Chapter 5: Accounting for Merchandising Operations

Question 1

What are merchandising businesses?

Answer 1

Involves purchasing products (merchandise inventory) for resale to customers

Question 2

What are the two types of merchandising businesses?

Answer 2

Retailers and wholesalers

Question 3

Who are retailers?

Answer 3

Merchandising companies who purchase and sell directly to customers

(e.g. Aritzia)

Question 4

Who are wholesalers?

Answer 4

Merchandising companies who sell to retailers

Question 5

What is costs of good sold?

Answer 5

The total cost of merchandise sold during the period. An expense

Question 6

What is gross profit?

Answer 6

Sales revenue less costs of goods sold

Question 7

What are operating expenses?

Answer 7

Expenses incurred in the process of earning sales revenue

Question 8

What is inventory?

Answer 8

Merchandise on hand (not sold). Reported as a current asset.

Question 9

What is inventory value?

Answer 9

Determined using all the costs related to making the product

Question 10

How is gross profit determined?

Answer 10

Sales revenue minus cost of goods sold

Question 11

How is net income (loss) determined?

Answer 11

Gross profit minus operating expenses

Question 12

What are the two systems to account for inventory?

Answer 12

Perpetual inventory system and periodic inventory system

Question 13

What is the perpetual inventory system?

Answer 13

Inventory that is continuously tracked for each sale and purchase. A running total in the “Inventory” account is continuous

Question 14

What is the periodic inventory system?

Answer 14

Inventory that is counted and reconciled at the end of each period

Question 15

What is a subsidiary ledger?

Answer 15

A group of accounts that share a common characteristic

Question 16

What at subsidiary ledgers used for under the perpetual system?

Answer 16

Under the perpetual system, subsidiary ledgers are used to:

• Organize and track individual inventory items
• Frees the general ledger from the details of individual balances
• Used commonly for accounts receivable, payable and payroll

Question 17

What is a control account?

Answer 17

A general ledger account that summarizes subsidiary ledger data

• Cash is not a control account because there is no subsidiary ledger for this account
• Detailed data is summarized in the Merchandise Inventory control account
• Control account balance must equal total of all individual inventory account balances

Question 18

What are freight costs FOB (Free on Board)?

Answer 18

Indicates where ownership, costs, and responsibility are transferred. It is included as part of the terms sale

Question 19

What is FOB Destinaion?

Answer 19

Means that the buyer accepts ownership when the freight reaches its destination.

• Shipping is paid by the seller and is responsible for damages to the goods during transit

Question 20

What is FOB Shipping Point?

Answer 20

Means that the buyer accepts ownership when the freight leaves the shipper’s warehouse

• The buyer pays shipping costs and is responsible for damages

Question 21

What should the merchandise inventory total include?

Answer 21

It should include all costs incurred to purchase merchandise, bringing the goods to destination, preparing the goods for resale

Question 22

What is purchase returns and allowances?

Answer 22

The return, or reduction in price, of unsatisfactory merchandise that was purchased. It results in a debit to Cash or Accounts Payable

Question 23

What are purchase discounts?

Answer 23

A discount, based on the invoice price less any returns and allowances, given to a buyer for early payment of a balance due

Question 24

What is sales return and allowances?

Answer 24

The return, or reduction in price, of unsatisfactory merchandise that was sold

Question 25

What are some attributes of the sales return and allowances account?

Answer 25

• A contra-revenue account
• Provides information on sales return and allowances to management

Question 26

If there are a large amount of returns and allowances, what does it suggest?

Answer 26

1) Inferior merchandise
2) Inefficiencies in filling merchandise
3) Errors in billing customers, and/or
4) Mistakes in the delivery or shipment of goods

Question 27

What are sales discounts?

Answer 27

A reduction, based on the invoice price less any returns and allowances, given by a seller for early payment of a credit sale

• The contra-revenue “Sales Discount” is used

Question 28

What are trade discounts?

Answer 28

Wholesalers that give discounts for large quantity purchase

e.g. government agencies, larger businesses

Note: Trade discounts do not impact the accounting entry as they are a pre-negotiated discount applied to certain purchasers

Question 29

How are net sales calculated?

Answer 29

Sales minus returns and allowances and sales discounts

Question 30

What are gross sales?

Answer 30

The total sales before deducting the contra-revenue accounts

Question 31

What’s the relation with merchandising companies and GST and PST?

Answer 31

• GST or HST is paid by merchandising companies on the goods they purchase for resale
• GST and PST are collected by merchandising companies on the goods that they sell
• PST is not paid by a merchandiser - it is paid by the final consumer

Question 32

Why does inventory loss occur?

Answer 32

• Normal damage
• Shoplifting
• Employee theft
• Errors

Question 33

Under IFRS, how do merchandising companies classify their expenses?

Answer 33

Nature or function within the company

Question 34

What is nature in terms of accounting?

Answer 34

Classifying expenses based on what resources were spent on

e.g. depreciation, employee costs, transportation, ads

Question 35

What is function in terms of accounting?

Answer 35

Classifying expenses based on who ch business function he resources were spent on

e.g. cost of sales, administration, selling

Question 36

What are operating expenses?

Answer 36

Expenses incurred in the process of earning sales revenue

Question 37

What are non-operating activities?

Answer 37

Other revenue and expenses unrelated to the company’s main operations

Question 38

What is gross profit margin and how is it calculated?

Answer 38

The gross profit expressed as a percentage of net sales. It is calculated by dividing gross profit by net sales

Question 39

What does gross profit margins give info about?

Answer 39

The effectiveness of a company’s purchasing and the soundness of its pricing policies

Question 40

What are some fun facts about gross profit margins?

Answer 40

• A higher gross profit margin is seen as being more favourable than a lower gross profit margin
• Gross profit is important because inventory has a significant effect on a company’s profitability
• Gross profit represents a company’s merchandising profit
• It is not a measure of the overall profitability because operating expenses have not been deducted
• Costs of goods sold is usually the largest expense on the income statement

Question 41

What is the profit margin an how is it calculated?

Answer 41

Profit margins measure the percentage of each dollar of sales that result in a profit. It is calculated by dividing profit by net sales

Question 42

How can a company improve its profit margin?

Answer 42

By increasing its gross profit margin

e.g. increasing sales, or decreasing costs of goods sold, or by controlling its operating expenses and non-operating activities

Question 43

How are sales recorded in the periodic inventory system?

Answer 43

Sales are recorded in the same way as the Perpetual Inventory System but costs of goods sold is not recorded on the date of sale

Question 44

What are some facts about the periodic inventory system?

Answer 44

Uses purchases (not inventory) in terms of the charts of accounts

Costs of Goods Sold is calculated at the end of the period

It is calculated by adding the operating inventory and costs of goods pitches and subtracting the inventory counted at period end