Chapter 5 - Accounting for Merchandising Businesses
Learning Objectives
Objective 1:
Distinguish between the activities and financial statement of service and merchandising
businesses
Answer:
Activities
The activities of a service business differ from those of a merchandising business. These
differences are reflected in the operating cycles of the service and merchandising business
as well as in their financial statement.
The operating cycle is a process by which a company spends cash, generates revenues,
and receives cash either at the time the revenues are generated or later by collecting
accounts receivable. The operating cycle of a service and merchandising business differs in
that a merchandising business must purchase merchandise for sale to customers.
Financial Statement
Service Business Merchandising Business
Fees Earned XXX Sales XXX
Operating Expense (XXX) Cost of goods sold (XXX)
Operating Income XXX Gross profit XXX
Operating expenses (XXX)
Operating income XXX
The revenue activities of a service business involve providing services to customers. On the
income statement for a service business, the revenues from services are reported as fees
earned. The operating expenses incurred in providing the services are subtracted from the
fees earned to arrive at operating cost.
In contrast, the revenue activities of a merchandising business involve the buying
and selling of merchandise. A merchandising business first purchases merchandise to sell to
its customers. When the merchandise is sold, the revenue is reported as sales, and its cost
is recognized as an expense. This expense is called the cost of goods sold or cost of
, merchandise sold. The cost of goods sold is subtracted from sales to arrive at gross profit.
This amount is called gross profit because it is the profit before deducting operating
expenses. The operating expenses are subtracted from gross profit to arrive at operating
income. Merchandise on hand (not sold) at the end of an accounting period is called
inventory or merchandise inventory. Inventory is reported as a current asset on the balance
sheet.
Objective 2:
Describe and illustrate the accounting for merchandise transactions
Answer:
Merchandise transactions are recorded in the accounts, using the rules of debit and credit.
However, the accounting system for merchandise businesses is often modified to more
efficiently record transactions. For example, an accounting system should be designed to
provide information on the amounts due from various customers (accounts receivable) and
amounts owed to various creditors (accounts payable) A separate account for each
customer and creditor could be added to the ledger. However, as the number of customers
and creditors increases, the ledger would become large and awkward to use. Individual
accounts with common characteristics can be grouped together in a separate ledger, called
a subsidiary ledger. The primary ledger, which contains all of the balance sheet and income
statement accounts, is then called the general ledger. Each subsidiary ledger is represented
in the general ledger by a summarizing account, called a controlling account. Controlling
accounts balance must equal all of the subsidiary ledgers balances. Common subsidiary
ledgers are:
● Accounts receivable subsidiary ledger, or customers ledger, this lists the individual
customer accounts in alphabetical order. The controlling account in the general
ledger is Accounts Receivable.
● Accounts payable subsidiary ledger, or creditor ledger, this lists individual creditor
accounts in alphabetical order. The controlling account in the general ledger is
Accounts Payable.
● Inventory subsidiary ledger, or inventory ledger, this lists individual inventory by item
number (barcode.) The controlling account in the general ledger is Inventory. An
inventory subsidiary ledger is used in the perpetual inventory system.
Most Merchandising companies also use computerized accounting systems that record
similar transactions in separate journals, which generate purchase, sales, and inventory
reports. These separate journals are called special journals.
There are two systems for accounting for merchandise transactions: perpetual and periodic:
Perpetual Inventory System - In a perpetual inventory system, each purchase and sale of
merchandise is recorded in the inventory account and related subsidiary ledger. In this way,
the amount of merchandise available for sale and the amount sold are continuously updated
in the inventory records
Periodic Inventory System - In a periodic inventory system, the inventory does not show the
amount of merchandise available for sale and the amount sold. Instead, a listing of inventory
on hand called a physical inventory, is prepared at the end of the accounting period.
Most merchandise companies use computerized perpetual inventory systems.
