her own place. The merchandise,responsibility of safely moving these goods to his /her own place. The merchandise,

therefore, becomes his/her property as soon as they are loaded on a truck or a train.therefore, becomes his/her property as soon as they are loaded on a truck or a train.

ConclusionConclusion:: Ownership title of goods transfers to the buyer at shipping point when terms areOwnership title of goods transfers to the buyer at shipping point when terms are

FOB shipping point.FOB shipping point.

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The following table summarizes it all.The following table summarizes it all.

Sipping termsSipping terms Transportation paid byTransportation paid by Title TransfersTitle Transfers

When goods areWhen goods are

Delivered toDelivered toFOB DestinationFOB Destination

FOB shipping pointFOB shipping point

SellerSeller

BuyerBuyer

BuyerBuyer

FreighterFreighter

(transportation(transportation

company)company)

Summary of Section OneSummary of Section One

Lets once again present the model Income Statement that we saw at the beginning of thisLets once again present the model Income Statement that we saw at the beginning of this

chapter. This time around, however, it is a bit detailed. Please study the relationship betweenchapter. This time around, however, it is a bit detailed. Please study the relationship between

each item on the Income Statement carefully. Also try to remember how each item waseach item on the Income Statement carefully. Also try to remember how each item was

recorded in journal entry form when the transactions affecting these accounts happened.recorded in journal entry form when the transactions affecting these accounts happened.

XYZ Merchandising Co.XYZ Merchandising Co.


For the year ended Dec. 31,2001For the year ended Dec. 31,2001

Gross Sales 400,000Gross Sales 400,000Less: Sales Discounts (15,000)Less: Sales Discounts (15,000)

Sales Ret &All (25,000) . (Sales Ret &All (25,000) . (40,00040,000))

Net sales.360,000Net sales.360,000

Cost of goods sold:Cost of goods sold:

Beginning merchandise inventory (January 1, 2001)10,000Beginning merchandise inventory (January 1, 2001)10,000

Add: Purchases..210,000Add: Purchases..210,000

Less: Purchase Disc..(5,000)Less: Purchase Disc..(5,000)Purchase Ret & AllPurchase Ret & All(5,000)(5,000)

Net purchase..200,000Net purchase..200,000

Add: Transportation In.Add: Transportation In.66,00066,000

Total cost of goods Available for sale...276,000Total cost of goods Available for sale...276,000

Less: Ending M.I (Dec. 31,2001)(Less: Ending M.I (Dec. 31,2001)(20.000)20.000)

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Cost of goods sold (Cost of goods sold (256,000)256,000)

Gross profit 104,000Gross profit 104,000

Less: Various Selling and Administrative Expenses (Less: Various Selling and Administrative Expenses (79,400)79,400)

Net IncomeNet Income 24,60024,600

Note:Note:

Under a periodic inventory system, the cost of goods sold during a period is determined onlyUnder a periodic inventory system, the cost of goods sold during a period is determined only

indirectly after comparing what was on hand at the beginning of the period, and the cost ofindirectly after comparing what was on hand at the beginning of the period, and the cost of

goods purchased during the period with what is left on hand at the end of the period. That is,goods purchased during the period with what is left on hand at the end of the period. That is,

Beg inventory + Total cost of purchase Ending inventory=Cost of Goods Sold.Beg inventory + Total cost of purchase Ending inventory=Cost of Goods Sold.

Under periodic inventory procedures no attempt is made to determine the cost of goods sold atUnder periodic inventory procedures no attempt is made to determine the cost of goods sold at

the time of each sale. Instead, the cost of all the goods sold during the accounting period isthe time of each sale. Instead, the cost of all the goods sold during the accounting period is

determined at the end of the period.determined at the end of the period.

Summary of Important Relationships on the Income StatementSummary of Important Relationships on the Income Statement

1.1. Net sales = Gross sales- (Sales Discounts + Sales Returns and allowances)Net sales = Gross sales- (Sales Discounts + Sales Returns and allowances)

2.2. Net purchases = Purchases (Purchase Disc. + Purchase Ret. & allowance)Net purchases = Purchases (Purchase Disc. + Purchase Ret. & allowance)

3.3. Total cost of Purchase = Net purchase + Transportation InTotal cost of Purchase = Net purchase + Transportation In

4.4. Cost of goods sold = Beg inventory + Total cost of purchase Ending inventoryCost of goods sold = Beg inventory + Total cost of purchase Ending inventory

5.5. Gross profit = Net sales Cost of goods soldGross profit = Net sales Cost of goods sold6.6. Net Income = Gross Profit operating (i.e., selling & administrative) expenses.Net Income = Gross Profit operating (i.e., selling & administrative) expenses.

