Principles of Financial Accounting

Chapter 5 | Accounting for Merchandising Operations

1) Differences between service and merchandising companies.

2) Recording of purchases and Sales Revenues under a perpetual inventory system.

3) Recording of purchases and Sales Revenues under a periodic inventory system

4) Prepare an income statement for a merchandiser.

Prepared by: Saira Rizwan for LUMS Undergraduate Course- ACCT100

 Merchandising Vs. Service Companies
Buy and Sell Goods Provides Services

Flow of Costs Beginning Inventory + Purchases – Cost of Goods Sold (COGS) = Ending Inventory
OR
Cost of Good Available for Sales (COGAS)
Beginning Inventory + Purchases – Ending Inventory = Cost of Goods Sold (COGS)

Inventory Systems
2) Periodic Inventory System
1) Perpetual Inventory system
 Counting of physical stock to determine the costs
 Updated inventory record on real time basis; of goods sold and stock in hand.
following heads are updated after every transactions:
(i) Quantity & Cost of Sales and  Recording / Entries are made periodically
(ii) Ending Inventory i.e., end of the accounting period.
 Calculation of Cost of Goods Sold:
 Physical stock counts is done to
(i) Account for theft and damaged stock Beginning inventory PKR 100,000
(ii) Ensure physical stock value matches with accounting Add: Purchases, net 800,000
record Goods available for sale 900,000
Less: Ending inventory 125,000
Prepared by: Saira Rizwan for LUMS Undergraduate Course- ACCT100 Cost of goods sold PKR 775,000
 Prepared by: Saira Rizwan for LUMS Undergraduate Course- ACCT100

Comparison of entries for Perpetual and Periodic Inventory Systems

Entries in BUYER’S BOOKS

Jan. 1

10

Remember: Under Perpetual Inventory system, all purchases, freight-in,

purchases’ returns and allowances, purchase discounts are recorded /
charged to inventory account
 Freight Cost – Transportation Charges
FOB – Free on Board / Freight on Board – is a point where the title of goods change hands.

FOB Shipping Point – buyer pays freight cost

FOB Destination Point – Seller pays freight cost

CNF – Cost Net Freight – seller pays for transpiration charges

CIF – Cost, Insurance, Freight – Seller pays for freight and insurance both

Freight costs incurred by the seller are an operating expense.

Prepared by: Saira Rizwan for LUMS Undergraduate Course- ACCT100

 Purchase Discounts - A cash discount for prompt payment

2/10, n/30
1/10 EOM n/10 EOM
Credit terms – terms of payment 2% discount if
1% discount if Net amount
as per agreement between buyer paid within 10
paid within first due within the
and seller days, otherwise
10 days of next first 10 days of
net amount due
month. the next month.
within 30 days.

Question: Flynn Company purchased merchandise

2% @ $5,000 = $100
inventory with an invoice price of $5,000 and credit
terms of 2/10, n/30. What is the net cost of the COG = Sale Price – Purchase Discount
goods if Flynn Company pays within the discount $5,000 - $100 = $4,900
period?

Prepared by: Saira Rizwan for LUMS Undergraduate Course- ACCT100

 Purchase Discounts – Practice Question
Stine Ltd. purchased merchandise with an invoice price of $2,000 and credit terms of 3/10, n/45.
Assuming a 360 day year, what is the implied annual interest rate inherent in the credit terms?

Discount: 3% @ $2,000 = $60 EXPLANATION:

Stine Ltd. saves $60 (i.e., $2,000 x .03) if it pays no later than 10
If $60 / 35 = $1.71 discount per day
days after the sale.
Also, Stine Ltd. must pay no later than 45 days after the sale.
Then interest for 360 days would be =
Thus, Stine Ltd. saves $60 if it pays 35 days before the final due
1.71*360 = $617
date.
$617 /$2,000 = 0.308 (i.e., 31%)
Therefore, Interest = Principal x Interest rate x Time

$60 = $2,000 x Interest rate x (30-10)/360

Interest rate = [360/(45-10)] x $60/$2,000 = 0.308 (i.e., 31%)

