Chapter 5: Accounting for Merchandising Operations

Question 1

FOB Shipping Point vs. FOB Destination

Answer 1

Shipping Point: Purchaser pays freight

• Cost of freight added to COGS in merchandise inventory
• Purchaser owners the freight in transit

Destination: Shipper pays freight

• cost of freight is an operating expense for the shipper
• Shipper owns freight in transit

Question 2

Income from Operations

Answer 2

Does not include interest revenue/expense or other non-operations gains and losses (such as disposal of plant assets)

Question 3

Perpetual vs Periodic Inventory Systems

Answer 3

Cost flow methods
Perpetual: records cost of goods and reduces inventory at the time of sale (so inventory always shows current)
- uses merchandise inventory account
vs.
Periodic: Cost of goods sold determined and recorded only at the end of the accounting period.
- no merchandise inventory account

Question 4

Merchandising Company Operating Cycle

Answer 4

Have cash -> Buy inventory ->
inventory goes into merchandise inventory->
sell the inventory -> record sale in A/R–>
A/R paid in cash–> have cash to buy more inventory

Question 5

Service Company Operating Cycle

Answer 5

Have cash –> Pay employees to perform services–>

Record services in A/R–> A/R paid in Cash–> have cash to pay employees

Question 6

Merchandising Companies

Answer 6

AKA retailers and wholesalers. Businesses that buy and sell goods
Revenue account = sales revenue or just sales

Question 7

Purchase Returns and Allowances

Answer 7

Return: product returned for credit or cash refund

Allowance: buyer keeps (defective/ unwanted) product and gets a deduction from the purchase price

Question 8

Purchase Discounts

Answer 8

Incentivizes quick payments, thus shortening the operating cycle
- applies to invoice price LESS returns and allowances, not including freight

2/10, n/30: 2% off if paid in 10 days, net due in 30 days

1/10 EOM: 1% off if paid within 1st 10 days of next month

n/10 EOM: Net due within 1st 10 days of next month

Question 9

Contra-Revenue account

Answer 9

Debit Increase | Credit Decrease
Debit Normal Balance

Normal balance decreases sales revenue. Sales less contra-revenue = net sales

ex:
- sales returns and allowances
- sales discounts

Question 10

Journaling Sales Returns

Answer 10

(Sales Returns + allowances is a contra-revenue account. Sales account is not directly reduced to keep comparisons across periods even)

Case: Perpetual inventory item is returned.

Debit (increase) Sales returns + Allowances
   Credit (decrease) Accounts Receivable
\+
Debit (increase) Merchandise Inventory
   Credit (decrease) Cost of Goods Sold

If return is defective the 2nd transaction is only for the scrap/ residual value.

If periodic inventory 2nd transaction isn’t done

Question 11

Sales Allowance

Answer 11

An incentive for the customer to keep the unsatisfactory merchandise

Debit (increase) Sales Returns and Allowances
Credit (decrease) Accounts Receivable

same for perpetual and periodic inventory

Question 12

Merchandise inventory account

Answer 12

A CURRENT asset account that exists in perpetual inventory systems only.

Debit increase | Credit decrease
Debit NB

Increases from: cost of merchandise purchased, freight

decrease from: returns, discounts, allowances

Permanent account - goes after A/R on balance sheets (only marketable inventory goes to this account)

Question 13

Journaling Inventory Purchase (Perpetual Inventory)

Answer 13

Debit (increase) Merchandise Inventory
Credit (increase) A/R (or decrease cash)

Periodic inventory - Debit to purchases expense

Question 14

Merchandise Transactions (Periodic Inventory)

Answer 14

Sales recorded in revenue account
Purchases recorded in Purchase account
Freight, purchase discounts etc all in separate accounts

A physical inventory count determines the Cost (value) of inventory on hand AND the cost of goods sold

Question 15

Recording perpetual inventory on-time payment purchase discount

Answer 15

Assumes already recorded Debit Merchandise Inventory, Credit A/P

Debit (decrease) Accounts Payable (full amount)
Credit (decrease) cash (amount less discount)
Credit Merchandise inventory (discount amount)

Periodic inventory: Credit purchase discounts for discount amount

Question 16

Determining Cost of goods sold (Periodic inventory system)

Answer 16

Beginning Inventory 
\+ Cost of Goods Purchased = Purchases
- Returns and Allowances
- Discounts
\+ Freight in
= Goods Available for Sale 
- Ending Inventory
= Cost of Goods Sold

Question 17

Sale of Inventory (perpetual system)

Answer 17

Debit (increase) A/R or Cash
Credit (increase) Sales/Revenue
+
Debit (increase) Costs of Good Sold (expense)
Credit (decrease) Merchandise inventory (asset)

Transaction recorded when the customer receives the goods, requires invoice or receipt backup.
Any shipping costs are recorded separately.

