FINANCIAL ACCOUNTING I

Assoc. Prof. Dr. Nuray DEMİREL ARICI

MCBU Faculty of Business
 Accounting For
Merchandising Operations
Chp 6
 CONCEPTS UNDERLYING MERCHANDISING
ACCOUNTING
• A merchandising company earns income by buying and selling goods,
which are called merchandise inventory.
• Two basic systems of accounting are used for merchandise inventory.

Inventory
Accounting
System

Perpetual Periodic
Inventory Inventory
System System
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The Perpetual Inventory System
• The cost of each item is recorded in the Merchandise Inventory
account when it is purchased. As merchandise is sold, its cost is
transferred from the Merchandise Inventory account to the Cost of
Goods Sold (COGS) account.
• Thus, at all times the balance of the Merchandise Inventory account
equals the cost of goods on hand, and the balance in COGS equals the
cost of merchandise sold to customers.
• Companies that sell items that have a high unit value, such as
appliances, have tended to use the perpetual inventory system.

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The Periodic Inventory System
• No detailed records of the inventory are maintained during the
accounting period. The figure for inventory is accurate only on the
balance sheet date.
• In this system, the inventory not yet sold is counted periodically. This
physical count is called physical inventory, which is usually taken at
the end of the accounting period.
• Companies that sell items of low value in high volume have
traditionally used the inventory system. Examples are small retailers,
pharmacy stores, and grocery stores.

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Inventory Calculation
• Beginning Inventory …………………….xx
• Purchases in the period………………..xx
• Cost of Goods Available for Sales…xxx
• Cost of Goods Sold………………………(xx)
• Ending Inventory………………………….xx

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PERPETUAL INVENTORY SYSTEM

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Purchases of Merchandise
• On August 3, Kawar received merchandise purchased on credit,
invoice dated August 1, terms n/10, $4, 890.

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Purchases Returns and Allowances
• On August 6, Kawar returned part of merchandise received on August
3 for credit, $480.

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Payments on Account
• On August 10, Kawar paid amount in full due for the purchase of
August 3, part of which was returned on August 6, $4,410. ($4,890 -
$480 = $4,410)

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Sales of Merchandise (on Credit)
• On August 7, Kawar sold merchandise on credit, terms n/30, FOB
shipping point, $1,200. The cost of the merchandise was $720.

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Sales Returns and Allowances
• On August 9, Kawar accepted, for full credit, a return of part of
merchandise sold on August 7, and returned it to merchandise
inventory, $300. The cost of the merchandise was $180.

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Receipts on Account
• On September 5, Kawar collected in full for sale of merchandise on
August 7, less the return on August 9, $900. ($1,200 - $300 = $900)

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PERIODIC INVENTORY SYSTEM

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Purchases of Merchanise (on Credit)
• On August 3, Kawar received merchandise purchased on credit,
invoice dated August 1, terms n/10, $4,890.

03/08/20xx
Merchandise Inventory 4,890
Accounts Payable 4,890

Purchased merchandise on credit ../../..... √

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Purchases Returns and Allowances
• On August 6, Kawar returned part of merchandise received on August
3 for credit, $480.

06/08/20xx
Accounts Payable 480
Merchandise Inventory 480

Returned merchandise from

√
purchase ../../.....

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Freight-in
• On August 7, Kawar received a bill for freight costs of the purchases
on August 3, $230.

07/08/20xx
Merchandise Inventory 230
Accounts Payable 230

Recorded freight costs √

on August 3 purchase ../../.....

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Payments on Account
• On August 10, Kawar paid amount in full due for the purchase of
August 3, part of which was returned on August 6, $4,410. ($4,890-
$480 = $4,410).

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Sales of Merchandise (on Credit)
• On August 7, Kawar sold merchandise on credit, terms n/30, FOB
destination, $1,200. The cost of the merchandise was $720.

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Sales Returns and Allowances
• On August 9, Kawar accepted return of part of merchandise sold on
August 7 for full credit and returned it to merchandise inventory,
$300. The cost of the merhandise was $180.

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Receipts on Account
• On September 5, Kawar collected in full for sale of merchandise on
August 7, less the return on August 9, $900. ($1,200-$300 = $900)

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TriLevel Problem (p.231)

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 TriLevel Problem (p.231)
July 1 Sold merchandise to Eric Ortega on credit, terms n/30, FOB shipping point,
$2,100 (cost, $1,260).
• Perpetual Inventory System • Periodic Inventory System
01/07/20xx 01/07/20xx
Accounts Accounts
Receivable 2,100 Receivable 2,100
Sales Revenue 2,100 Sales Revenue 2,100
../../..... ../../.....

