Accounting for Merchandising Operations: Chapter 5 Study Notes

Accounting for Merchandising Operations

Chapter Overview

This chapter introduces the fundamental principles of accounting for merchandising operations, focusing on the activities, cost flows, and financial reporting unique to companies that buy and sell products. Key learning objectives include understanding merchandising activities, analyzing cost flows, recording transactions, and preparing financial statements.

Chapter 5 Learning Objectives

• Conceptual: Describe merchandising activities and cost flows.

• Analytical: Compute and analyze the acid-test ratio and gross margin ratio.

• Procedural:

  • Analyze and record transactions for merchandise purchases using a perpetual system.

  • Analyze and record transactions for merchandise sales using a perpetual system.

  • Prepare adjustments and close accounts for a merchandising company.

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

  • Record and compare merchandising transactions using both periodic and perpetual inventory systems.

  • Prepare adjustments for discounts, returns, and allowances per revenue recognition rules.

  • Record and compare merchandising transactions using the gross method and net method.

Merchandising Activities and Cost Flows

Service Companies vs. Merchandising Companies

Service companies and merchandising companies differ in how they earn revenue and report income.

• Service Companies: Sell time and expertise to earn revenue. Examples include accounting firms, law firms, and plumbing services.

• Merchandising Companies: Sell products to earn revenue. Examples include sporting goods stores, clothing retailers, and auto parts stores.

Income reporting for service companies involves subtracting expenses from revenues to determine net income. Merchandising companies must also account for the cost of goods sold (COGS) before calculating gross profit and then subtracting expenses to arrive at net income.

Operating Cycle for a Merchandiser

The operating cycle for a merchandising company begins with the purchase of merchandise and ends with the collection of cash from the sale of merchandise.

• (a) Purchase merchandise inventory

• (b) Credit sales to customers

• (c) Accounts receivable collection

• (d) Cash received

This cycle highlights the flow of resources and cash through the business.

Inventory Systems

Merchandising companies use inventory systems to track the flow of goods and costs.

Inventory Systems: Graphic Representation

The cost flow for merchandise inventory can be summarized as:

• Net Purchases + Beginning Inventory = Merchandise Available for Sale

• Merchandise Available for Sale is then split into Cost of Goods Sold and Ending Inventory

Inventory Systems: Definitions

• Perpetual Inventory System: Updates accounting records for each purchase and each sale of inventory. This system provides real-time inventory tracking and is commonly used with computerized systems.

• Periodic Inventory System: Updates accounting records for purchases and sales of inventory only at the end of an accounting period. Inventory counts are performed periodically to determine ending inventory and cost of goods sold.

Key Terms and Concepts

• Merchandise Inventory: Goods held for resale by a merchandising company.

• Cost of Goods Sold (COGS): The cost of inventory sold to customers during a period.

• Gross Profit: The difference between net sales and cost of goods sold. $\text{Gross Profit} = \text{Net Sales} - \text{COGS}$

• Operating Cycle: The time span from the purchase of inventory to the collection of cash from sales.

• Perpetual Inventory System: Continuous tracking of inventory transactions.

• Periodic Inventory System: Inventory updates at the end of the period.

Example: Income Reporting Comparison

Company Type	Revenues	COGS	Gross Profit	Expenses	Net Income
Service Company	$3,472	N/A	N/A	$2,918	$554
Merchandising Company	$14,693	$9,390	$5,303	$5,236	$67

Additional info: Table values inferred from typical textbook examples; actual values may vary.

Summary

• Merchandising operations involve buying and selling products, requiring specialized accounting for inventory and cost flows.

• Understanding the operating cycle and inventory systems is essential for accurate financial reporting.

• Merchandising companies must track both the cost of goods sold and ending inventory to determine gross profit and net income.