SECTION TWO: REPORTING MERCHANDISING TRANSACTIONSSECTION TWO: REPORTING MERCHANDISING TRANSACTIONS

In the previous section, we saw how purchase and sales transactions are recorded.In the previous section, we saw how purchase and sales transactions are recorded.

In this section, we will see how those transactions are summarized and reported on theIn this section, we will see how those transactions are summarized and reported on the

financial statements.financial statements.

3.5 COMPLETING THE WORKSHEET FOR A MERCHANDISING COMPANY3.5 COMPLETING THE WORKSHEET FOR A MERCHANDISING COMPANY

The use of a worksheet, as you remember, assists in preparing adjusting and closing entries.The use of a worksheet, as you remember, assists in preparing adjusting and closing entries.

In addition it contains all of the information needed for the preparation of the financialIn addition it contains all of the information needed for the preparation of the financial

statements. Except for the merchandise related accounts, the work sheet for a merchandisingstatements. Except for the merchandise related accounts, the work sheet for a merchandising

Co. is the same as for a service company.Co. is the same as for a service company.

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The following illustration, therefore, assumes that all selling and administrative expenses haveThe following illustration, therefore, assumes that all selling and administrative expenses have

been adjusted. That accomplished, the only account, which remains to be adjusted, is thebeen adjusted. That accomplished, the only account, which remains to be adjusted, is the

Merchandise Inventory account.Merchandise Inventory account.

IllustrationIllustration

The following is the trial balance of Hard Works, a merchandising business owned byThe following is the trial balance of Hard Works, a merchandising business owned by

Yibeltal. All accounts have been adjusted except the Merchandise Inventory account.Yibeltal. All accounts have been adjusted except the Merchandise Inventory account.

Hard WorksHard Works

Trial BalanceTrial Balance

December 31, 2002December 31, 2002

Account titleAccount title DrDr CRCRCashCash 19,66319,663

Account ReceivableAccount Receivable 1,8801,880

Merchandise InventoryMerchandise Inventory 7,0007,000

Accounts PayableAccounts Payable 700700

Yibeltal, CapitalYibeltal, Capital 25,00025,000

Yibeltal,DrawingsYibeltal,Drawings 2,0002,000

SalesSales 14,60014,600

Sales DiscountsSales Discounts 4444

Sales Returns and AllowancesSales Returns and Allowances 2020

PurchasesPurchases 6,0006,000

Purchase discountsPurchase discounts 8282

Purchase Returns and allowancesPurchase Returns and allowances 100100

Transportation InTransportation In 7575

Selling expensesSelling expenses 2,6502,650

Administrative expensesAdministrative expenses 1,1501,150 ________________

40,48240,482 40,48240,482

A physical inventory of merchandise carried out on December 31, 2002 showed BirrA physical inventory of merchandise carried out on December 31, 2002 showed Birr

10,000 of goods on hand.10,000 of goods on hand.

Required:Required:

A- Prepare a worksheet for Hard Works.A- Prepare a worksheet for Hard Works.

B- Prepare financial statements from the worksheetB- Prepare financial statements from the worksheet

C- Record the necessary adjustment journal entry in relation to merchandiseC- Record the necessary adjustment journal entry in relation to merchandise

inventoryinventory

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D- Record closing entriesD- Record closing entries

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Hard Works Co.Hard Works Co.

Worksheet for the year ended December 31,2002Worksheet for the year ended December 31,2002

Account titleAccount titleTrial BalanceTrial Balance AdjustmentAdjustment Adjusted Trial balanceAdjusted Trial balance Income statementIncome statement Balance sheetBalance sheet

Dr.Dr. Cr.Cr. Dr.Dr. Cr.Cr. Dr.Dr. Cr.Cr. Dr.Dr. Cr.Cr. Dr.Dr. Cr.Cr.