01/07/20xx
Cost of Goods Sold 1,260
Merchandise
Inventory 1,260

../../.....

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 July 2 Purchased merchandise on credit from Debra Company, terms n/30, FOB
shipping point, $3,800.
• Perpetual Inventory System • Periodic Inventory System
02/07/20xx 02/07/20xx
Merchandise Merchandise
Inventory 3,800 Inventory 3,800
Accounts Payable 3,800 Accounts Payable 3,800

../../..... ../../.....

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 July 2 Paid Custom Freight $290 for freight charges on merchandise received.
• Perpetual Inventory System • Periodic Inventory System
02/07/20xx 02/07/20xx
Merchandise Merchandise
Inventory 290 Inventory 290
Cash 290 Cash 290

../../..... ../../.....

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 July 9 Purchased merchandise on credit from RBT Company, terms n/30, FOB
shipping point, $3,600, including $200 freight costs paid by RBT Company.
• Perpetual Inventory System • Periodic Inventory System
09/07/20xx 09/07/20xx
Merchandise Merchandise
Inventory 3,600 Inventory 3,600
Cash 3,600 Cash 3,600

../../..... ../../.....

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 July 11 Accepted from Eric Ortega a return of merchandise, which was returned
to inventory, $300 (cost, $180).
• Perpetual Inventory System • Periodic Inventory System
11/07/20xx 11/07/20xx
Sales Returns 300 Sales Returns 300
Accounts Accounts
Receivable 300 Receivable 300

../../..... ../../.....

11/07/20xx
Merchandise
Inventory 180
Cost of Goods Sold 180

../../.....
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 July 14 Returned for credit $600 of merchandise purchased on July 2.
• Perpetual Inventory System • Periodic Inventory System
14/07/20xx 14/07/20xx
Accounts Payable 600 Accounts Payable 600
Merchandise Merchandise
Inventory 600 Inventory 600

../../..... ../../.....

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 July 16 Sold merchandise for cash, $1,000 (cost, $600).
• Perpetual Inventory System • Periodic Inventory System
16/07/20xx 16/07/20xx
Cash 1,000 Cash 1,000
Sales Revenue 1,000 Sales Revenue 1,000

../../..... ../../.....

16/07/20xx
Cost of Goods Sold 600
Merchandise
Inventory 600

../../.....

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 July 22 Paid Debra Company for purchase of July 2 less return on July 14.
• Perpetual Inventory System • Periodic Inventory System
22/07/20xx 22/07/20xx
Accounts Payable 3,200 Accounts Payable 3,200
Cash 3,200 Cash 3,200

(3,800-600=$3,200) ../../..... (3,800-600=$3,200) ../../.....

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 July 23 Received full payment from Eric Ortega for his July 1 purchase, less return
on July 11.
• Perpetual Inventory System • Periodic Inventory System
23/07/20xx 23/07/20xx
Cash 1,800 Cash 1,800
Accounts Accounts
Receivable 1,800 Receivable 1,800

(2,100-300=$1,800) ../../..... (2,100-300=$1,800) ../../.....

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Perpetual Inventory System
Income Statement
Sales Revenue Sales Returns
2,100 300 Sales Revenue………………………..3,100
1,000 Sales Returns…………………………..(300)
Net Sales………………………………..2,800
3,100 300
COGS.…………………………..………..(1,680)
Gross Profit……………………….……1,120
COGS
1,260 180
600
1,860 180 Periodic Inventory System
Cost of Goods Available for Sale – Ending Inventory = COGS
1,680

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TriLevel Problem (p.231)

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35
 PERPETUAL INVENTORY SYSTEM PERIODIC INVENTORY SYSTEM
The cost of purchased item is recorded in Merc. Inv. Same as in perpetual inventory system
The cost of goods sold item is recorded in COGS when The cost of goods sold is recorded at the end of the
the item is sold. period.
If sales return occurs, COGS and Merch.Inv. are No update in COGS.
updated.
Company always knows its inventory level and COGS. Company knows its inventory level and COGS only at
the end of the period.
Inventory on hand is counted periodically. Inventory on hand is counted at the end of the period
and compared with ending balance of Merch.Inv.
account. The difference gives us COGS.
It requires detailed clerical work and data. It reduces the amount of clerical work.
Large companies and companies that sell high unit Small businesses and businesses that sell items of low
value in low volume items use this system. i.e. unit value in high volume use this system. i.e.
Appliances, autos, furniture etc. Pharmacy, grocery stores, small retailers etc.
Bar codes and square codes increased the usage of
this system.