Question 18

Sales Discounted payment

Answer 18

Debit (increase) Cash (due amount less discount)
Debit (increase) Sales Discount (amount of discount)
Credit (decrease) A/R (full amount

Check “Under new revenue recognition standards sales recorded at net amount or amount of sale less any discounts” (use “Sales Discount Forfeited account”)

Question 19

Closing in a periodic system

Answer 19

• Purchase returns + Allowances and Purchase Discounts both closed via Income summary
• Merchandise Inventory + estimated returns inventory recorded as debits
• Beginning merchandise inventory and expense accounts closed via income summary

This should result in a merchandise inventory balance

Question 20

Closing Merchandising Accounts

Answer 20

1) Revenue Accounts closed to income summary (includes sales revenue and discounts forfeited)
2) Expenses accounts closed to income summary (includes cost of goods sold + delivery expense
3) Close income summary to retained earnings
4) Close dividends to retained earnings

Question 21

Merchandise Inventory Adjustment (perpetual inventory)

Answer 21

Reconciles actual inventory to books
Requires physical inventory count

Ending inventory (book)
- Ending inventory (actual)
= Over or understatement of books

Overstatement of books (need to reduce inventory)
Debit Cost of Goods Sold
Credit Merchandise Inventory

Understatement of books (need to increase inventory)
Debit Merchandise Inventory
Credit Cost of Goods Sold

Question 22

Purchase Returns + Allowances and Purchase Discounts

Answer 22

Debit (decrease) A/P
Credit Merchandise Inventory Account (perpetual inventory)
or Credit Purchase Returns and Allowances (periodic inventory)

Question 23

Freight

Answer 23

If shipping to a customer and seller pays freight

Debit (increase) expense
Credit (increase) liability or (decrease) cash

For freight in
Perpetual inventory ; freight debited to merchandise inventory (asset) account
Periodic inventory: Freight debited to Freight-in (expense) account

Question 24

Estimating Sales Returns

Answer 24

(This was not in the Albany presentation)
Have a refunds payable account based on estimated returns calculated using historical data.

to adhere to the matching principle - so that statements show the “actual” sales for that period after returns

Refunds payable is a liability account
Estimated returns inventory (asset account) estimates the cost of goods sold that are returned

Returns then go to Refunds payable/ estimated returns inventory account.

Question 25

Gross Profit Rate

Answer 25

(or Gross Profit Percentage)

Gross Profit/ Net Sales = Gross Profit Rate

Question 26

Net Cost of Inventory Purchased

Answer 26

Purchase cost of inventory
- Purchase returns and allowances 
- purchase discounts
\+ freight in
= Net Cost of Inventory Purchased

Question 27

Gross Profit

Answer 27

Markup on merchandise inventory

Revenue - Returns - allowances - discounts = Net Sales
Net sales - cost of goods sold = gross profit (BEFORE operating expenses accounted for

Question 28

Cost of Goods Sold for Periodic Inventory

Answer 28

Beginning Inventory
Purchases
Less Returns + Allowances
Less Discounts
= Net Purchases
(add)Freight In
Cost of Goods Purchased
= Cost of Goods Available for Sale
Less Ending Inventory
= Cost of goods sold

Question 29

Multi-Step Income Statement

Answer 29

Distinguishes between operating and non-operating activities (can also distinguish between selling and admin expense)

Sales less contra-revenue accounts = Net Sales
Net Sales less Cost of Goods Sold = Gross Profit
Gross profit less operating expenses = income from operations
Income from operations + other revenue or gains - other expenses or losses (less income tax expenses) = Net Income

Question 30

Merchandising company Income Formula

Answer 30

Sales Revenue
Less Cost of Goods Sold 
= Gross Profit
Less Operating Expenses
= Net income (or loss)

Question 31

Sales Revenue Section of Income Statement

Answer 31

Sales Revenue
  Sales
  Less: Sales Returns + allowances
            Sales discounts
 Net Sales

Question 32

Single Step income statement

Answer 32

Total Revenues less total expenses = income

List Revenues
total Revenues
List Expenses
Total Expenses
Revenues - Expenses = Net Income

Question 33

IFRS vs GAAP Revaluation

Answer 33

Under IFRS companies may revalue land/ buildings/ intangible assets. These gains and losses are reported as equity adjustments, not income or loss

Question 34

IFRS vs GAAP Income Statement Classifications

Answer 34

GAAP: classified by function (admin, distribution, manufacturing)

IFRS: either by function or by nature
if by function on income statement then the nature must be included in the notes
(Nature = salaries, depreciation, utilities etc…)

Also- no single vs. multi step income statements under IFRS