Prepared by: Saira Rizwan for LUMS Undergraduate Course- ACCT100

 Purchase Discounts – Practice Questions
1. Assume Alpha Sports pays the balance due of $3,500 (gross invoice price of $3,800 less purchase returns
and allowances of $300) on Jan. 10, the last day of the discount period. Journal entry in Alpha Sports on
Jan. 10 to record the payment would be:

Jan 10 Accounts Payable 3,500

Inventory 70
(discount of 2% on $3,500)
Cash 3,430

Jan 10 Accounts Payable 3,500

Purchase Discount 70
Cash 3,430

In case the buyer fails to avail discount and makes full payment, the entry would be:

Jan 30 Accounts Payable 3,500

Cash 3,500
Prepared by: Saira Rizwan for LUMS Undergraduate Course- ACCT100
Comparison of entries for Perpetual and Periodic Inventory Systems

Entries in SELLER’s Books

Jan. 1

10

Prepared by: Saira Rizwan for LUMS Undergraduate Course- ACCT100

P5-1A Ready-Set-Go, Ltd. distributes suitcases to retail stores and extends credit terms of 1/10, n/30 to all of
Ready-Set-Go its customers. At the end of June, Ready-Set-Go’s inventory consisted of suitcases costing £1,200. During
the month of July, the following merchandising transactions occurred.

July 1 Purchased suitcases on account for £1,620 from Trunk Manufacturers, FOB destination, terms
2/10, n/30. The appropriate party also made a cash payment of £100 for freight on this date.
3 Sold suitcases on account to Satchel World for £2,200. The cost of suitcases sold was £1,400.
9 Paid Trunk Manufacturers in full.
12 Received payment in full from Satchel World.
17 Sold suitcases on account to Lady GoGo for £1,400. The cost of the suitcases sold was £1,030.
18 Purchased suitcases on account for £1,900 from Holiday Manufacturers, FOB shipping point,
terms 1/10, n/30. The appropriate party also made a cash payment of £125 for freight on
this date.
20 Received £300 credit (including freight) for suitcases returned to Holiday Manufacturers.
21 Received payment in full from Lady GoGo.
22 Sold suitcases on account to Vagabond for £2,400. The cost of suitcases sold was £1,350.
30 Paid Holiday Manufacturers in full.
31 Granted Vagabond £200 credit for suitcases returned costing £120.

Instructions: Journalize the transactions for the month of July for Ready-Set-Go, Ltd. using a perpetual inventory system.

Prepared by: Saira Rizwan for LUMS Undergraduate Course- ACCT100

P5-1A | Ready-Set-Go

July 1 Purchased suitcases on account for £1,620 from Trunk

Manufacturers, FOB destination, terms 2/10, n/30. The
appropriate party also made a cash payment of £100 for
freight on this date.

3 Sold suitcases on account to Satchel World for £2,200.

The cost of suitcases sold was £1,400.

9 Paid Trunk Manufacturers in full within 10days.

12 Received payment in full from Satchel World.

17 Sold suitcases on account to Lady GoGo for £1,400. The

cost of the suitcases sold was £1,030. Terms 1/10, n/30.

18 Purchased suitcases on account for £1,900 from Holiday

Manufacturers, FOB shipping point. The appropriate
party also made a cash payment of £125 for freight on
this date.

Prepared by: Saira Rizwan for LUMS Undergraduate Course- ACCT100

P5-1A | Ready-Set-GoQ

July 20 Received £300 credit (including freight) for suitcases

returned to Holiday Manufacturers.

21 Received payment in full from Lady GoGo (Discount 1%).

22 Sold suitcases on account to Vagabond for £2,400.

The cost of suitcases sold was £1,350.

30 Paid Holiday Manufacturers in full.

31 Granted Vagabond £200 credit for suitcases returned

costing £120.

Prepared by: Saira Rizwan for LUMS Undergraduate Course- ACCT100

P5-3B Lerwick Store Ltd. is located in midtown Metropolis. During the past several years, net income has
Lerwick Store Ltd. been declining because of suburban shopping centers. At the end of the company’s fiscal year on
Nov. 30, 2017, following accounts appeared in two of its Trial Balances.

ADJ.

ADJ.

ADJ.