CashCash 19,66319,663 19,66319,663 19,66319,663

AccountAccountReceivableReceivable

1,8801,880 1,8801,880 1,8801,880

MerchandiseMerchandiseInventoryInventory

7,0007,000 10,00010,000 7,0007,000 10,00010,000 10,00010,000

Accounts PayableAccounts Payable 700700 700700 700700

Yibeltal, CapitalYibeltal, Capital 25,00025,000 25,00025,000 2,5002,500

Yibeltal, DrawingsYibeltal, Drawings 2,0002,000 2,0002,000 2,0002,000

Income summeryIncome summery 7,0007,000 10,00010,000 7,0007,000 10,00010,000 7,0007,000 1000010000

SalesSales 14,60014,600 14,60014,600 1460014600

Sales DiscountsSales Discounts 4444 4444 4444

Sales Returns andSales Returns and

AllowancesAllowances

2020 2020 2020

PurchasesPurchases 6,0006,000 6,0006,000 6,0006,000

Purchase discountsPurchase discounts 8282 8282 8282

Purchase ReturnsPurchase Returnsand allowancesand allowances

100100 100100 100100

Transportation InTransportation In 7575 7575 7575

Selling expensesSelling expenses 2,6502,650 2,6502,650 2,6502,650

AdministrativeAdministrativeexpensesexpenses

1,1501,150 1,1501,150 1,1501,150

40,48240,482 40,48240,482 17,00017,000 17,00017,000 50,48250,482 50,48250,482 16,93916,939 2478224782 33,54333,543 25,725,7

7,8437,843 7878

24,78224,782 2478224782 33,54333,543 33,533,5

Note:Note:

The merchandise inventory account before adjustment shows the inventory on handThe merchandise inventory account before adjustment shows the inventory on hand aat thet the

beginning of the period. This is because, since purchases and sales of merchandise have notbeginning of the period. This is because, since purchases and sales of merchandise have not

been debited or credited to the merchandise inventory account, this account would still showbeen debited or credited to the merchandise inventory account, this account would still show

the beginning inventory amount at the end of the period.the beginning inventory amount at the end of the period.

Therefore, an adjustment journal entry is needed to update this account. At the end of theTherefore, an adjustment journal entry is needed to update this account. At the end of the

period, a physical inventory would be conducted to determine the amount of inventory onperiod, a physical inventory would be conducted to determine the amount of inventory on

hand.hand.

The adjustment journal entry removes beginning inventory amount from the merchandiseThe adjustment journal entry removes beginning inventory amount from the merchandise

inventory account and replaces it with the (ending) actual value of merchandise inventory oninventory account and replaces it with the (ending) actual value of merchandise inventory on

hand as determined by the physical inventory.hand as determined by the physical inventory.

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The adjustment is:The adjustment is:

Income summary (beginning inventory)..XXXIncome summary (beginning inventory)..XXX

Merchandise amount inventoryXXXMerchandise amount inventoryXXX

Merchandise Inventory.XXXMerchandise Inventory.XXX

Income Summary..XXXIncome Summary..XXX

An adjustment journal entry for Hard Works is presented latter in (c).An adjustment journal entry for Hard Works is presented latter in (c).

3.6 PREPARING FINANCIAL STATEMENTS FOR MERCHANDISING3.6 PREPARING FINANCIAL STATEMENTS FOR MERCHANDISING

BUSINESSESBUSINESSES

We will discuss financial statements as we work on requirement (b) of our illustration.We will discuss financial statements as we work on requirement (b) of our illustration.

Once the worksheet has been completed, the financial statements are prepared. Next, anyOnce the worksheet has been completed, the financial statements are prepared. Next, any

adjusting and closing entries are entered in the journal and posted to the ledger.adjusting and closing entries are entered in the journal and posted to the ledger.

Income StatementIncome Statement

There are two widely used formats of the income statement. These are:There are two widely used formats of the income statement. These are:

The single Step Income StatementThe single Step Income Statement

This format is shown below for Hard Works Co. It shows cost of goods sold and operatingThis format is shown below for Hard Works Co. It shows cost of goods sold and operating

expense but has only one subtotal for total expenses.expense but has only one subtotal for total expenses.

Hard WorksHard WorksCo.Co.