Objective 3:
Describe and illustrate the financial statements of a merchandising business
Learning Objectives
Objective 1:
Distinguish between the activities and financial statement of service and merchandising
businesses
Answer:
Activities
The activities of a service business differ from those of a merchandising business. These
differences are reflected in the operating cycles of the service and merchandising business
as well as in their financial statement.
The operating cycle is a process by which a company spends cash, generates revenues,
and receives cash either at the time the revenues are generated or later by collecting
accounts receivable. The operating cycle of a service and merchandising business differs in
that a merchandising business must purchase merchandise for sale to customers.
Financial Statement
Service Business Merchandising Business
Fees Earned XXX Sales XXX
Operating Expense (XXX) Cost of goods sold (XXX)
Operating Income XXX Gross profit XXX
Operating expenses (XXX)
Operating income XXX
The revenue activities of a service business involve providing services to customers. On the
income statement for a service business, the revenues from services are reported as fees
earned. The operating expenses incurred in providing the services are subtracted from the
fees earned to arrive at operating cost.
In contrast, the revenue activities of a merchandising business involve the buying
and selling of merchandise. A merchandising business first purchases merchandise to sell to
its customers. When the merchandise is sold, the revenue is reported as sales, and its cost
is recognized as an expense. This expense is called the cost of goods sold or cost of
, merchandise sold. The cost of goods sold is subtracted from sales to arrive at gross profit.
This amount is called gross profit because it is the profit before deducting operating
expenses. The operating expenses are subtracted from gross profit to arrive at operating
income. Merchandise on hand (not sold) at the end of an accounting period is called
inventory or merchandise inventory. Inventory is reported as a current asset on the balance
sheet.
Objective 2:
Describe and illustrate the accounting for merchandise transactions
Answer:
Merchandise transactions are recorded in the accounts, using the rules of debit and credit.
However, the accounting system for merchandise businesses is often modified to more
efficiently record transactions. For example, an accounting system should be designed to
provide information on the amounts due from various customers (accounts receivable) and
amounts owed to various creditors (accounts payable) A separate account for each
customer and creditor could be added to the ledger. However, as the number of customers
and creditors increases, the ledger would become large and awkward to use. Individual
accounts with common characteristics can be grouped together in a separate ledger, called
a subsidiary ledger. The primary ledger, which contains all of the balance sheet and income
statement accounts, is then called the general ledger. Each subsidiary ledger is represented
in the general ledger by a summarizing account, called a controlling account. Controlling
accounts balance must equal all of the subsidiary ledgers balances. Common subsidiary
ledgers are:
● Accounts receivable subsidiary ledger, or customers ledger, this lists the individual
customer accounts in alphabetical order. The controlling account in the general
ledger is Accounts Receivable.
● Accounts payable subsidiary ledger, or creditor ledger, this lists individual creditor
accounts in alphabetical order. The controlling account in the general ledger is
Accounts Payable.
● Inventory subsidiary ledger, or inventory ledger, this lists individual inventory by item
number (barcode.) The controlling account in the general ledger is Inventory. An
inventory subsidiary ledger is used in the perpetual inventory system.
Most Merchandising companies also use computerized accounting systems that record
similar transactions in separate journals, which generate purchase, sales, and inventory
reports. These separate journals are called special journals.
There are two systems for accounting for merchandise transactions: perpetual and periodic:
Perpetual Inventory System - In a perpetual inventory system, each purchase and sale of
merchandise is recorded in the inventory account and related subsidiary ledger. In this way,
the amount of merchandise available for sale and the amount sold are continuously updated
in the inventory records
Periodic Inventory System - In a periodic inventory system, the inventory does not show the
amount of merchandise available for sale and the amount sold. Instead, a listing of inventory
on hand called a physical inventory, is prepared at the end of the accounting period.
Most merchandise companies use computerized perpetual inventory systems.
Objective 3:
Describe and illustrate the financial statements of a merchandising business