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PERPETUAL INVENTORY SYSTEM PERIODIC INVENTORY SYSTEM
• merchandise on hand at the • merchandise on hand at the
beg.of the period beg.of the period
• +net cost of Purchases during • +net cost of Purchases during the
the period (Total Purchases + period (Total Purchases + freight-
freight-in – Purchases Returns in – Purchases Returns and
and Allowances) Allowances)
• = COG available for sale • = COG available for sale
• - ending Merhandise Inventory
• - Cost of Goods Sold (COGS) (physical count of inventory)
• =ending Merchandise Inventory • = Cost of Goods Sold (COGS)
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Terms of Sale
• Trade Discount: It is a percentage off list or catalogue prices. It is the
discount offered at the beginning of the sale. So this discount doesn’t
record in the accounting books.
• i.e. If a cell phone is listed at $1,000 with a trade discount of 40%, $400, the seller
records the sale at $600, and the buyer records the purchase at $600.
• Sales Discount: It is offered to encourage the early payment after the sale.
• i.e. 2/10, n/30 means that if you pay within 10 days you gain 2% discount or you can
wait 30 days for payment and pay the full amount of the invoice. Since we don’t
know the customer will take advantage of a sales discount at the time of a sale, sales
discounts are recorded by the seller only at the time the customer pays.
• Sales discount is deducted from Gross Sales on the Income Statement. It increases
the liquidity of the seller and reduces the amount of money tied up in account
receivables.

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 Example Accounts
Receivable
xx/xx/20xx

600

• Kawar Motor sells merchandise to Sales Revenue 600

a customer on September 20 for ../../.....

$600. Terms of sale is 2/10, n/30. xx/xx/20xx

Cash 600
Accounts
• In the situation of payment on time Receivable 600

../../.....

• In the situation of early payment xx/xx/20xx

on or before September 30, the Cash 588
Sales Discounts 12
customer takes the advantage of Accounts
$12 sales discounts. Receivable 600

../../.....

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• Purchase Discount: It is discount that a buyer takes for the early
payment of merchandise.
• It is recorded in Purchases Discounts in USA and in Merchandise Inventory (credit) in Turkey.
Purchase Discount reduces the Merchandise Inventory.

• Transportation Costs:
• When the business buy a merchandise and responsible for transportation
cost, it is recorded to Merchandise Inventory because this expense increases
the cost of inventory.
• When the business sell a merchandise and responsible for transportation
cost, it is recorded to Marketing, Selling and Distribution Expenses because it
it an operating expense.

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Terms of Debit and Credit Cards
• Many retailers allow customers to use debit or credit cards to charge their
purchases. Debit cards deduct directly from a person’s bank account, whereas a
credit card allows for payment later.
• Three of the most widely used credit cards are American Express, MasterCard,
and Visa. The customer establishes credit with the lender (the credit card issuer)
and receives a card to use in making purchases.
• If a seller accepts the card, the customer signs an invoice at the time of the sale.
The sale is communicated to the seller’s bank, resulting in a cash deposit in the
seller’s bank account. Thus, the seller does not have to establish the customer’s
credit, collect from the customer, or tie up money in accounts receivable. The
lender takes a discount, which is a selling expense for the merchandiser.
• For example, if a restaurant makes sales of $1,000 on Visa credit cards and Visa takes a 4
percent discount on the sales, the restaurant would record Cash in the amount of $960 and
Credit Card Expense in the amount of $40. xx/xx/20xx
Cash
Commission 960
Expense (CC Exp.) 40
Service Revenue 1,000

../../..... 41
 Operating Cycle
&
Foreign Exchange Transactions
 OPERATING CYCLE
• The operating cycle is a series of
transactions to buy, sell and collect
for merchandise inventory.
• Most merchandise business
engages in the following four
transactions:
• 1. Purchase of merchandise inventory
for cash or on credit,
• 2. Sales of merchandise inventory for
cash or on credit,
• 3. Collection of cash from credit sales,
• 4. Payment for purchases made on
credit.

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FOREIGN BUSINESS TRANSACTIONS
• While all transactions involve money measures, an international
transaction is measured in two different currencies, and foreign
currency has to be translated into national currency by using the
exchange rate.
• The values of currencies rise and fall daily according to supply and
demand. Thus an exchange gain or loss arises if the exchange rate
between national and other currency changes between the date of
sale and the date of payment.