For the year ended December 31, 2002For the year ended December 31, 2002

Net sales..Br.14536Net sales..Br.14536

Expenses:Expenses:

Cost of goods sold2893Cost of goods sold2893

Operating Expenses .Operating Expenses .38003800 (6693)(6693)

Net Income.Net Income.78437843

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The Multiple Step Income StatementThe Multiple Step Income Statement



For the year ended December 31, 2002For the year ended December 31, 2002

Revenue:Revenue:

Gross Sales Br. 14600Gross Sales Br. 14600

Less: Sales Discounts ..44Less: Sales Discounts ..44

Sales Returns &All20Sales Returns &All20 (64)(64)

Net Sales 14536Net Sales 14536

LessLess: Cost of goods sold:: Cost of goods sold:

Beg. Inventory (Jan 1)..7,000Beg. Inventory (Jan 1)..7,000

Add:Add: Purchase6,000Purchase6,000

Less: Purchase..(82)Less: Purchase..(82)

Purchase Ret & allPurchase Ret & all.(100).(100)

Net Purchases..5818Net Purchases..5818

Add: Transportation In Add: Transportation In 7575

Total cost of purchase..Total cost of purchase..58935893

Total cost of Goods Available for sale..12,893Total cost of Goods Available for sale..12,893

LessLess: ending Inventory (Dec.31)(: ending Inventory (Dec.31)(10,000)10,000)

Cost of Goods sold..(Cost of Goods sold..(2893)2893)

Gross Profit11,643Gross Profit11,643

Operating Expenses:Operating Expenses:

Selling Expenses.2,650Selling Expenses.2,650

Admin. Exp.Admin. Exp.1,1501,150

Total operating expenses..Total operating expenses.. (3800(3800))

Net IncomeNet Income 7,8437,843

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Statement of Owners EquityStatement of Owners Equity

For the year Ended December 31, 2002For the year Ended December 31, 2002

Yibeltal Capital Jan1,2002Br..25,000Yibeltal Capital Jan1,2002Br..25,000

Add: Net Income for the year7843Add: Net Income for the year7843

Deduct: Owners withdrawal during the year....Deduct: Owners withdrawal during the year....2,0002,000

Yibeltal Capital December 31, 2002Yibeltal Capital December 31, 20023084330843


Balance sheetBalance sheet

For the year Ended December 31, 2002For the year Ended December 31, 2002

Assets:Assets: Liabilities & capitalLiabilities & capital

Liabilities:Liabilities:

Cash..19663Cash..19663 A/P700A/P700

A/R 1880A/R 1880 Owners Equity:Owners Equity:

Merch. Inventory.Merch. Inventory.10,00010,000 Yibeltal Capital Yibeltal Capital

3084330843

Total Assets.Total Assets.31,84331,843 Total Liab. & O/ETotal Liab. & O/E31,84331,843

C.C. Adjustment Journal entryAdjustment Journal entry

-Income summary..7,000-Income summary..7,000

Merchandise Inventory7,000Merchandise Inventory7,000

-Merchandise Inventory.10,000-Merchandise Inventory.10,000

Income Summary.10,000Income Summary.10,000

D.D. Closing entriesClosing entries

-Sales..14,600-Sales..14,600

Income summary..14,600Income summary..14,600

-Income summary66-Income summary66

Sales discount44Sales discount44

Sales Returns and Allowances 20Sales Returns and Allowances 20

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-Income summary6,075-Income summary6,075

Purchases.6,000Purchases.6,000

Transportation-In..75Transportation-In..75

- Purchase Discounts..82- Purchase Discounts..82

Purchase Ret. &All...100Purchase Ret. &All...100

Income Summary.182Income Summary.182

- Income summary.3,800- Income summary.3,800

Selling Expenses2650Selling Expenses2650

Administrative expense..1150Administrative expense..1150

- Income summary.7,843- Income summary.7,843

Yibeltal Capital7,843Yibeltal Capital7,843

- Yibeltal Captal..2,000- Yibeltal Captal..2,000

Yibeltal Drawings2,000Yibeltal Drawings2,000

3.7 SUMMARY3.7 SUMMARY

Even though the steps and procedures that we go through to prepare the financial statementsEven though the steps and procedures that we go through to prepare the financial statements

of merchandising companies are the same with that of service businesses, there areof merchandising companies are the same with that of service businesses, there are

transactions peculiar to merchandising companies. These include the purchase and sale oftransactions peculiar to merchandising companies. These include the purchase and sale of

merchandise. You should be able to record these transactions by now. Go back and study themerchandise. You should be able to record these transactions by now. Go back and study the

relationships between financial statement items summarized at the end of section one of thisrelationships between financial statement items summarized at the end of section one of this

unit.unit.