ADJ.

a) Prepare an income statement, a retained earnings statement, and a classified statement of financial
position. Notes payable are due in 2020.
(b) Journalize the adjusting entries that were made.
(c) Journalize the closing entries that are necessary.
Part a) LERWICK STORE LTD. P5-3B | Lerwick Store Ltd.
Income Statement
For the Year Ended November 30, 2017
Sales
Sales revenue £706,000
Less: Sales returns & allowances 9,000
Net sales 697,000 LERWICK STORE LTD.
Cost of goods sold 507,000 Retained Earnings Statement
Gross profit 190,000 For the Year Ended November 30, 2017
Operating expenses
Salaries and wages expense £96,000 Retained Earnings, Dec. 1, 2016 £61,700
Rent expense 15,000 Add: Net income 32,200
Sales commissions expense 13,500 93,900
Depreciation expense 11,000 Less: Dividends 8,000
Utilities expense 8,500 Retained Earnings, Nov. 30, 2017 £85,900
Insurance expense 6,000
Freight–out 6,500
Property tax expense 3,200
Total oper. expenses 159,700
Income from operations 30,300
Other income and expense
Interest revenue 8,000
Interest expense 6,100
Net income £ 32,200 Prepared by: Saira Rizwan for LUMS Undergraduate Course- ACCT100
 a) Prepare a classified statement of financial position. Notes payable are due in 2020. P5-3B | Lerwick Store Ltd.

LERWICK STORE LTD.

Statement of Financial Position
November 30, 2017

Assets Equity & Liabilities

PPE / Non-current Asset Share capital—ordinary £45,000
Equipment £154,300 Retained earnings 85,900 £130,900
Less: Accumulated depreciation—
equipment 33,000 £121,300 Non-current liabilities
Current assets Notes payable 37,000
Prepaid insurance 4,500 Current liabilities
Inventory 26,000 Accounts payable 25,200
Accounts receivable 30,500 Sales commissions payable 7,000
Cash 21,000 82,000 Property taxes payable 3,200 35,400
Total assets £203,300 Total equity and liabilities £203,300

Prepared by: Saira Rizwan for LUMS Undergraduate Course- ACCT100

 P5-3B | Lerwick Store Ltd. b) Journalize the adjusting entries that were made.

Nov. 30 Depr. Expense 11,000

Acc. Depr.—Equipment 11,000

Nov. 30 Insurance Expense 6,000

Prepaid Insurance 6,000

Nov. 30 Property Tax Expense 3,200

Property Taxes Payable 3,200

Nov. 30 Sales Commissions Expense 7,000

Sales Commissions Payable 7,000

Prepared by: Saira Rizwan for LUMS Undergraduate Course- ACCT100

 P5-3B | Lerwick Store Ltd. (c) Journalize the closing entries that are necessary.

Nov. 30 Sales Revenue 706,000

Interest Revenue 8,000
Income Summary 714,000
Nov. 30 Income Summary 32,200
Nov. 30 Income Summary 681,800 Retained Earnings 32,200
Sales Returns
& Allowances 9,000
Cost of Goods Sold 507,000 Nov. 30 Retained Earnings 8,000
Salaries Expense 96,000 Dividends 8,000
Depr. Expense 11,000
Freight–Out 6,500
Sales Commissions
Expense 13,500
Insurance Expense 6,000
Rent Expense 15,000
Property Tax Expense 3,200
Utilities Expense 8,500
Interest Expense 6,100

Prepared by: Saira Rizwan for LUMS Undergraduate Course- ACCT100

 Practice Question
2. Prepare the journal entries to record the following transactions on Fireworks Company, Ltd.’s
books using a perpetual inventory system.

a) On March 2, Fireworks Company sold

£800,000 of merchandise to Glaxy
Company, terms 2/10, n/30. The cost of
the merchandise sold was £620,000.

b) (b) On March 6, Glaxy Company

returned £120,000 of the merchandise
purchased on March 2. The cost of the
returned merchandise was £90,000.

c) (c) On March 12, Fireworks Company

received the balance due from Glaxy
Company.

Prepared by: Saira Rizwan for LUMS Undergraduate Course- ACCT100