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 Sale in Foreign Currency
• A US company billed a sale of Accounts Receivable
xx/xx/20xx
200,000
$200,000 at £ 100,000, reflecting Sales Revenue 200,000
an exchange rate of 2.00 (1£ = $2) (£100,000x2=$200,000) ../../.....
on the sale date.

• By the date of payment, the

exchange rate has fallen to 1.90. xx/xx/20xx
When the US company receives its Cash 190,000
£100,000, it will be worth only Exchange Loss 10,000
$190,000 (£100,000 x $1.90 = Accounts 200,000
$190,000. It will have incurred an Receivable
../../.....
exchange loss of $10,000. (£100,000x1.90=$190,000)

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 Purchase in Foreign Currency
xx/xx/20xx
Merchandise
• A US company purchases products Inventory 200,000
from a British company for Accounts
Payable 200,000
$200,000 (1£ = $2)
../../.....

xx/xx/20xx
• By the date of payment Accounts Payable
Cash
200,000
190,000
(1£ = $1.90) Exchange Gain 10,000
../../.....

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Example
• On January 19, 2018, Mr. Kitty Company performed services for
Cartour Company. The contracted price for the services was 20,000
euros, to be paid on March 23, 2018. On January 19, 2018, one euro
equaled $0,94, and on March 23, 2018, one euro equaled $0,91.
Accounts receivable
18,800
Sales Revenue 18,800
20,000 ₤ x 0,94 = 18,800$

Cash 18,200
Foreign exc.loss 600 20,000 ₤ x 0,91 = 18,200$
Accounts receivable 18,800

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Income Statement

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Forms of Income Statement
• In the income statements, basically expenses are deducted from
revenue in order to arrive at net income. Here we look at a multistep
income statement and a more complex single-step format.

Forms of the
Income
Statement

Single-step Multistep
Inc.Stat. Inc.Stat.
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 Single-Step Income Statement
• In this form of income statement,
net income is derived in a single
step by putting the major
categories of revenues in the first
part of the statement and the
major categories of costs and
expenses in the second part.

• Both the multistep form and the

single-step form have advantages:
the multistep form shows the
components used in deriving net
income, and the single-step form
has the advantage of simplicity.

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 Multistep Income Statement
• A multistep income statement goes through a
series of steps, or subtotals, to arrive at net income.
• In a service company’s multistep income statement,
the operating expenses are deducted from revenues
in a single step to arrive at income from operations.
• In contrast, because manufacturing and
merchandising companies make or buy goods for
sale, their income statements include an additional
step of calculating gross margin by subtracting the
cost of goods from net sales.
• Exhibit 1 compares the multistep income statement
of a service company (which provides services as
opposed to products) with that of a merchandising
company (which buys and sells products) and a
manufacturing company (which makes and sells
products).
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• Net sales (Net Revenue) is computed as follows.

• Gross Sales consist of the total revenue from cash and credit sales during a period. Under the
revenue recognition concept, even when cash from a credit sale is not received during the
current period, it is recorded if title to the merchandise has passed to the buyer.
• Sales Returns and Allowances include cash refunds and credits on account. They also include
any discounts from selling prices made to customers who have returned defective products or
products that are otherwise unsatisfactory. If sales discounts are given to customers, they also
should be deducted from gross sales.
• Cost of Goods Sold (Cost of Sales or Cost of Revenue) is the amount a merchandiser paid for the
merchandise it sold during a period. For a manufacturer, it is the cost of making the products it
sold during a period.
• Gross margin (Gross Profit) is computed as follows.

• Operating Expenses are the expenses, other than the cost of goods sold, that are incurred in
running a business. They are often grouped into the categories of selling expenses and general
and administrative expenses.
• Selling expenses include the costs of storing goods and preparing them for sale;
preparing displays, advertising, and otherwise promoting sales; and delivering goods to
a buyer if the seller has agreed to pay the cost of delivery. • Other revenues and expenses (Nonoperating revenues and expenses)
• General and administrative expenses include expenses for accounting, personnel, are not related to a company’s operating activities. Among the items
credit checking, collections, and any other expenses that apply to overall operations. included in this section are revenues from investments (such as
Although occupancy expenses, such as expenses of rent, insurance, and utilities, are dividends and interest on stocks, bonds, and savings accounts) and
often classified as general and administrative expenses, they can also be allocated interest expense and other expenses that result from borrowing money.
between selling expenses and general and administrative expenses.
• Net Income (Net Earnings) is the final figure, or “bottom line,” of an
• Income from Operations (Operating Income) is the income from a company’s main business income statement and is computed as follows.
and is computed as follows.

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