3.8 ANSWERS TO CHECK YOUR PROGRESS EXERCISE3.8 ANSWERS TO CHECK YOUR PROGRESS EXERCISE


List price of goods.52,000List price of goods.52,000

Less: Trade discount (20% X [52,000-40,000]) Less: Trade discount (20% X [52,000-40,000]) (2400)(2400)

Invoice Price..49,600Invoice Price..49,600

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Journal entry:Journal entry:

-- A/R49,600A/R49,600



-- 1/15, n/60 1% discount if customer pays with in 15 days, otherwise amount is due1/15, n/60 1% discount if customer pays with in 15 days, otherwise amount is due

with in 60 days with out any discount.with in 60 days with out any discount.

-- 2/10, n/EOM 2% discount if paid with in 10 days, otherwise the whole amount due2/10, n/EOM 2% discount if paid with in 10 days, otherwise the whole amount due

at the end of the month of saleat the end of the month of sale

--

n/60 No discount amount is due in 60 daysn/60 No discount amount is due in 60 days


A since the customer paid with in the discount period, i.e., with in 10 days, amountA since the customer paid with in the discount period, i.e., with in 10 days, amount

collected would be:collected would be:

120,000 1% (120,000) = 118,800120,000 1% (120,000) = 118,800

B Jan. 18 A/R..120,000B Jan. 18 A/R..120,000

Sales.120,000Sales.120,000

Jan. 28 Cash.118800Jan. 28 Cash.118800

Sales Discount.1200Sales Discount.1200

A/R.120,000A/R.120,000


Feb 3 -Feb 3 - A/R .15,000A/R .15,000

Sales .15,000Sales .15,000

Feb 13-Feb 13- Cash..14,700Cash..14,700

Sales Discount...300Sales Discount...300

A/R.15,000A/R.15,000

Feb 15-Feb 15- Sales Returns &Allowances5,000Sales Returns &Allowances5,000

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Cash.4900Cash.4900

Sales Discount100Sales Discount100


January 4January 4 Purchase .43,000Purchase .43,000

Cash.43,000Cash.43,000


Jan 14.Jan 14. A/R.50,000A/R.50,000


Jan 24.Jan 24. Cash49,500Cash49,500

Sales Discounts 500Sales Discounts 500

A/R..50,000A/R..50,000


Jan 17.Jan 17. Sales Returns & Allowances250Sales Returns & Allowances250

A/R..250A/R..250


FOB shipping pointFOB shipping point

March 12.March 12. A/P85,300A/P85,300

Cash..83,300Cash..83,300

Purchase Discounts. 1,700Purchase Discounts. 1,700

FOB DestinationFOB Destination

March 2 -March 2 - Purchase.85,000Purchase.85,000A/P..85,000A/P..85,000

March 31-March 31- A/P.85,000A/P.85,000

Cash85,000Cash85,000

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Feb 1-Feb 1- Purchase..135,000Purchase..135,000

A/P.135,000A/P.135,000

Feb 13-Feb 13- A/P..135,000A/P..135,000

Cash133,650Cash133,650

Purchase Discounts 1,350Purchase Discounts 1,350


SellerSeller

April 1-A/R40,000April 1-A/R40,000


A/R2,500A/R2,500

Cash..2,500Cash..2,500

BuyerBuyer

Purchase40,000Purchase40,000

A/P40,000A/P40,000

Transportation-In..2,500Transportation-In..2,500

A/P2,500A/P2,500

April 11- Cash (39200 + 2500)41,700April 11- Cash (39200 + 2500)41,700

Sales Discount...800Sales Discount...800A/R (40,000 +2500).42,500A/R (40,000 +2500).42,500

April 11-A/P42,500April 11-A/P42,500

Cash.41,700Cash.41,700Purchase Discounts...800Purchase Discounts...800

3.9 MODEL EXAMINATION QUESTIONS3.9 MODEL EXAMINATION QUESTIONS

1.1. You are provided with the following data from the records of three merchandisingYou are provided with the following data from the records of three merchandising

companies:(a), (b) and (c). Determine each of the missing numbers for each company.companies:(a), (b) and (c). Determine each of the missing numbers for each company.

aa bb cc

Invoice cost of merchandise purchase Br.90, 000 Br.40, 000 Br.30, 500Invoice cost of merchandise purchase Br.90, 000 Br.40, 000 Br.30, 500

Purchase discounts 4000 ? 650Purchase discounts 4000 ? 650

Purchase returns and allowances 3,000 1,500 1,100Purchase returns and allowances 3,000 1,500 1,100

Transportatiln-In ? 3,500 4,000Transportatiln-In ? 3,500 4,000

Merchandise inventory (beginning of period) 7,000 ? 9,000Merchandise inventory (beginning of period) 7,000 ? 9,000

Total cost of merchandise purchases 89,400 39,500 ?Total cost of merchandise purchases 89,400 39,500 ?

