Accounting for Merchandising Activities Accounting Help

Courtesy Sears.Roebuckand Co

Courtesy Sears.Roebuckand Co

1. Describe the operating cycle of a merchandising Company,
2. Define subsidiary ledgers and explain their usefulness,
3. Account ‘for purchases and salesof rnerchandlse in a perpetual inventory system.
4. Explain how a.periodic inventory system operates,
5: Discuss the factors to be considered in selecting an iriventory system,
6. Define special journals and explain their usefulness,
7. Account for additional merchandising transactions related to purchases and sales,
8. Compute ·gross profit margin and explain lts usefulness,


It’s urban’, it’s trendy, It’s … Sears? Not quite. ~ut after decades of closing stores in ~ltIes and building them in the suburbs, Sears, Roebuck & Co. is changing course. In 1996, Sears opened three full-line stores in’ metro Los Angeles, one in Queens, N.Y., and another in downtown Oakland, Calif. This year, . . sears is opening a Brooklyn store, bidding’ Qn’a mid-Manhattan site, and may acquire real estate in . .. . Harlem .. The company is also scouting locations in Chica~o, Detroit, Philadelphia, San Francisco, and Washington, D.C.

So far, Sears’s bet on downtown stores seems to be paying off. Rents are hlghe.r than those on Sears’s sub Urban stores, bu. the volumes are higher. The new stores average between $75 mlillon·.and $100 million in annual sales, almost triple the chain wide avem;:;e. “Our  metropolitan stores have really performed, and that’s not going unnoticed within our corooranen,” .say~Anan B. Stewart, Sears president for retail stores.

Retailers, like Sears, receive most of their revenues from selling products’ rather than services. For its newly . adopted’ market strategy to’ be successful, Sears jj lust maintain a high volume of sales at its. urban location  , Only if Sears’s urban stores sell merchandise quickly, and in large volume, will these stores outperform the company’s suburban locations


In the preceding chapters we examined organizations that render services to their customers. Merchandising companies earn most of their revenue by selling goods. Goods that are purchased for purposes of resale to customers are called inventory. The success of most merchandising companies depends on their ability to acquire, distribute, and sell inventory quickly. .

In many cases, inventory is a relatively “liquid” asset-that is, it usually is sold within a few days or weeks. For this reason, inventory appears near the top of the balance sheet, .immediately below accounts receivable.

The Operating Cycle of a Merchandising Company

The series of transactions through which a business generates its revenue and its casbreceipts from customers is called the operating cycle. The operating cycle of a merchandising company consists of the following basic transactions: (1) purchases of merchandise; (2) sales of the merchandise, often on account; and (3) collection of the accounts receivable from customers. As the word cycle suggests, this sequence of transactions repeats continuously. Some of the cash collected from the customers is used to purchase more merchandise, and the cycle begins anew. This continuous sequence of merchandising transactions is illustrated below

Comparing Merchandising Activities with Manufacturing Activities

Most merchandising companies purchase their inventories from other business organizations in a ready to- sell condition. Companies that manufacture their inventories such as General Motors IBM, and Boeing Aircraft, are called manufacturers, rather”than merchandisers.

The operating cycie of a manufacturing company is longer and more complex than that of a merchandising company, because the first transaction-purchasing merchandiseis replaced by the many activities involved in manufacturing the merchandise. Our examples and illustrations in .this chapter are limited to companies that purchase their inventory in a ready-to-sell condition. The basic concepts, however, also apply to manufacturers.

Retailers and WholesaJers

Merchandising companies include both-retailers and wholesalers. A retailer is a business that sells merchandise directly to the public, Retailers may be large or small; they vary in size from giant department store chains, such as Scars

operating cycle repeats

operating cycle repeats

Income Statement of a Merchandising Company

Selling merchandise introduces a new and major cost of doing business: the cost to the uierchundlsing company of the goods that it resells to its customers. This cost is termed the cost of goods sold. In essence, the cost of goods sold is an expense; however, this item is of such importance to a merchandising, company that itis shown separately from other expenses in the income statement

Revenue from sales represents the sales price of merchandise sold to customers during the period, The cost of goods sold, on the other hand, represents the cost incurred by the merchandising company. for purchasing these goods from the company’s suppliers. The-difference between revenue from sales and the cost of goods sold is called gross profit (or gross margin).

Gross profit is a useful means of measuring the profitability of sales transactions, but it does 1I0t represent the overall profitability of the business. A merchandising company has many expenses other than the cost of goods sold. Examples include salaries, rent, advertising, and depreciation. The company earns a net income only if its gross profit exceeds the sum of its other expenses

Michael Newll

Michael Newll

What Accounting Information Does a Merchandising Company Need?

Before we illustrate how a merchandising company accounts for the transactions in its operating cycle, let us consider the basic types of information that the company’s accounting system should develop. The company needs accounting information that will (1) meet its financial reporting requirements, (2) serve the needs of company personnel in conducting daily business operations, and (3) meet any special reporting requirements, such as information required by income tax authorities

In most respects, the information needed for income tax purposes parallels that used in the financial statements. Differences between income tax rules and financial reporting requirements will be discussed in later chapters.

Let us now see how the accounting system of a merchandising company meets the company’s needs for financial information

General Ledger Accounts

we have been.posting transactions only i~ general ledger-accounts. These· general ledger accourits are used to prepare financial statements and other accounting re- . J’Ot1S that summarize the financial position of a business and the results of its operations. Although general ledger accounts provide a useful overview of a company’s financial activities, they do not provide much of the detailed information needed by managers and other company employees in dally business operations. This detailed information is found in accounting records called subsidiary ledgers.