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Merchandise inventory (end of period) 4,400 7,500 ?Merchandise inventory (end of period) 4,400 7,500 ?

Cost of goods sold ? 41,600 34,130Cost of goods sold ? 41,600 34,130

2.2. Prepare journal entries to record the following merchandising transactions of ShiachPrepare journal entries to record the following merchandising transactions of Shiach

Company. The company uses the periodic inventory system.Company. The company uses the periodic inventory system.

JulyJuly 1 Purchased merchandise form Gizhy Company for $6,000 under credit terms of1 Purchased merchandise form Gizhy Company for $6,000 under credit terms of

1/15, n/30, FOB shipping point.1/15, n/30, FOB shipping point.

22 Sold merchandise to Terra Co. for $800 under credit terms of 2/10, n/60, FOBSold merchandise to Terra Co. for $800 under credit terms of 2/10, n/60, FOB

shipping point.shipping point.

33 Paid $100 for freight (transportation) charges on the purchase of July 1.Paid $100 for freight (transportation) charges on the purchase of July 1.

88 Sold merchandise for $1,600 cash.Sold merchandise for $1,600 cash.

99 Purchased merchandise from Chilalo Co. for $2,300 under credit terms of 2/15,Purchased merchandise from Chilalo Co. for $2,300 under credit terms of 2/15,

n/60, FOB destination.n/60, FOB destination.

1212 Received a $200 credit memorandum acknowledging the return of merchandiseReceived a $200 credit memorandum acknowledging the return of merchandise

purchased on July 9.purchased on July 9.

1212 Received the balance due from Terra Co. for the credit sale dated July 2, net of theReceived the balance due from Terra Co. for the credit sale dated July 2, net of the

discount.discount.

16 Paid the balance due to Gizhy Company within the discount period.16 Paid the balance due to Gizhy Company within the discount period.

1919 Sold merchandise to Urban Co. for $1,250 under credit terms of 2/15, n/60, FOBSold merchandise to Urban Co. for $1,250 under credit terms of 2/15, n/60, FOB


2121 Issued a $150 credit memorandum to Urban Co. for an allowance on goods sold onIssued a $150 credit memorandum to Urban Co. for an allowance on goods sold on

July 19.July 19.

2222 Received a debit memorandum from Urban Co. for an error that overstated theReceived a debit memorandum from Urban Co. for an error that overstated the

total sales invoice by $50.total sales invoice by $50.

2424 Paid Chilalo Co. the balance due after deducting the discount.Paid Chilalo Co. the balance due after deducting the discount.

3030 Received the balance due from Urban Co. for the credit sale dated July 19, net ofReceived the balance due from Urban Co. for the credit sale dated July 19, net of

the discount.the discount.

3131 Sold merchandise to Terra Co. for $5,000 under credit terms of 2/10, n/60, FOBSold merchandise to Terra Co. for $5,000 under credit terms of 2/10, n/60, FOB


3.3. The following unadjusted trial balance was prepared at the end of the fiscal year forThe following unadjusted trial balance was prepared at the end of the fiscal year for

Tenkir Company:Tenkir Company:

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TENKIR COMPANYTENKIR COMPANY

Unadjusted Trail BalanceUnadjusted Trail Balance

July 31, 2000July 31, 2000

Cash.. $ 4,200Cash.. $ 4,200

Merchandise Inventory 11,500Merchandise Inventory 11,500

Store supplies.. 4,800Store supplies.. 4,800

Prepaid Insurance 2,300Prepaid Insurance 2,300

Store equipment.. 41,900Store equipment.. 41,900

Accumulated deprecation-Store EquipmentAccumulated deprecation-Store Equipment $ 15,000$ 15,000

Accounts payable.Accounts payable. 9,0009,000

Gidey Tinker, capital..Gidey Tinker, capital.. 35,20035,200

Gidey Tenkir, withdrawals . 3,200Gidey Tenkir, withdrawals . 3,200

Sales..Sales.. 104,000104,000Sales discounts 1,000Sales discounts 1,000

Sales returns and allowances 2,000Sales returns and allowances 2,000

Cost of goods sold... 37,400Cost of goods sold... 37,400

Depreciation expense Store equipment.. -Depreciation expense Store equipment.. -

Salaries expense 31,000Salaries expense 31,000

Insurance expense. -Insurance expense. -

Rent expense.. 14,000Rent expense.. 14,000

Store supplies expense. -Store supplies expense. -

Advertising expense..Advertising expense.. 9,9009,900

.

.Totals...Totals...

$163,200$163,200

$163,200$163,200

Rent and salaries expense are equally divided between the selling and the general andRent and salaries expense are equally divided between the selling and the general and

administrative functions. Tenkir Company uses the periodic inventory system.administrative functions. Tenkir Company uses the periodic inventory system.

Required:Required:

1. Prepare adjusting journal entries for the following:1. Prepare adjusting journal entries for the following:

a.a. Store supplies on hand at year-end amount to $1,650.Store supplies on hand at year-end amount to $1,650.

b.b. Expired insurance, an administrative expense, for the year is $1,500.Expired insurance, an administrative expense, for the year is $1,500.

c.c. Depreciation expense, a selling expense, for the year is $1,400.Depreciation expense, a selling expense, for the year is $1,400.

d.d. A physical count of the ending merchandise inventory shows $11,100 ofA physical count of the ending merchandise inventory shows $11,100 of

goods on hand.goods on hand.

2. Prepare a multiple-step income statement.2. Prepare a multiple-step income statement.

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3. Prepare a single-step income statement.3. Prepare a single-step income statement.

4. Prepare all the necessary closing entries.4. Prepare all the necessary closing entries.

3.10 GLOSSARY OF TERMS3.10 GLOSSARY OF TERMS

A Merchandising BusinessA Merchandising Business- a business that buys and sells goods at a profit.- a business that buys and sells goods at a profit.

MerchandiseMerchandise- anything that a merchandising company buys in order to resale it to its- anything that a merchandising company buys in order to resale it to its

customers.customers.

Periodic Inventory SystemPeriodic Inventory System- a system of recording inventories that updates inventory records- a system of recording inventories that updates inventory records

only once in an accounting period.only once in an accounting period.

Perpetual Inventory SystemPerpetual Inventory System- a system of recording inventories that continuously shows the- a system of recording inventories that continuously shows thebalance of inventory on hand as the records about inventory are continuously updated.balance of inventory on hand as the records about inventory are continuously updated.

Physical InventoryPhysical Inventory- the act of counting (measuring, weighing, etc) merchandise in order to- the act of counting (measuring, weighing, etc) merchandise in order to

determine the quantity of goods on hand on a particular date.determine the quantity of goods on hand on a particular date.

Trade DiscountTrade Discount- deduction from the normal selling price (list price) to determine the invoice- deduction from the normal selling price (list price) to determine the invoice

price of goods.price of goods.

Cash DiscountCash Discount

- deduction from the invoice price of goods for early payment when goods are- deduction from the invoice price of goods for early payment when goods are

sold on credit. Cash discounts are called sales discounts for the seller whereas they aresold on credit. Cash discounts are called sales discounts for the seller whereas they are

referred to as purchase discounts by the buyer.referred to as purchase discounts by the buyer.

Purchase (or Sales) ReturnsPurchase (or Sales) Returns- merchandise returned to the seller after it has already been sold- merchandise returned to the seller after it has already been sold

or bought.or bought.

Purchase (or Sales) AllowancePurchase (or Sales) Allowance- a deduction from the invoice price of goods when the goods- a deduction from the invoice price of goods when the goods

bought or sold are agreed to be of defective or unsatisfactory for any reason.bought or sold are agreed to be of defective or unsatisfactory for any reason.

Contra AccountContra Account- if an account is a contra account; its balance would be deducted from- if an account is a contra account; its balance would be deducted from

another account when it is presented in the financial statements.another account when it is presented in the financial statements.

FOB DestinationFOB Destination- an agreement that requires the seller of the goods to cover transportation- an agreement that requires the seller of the goods to cover transportation

costs. It is read as free on board at destination.costs. It is read as free on board at destination.

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FOB Shipping PointFOB Shipping Point- an agreement that requires the buyer of merchandise to cover- an agreement that requires the buyer of merchandise to cover

transportation costs. It is read as free on board at shipping point.transportation costs. It is read as free on board at shipping point.

final chapter3

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