An accounts receivable . ubsi diary ledger provides the information used in billing customers and in reviewing their creditworthiness. The account includes information on the dates and amounts of past charges and payments, the current balance owed, and the customer’s billing address. In fact, each account provides a complete history of the credit sacticns between the company and the individual customer

Most businesses maintain a number of different subsidiary ledgers, each providing ‘detailed information about a different general ledger account. A general ledger account that summarizes the content of a subsidiary le.dger is called a controlling account (or’ control account.) ‘. .

For ‘convenience, the word “subsidiary” can be omitted in’ describing’ a specific subsidiary ledger. Thus the accounts receivable-subsidiary ledger might simply be called the accounts receivable ledger (or customer ledger).

Other Types of Subsidiary Ledgers

In this chapter we discuss the subsidiary ledgers for inventory, accounts payable, and accounts receivable. However, .subsidiary ledgers also are maintained for many other general ledger accounts. The schedule on the next ‘. page lists some of the general ledger accounts usually supported by a subsidiary ledger. Subsidiary ledgers are intended to meet the information needs of the company’s managers’ and employees. These accounting records are not used in the .preparation of financial statements, nor are they usually’ made available to persons outside of the business organization.

Accounts Payable

Accounts Payable

General ledger accounts

General ledger accounts


In a perpetual inventory system, merchandising transactions are recorded as they occur. The system draws its name from the fact that the accounting records are kept perpctually up-to-date: Purchases of merchandise are recorded by debiting an asset account entitled Inventory. When merchandise is sold, two entries are necessary: one to recognize the revel/Lie earned and the second to recognize the related cost of goods sold. 1 This second entry also reduces the balance of the Inventory .account to reflect the sale of some 01″ the company’s inventory.

.The data contained in this entry are posted to the general ledger and to the subsidiary ledgers. First, the entry is posted to the Inventory and Accounts Payable controlling ac counts in the general ledger. The debit to Inventory also is posted to the Regent CX-21 Monitors account in the inventory subsidiary .ledger,2 The quantity of monitors purchased (10) and the per-unit cost ($600) also are recorded in this subsidiary ledger account.

(This subsidiary ledger account is illustrated on the following page.) The credit to Accounts Payable also is posted to the account for Okawa Wholesale Co. in Computer Barn’s accounts payable subsidiary ledger.

Sales of Merchandise

The revenue earned in a sales transaction is equal to the salesprice of the merchandise and is credited to I! revenue account entitled Sales. Except in rare circumstances, Sales revenue is considered realized when the merchandise is delivered to the’ customer, even if the sale is made on account. Therefore, Computer Barn will recognize the revenue from the sale to RJ Travel Agency on September 7, as follows:

The Inventory Subsidiary ledger

An inventory subsidiary ledger includes a separate account for each type of product in the company’s inventory. Computer Barn’s subsidiary  inventory record for Regent monitors is illustrated below

In'l'flntory subsidiary ledger accounts

In’l’flntory subsidiary ledger accounts

When Regent CX-2l monitors are purchased, the quantity, unit cost, and total cost are entered in this subsidiary ledger account. When any of these monitors are sold, the number of units, unit cost, and total cost of the units sold also are recorded in this subsidiary ledger account. After each purchase or sales transaction, the Balance columns are updated to show the quantity, unit cost, and total cost of the monitors still on hand.’

An inventory ledger provides useful information to a variety of company personnel. A few examples of the company personnel who utilize this information on a daily basis are the following:

Sales managers use the inventory ledger to see at a glance which products are selling quickly and which are not.

Accounting personnel use these records to determine the unit costs of merchandise sold.

Sales personnel use this subsidiary ledger to determine the quantities of specific products currently on hand and the physical location of this merchandise.

Employees responsible for ordering merchandise refer to the inventory ledger to determine when specific products should be reordered, the quantities to order, and the names of major suppliers

Taking a Physical Inventory

The basic characteristic of the perpetual inventory system is that the Inventory account is continuously updated for all purchases and sales of merchandise. When a physical inventory is taken, management uses the inventory ledger to determine on a product by- product basis whether inventory on hand corresponds to the amount indicated in , the inventory subsidiary ledger. Over time normal ~nventory shrinkage usually causes some discrepancies between the quantities of merchandise shown in the -inventory records and the quantities actually on hand. Inventory shrinkage refers to unrecorded decreases in inventory resulting from such factors as breakage, spoilage, employee theft, and shoplifting.

Once the quantity of merchandise on hand has been determined by a physical count, the per-unit costs in the inventory ledger accounts are used to determine the total cost of the inventory. The Inventory controlling account and the accounts in the inventory subsidiary ledger then are u.ljusted to the quantities and dollar amounts indicated by the physical inventory

Closing Entries in a Perpetual Inventory System

As explained and illustrated in the previous chapters, revenue and expense accounts are closed at the end of each accounting period. A merchandising business with a perpetual inventory system makes closing entries that parallel those of <I service-type business. The Sales account is a revenue account and is closed into the Income Summary account along with other revenue accounts. The Cost of Goods Sold account is closed into the Income Summary account in the same manner as the other expense accounts

Posted on November 21, 2015 in Accounting for Merchandising Activities

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