Merchandizing Operations

Introduction

Merchandizing operations refer to the activities involved in buying and selling goods for resale. This chapter focuses on the accounting processes and journal entries required for merchandizing companies, including inventory systems, purchase and sales transactions, and the treatment of freight and returns.

Differences Between Service, Manufacturing, and Merchandising Companies

Types of Companies

• Service Companies: Provide services as their primary source of revenue (e.g., auto service, accountants, lawyers).

• Manufacturers: Produce goods to sell to retailers (e.g., car manufacturers, electronics, pharmaceuticals).

• Merchandisers: Buy finished goods for resale. Wholesalers: Purchase goods from manufacturers to sell to retailers (e.g., Sysco). Retailers: Purchase goods from wholesalers or manufacturers to sell to consumers (e.g., Walmart, The Bay, Artizia).

Income Measurement Process for Merchandisers and Manufacturers

Key Components

• Sales Revenue – Total income from sales of goods.

• Cost of Goods Sold (COGS) – The cost to purchase or produce the goods sold.

• Gross Profit – Difference between sales revenue and COGS.

• Operating Expenses – Costs incurred in running the business (excluding COGS).

• Income from Operations – Gross profit minus operating expenses.

Inventory Systems

Inventory Calculation

• Beginning Inventory – Inventory at the start of the period.

• Net Purchases – Purchases minus purchase returns and discounts.

• Cost of Goods Available for Sale (COGAS) – Sum of beginning inventory and net purchases.

• Ending Inventory – Inventory remaining at the end of the period (verified by counting).

• Cost of Goods Sold (COGS) – COGAS minus ending inventory.

Periodic vs. Perpetual Inventory Systems

• Periodic System: COGS is determined at the end of the reporting period.

• Perpetual System: COGS is recorded with each sales transaction; inventory records are updated continuously.

Perpetual Inventory System

Accounting for Inventory

• All costs to bring inventory to its intended location and condition for sale are included (e.g., purchase price, freight, taxes).

• Inventory increases with purchases and decreases with sales, returns, and discounts.

Recording Purchases of Inventory (Perpetual)

Journal Entries

Note: Freight expense is not recorded separately; it is included in inventory cost.

Freight and FOB Definitions

FOB Destination

• Seller pays freight costs and owns/insures goods until received by buyer.

• Buyer owns goods when received at destination.

FOB Shipping Point

• Buyer pays freight costs and owns/insures goods while in transit.

• Buyer records: Inventory (Dr) XX Cash (Cr) XX

Inventory Purchases – Perpetual

Purchase Returns and Allowances

• Purchase Returns: Buyer returns goods for a refund.

• Purchase Allowance: Buyer keeps goods but receives compensation for damage or problems.

Volume and Purchase Discounts

• Volume Discounts: Buying items in bulk at a reduced price.

• Purchase Discounts: Incentives for early payment (e.g., 2/10 net 30, 3/15 net 60).

Sales of Merchandise (IFRS)

Recording Sales in Perpetual Inventory System

• Requires two entries for each sale:

  1. Record sales revenue: Accounts Receivable (Dr) XX Sales Revenue (Cr) XX Refund Liability (Cr) XX (estimate)

  2. Record cost of sale: Cost of Goods Sold (Dr) XX Estimated Inventory Returns (Dr) XX (estimate) Inventory (Cr) XX

Balance Sheet Presentation

• Refund Liability: Recorded as a current liability (similar to deferred revenue).

• Estimated Inventory Returns: Recorded as a current asset.

Sales of Merchandise (Taxes and Freight)

Sales Taxes

• Sales taxes (GST, PST, HST) are not revenues; they are liabilities owed to governments.

Freight Costs (FOB Destination)

• Seller records freight cost as an operating expense (Delivery Expense).

• Journal Entry: Delivery Expense (Dr) XX Cash or Accounts Payable (Cr) XX

Sales Returns

Recording Sales Returns

• Requires two entries:

  1. Record sales return: Refund Liability (Dr) XX Accounts Receivable (Cr) XX

  2. Record return to inventory: Inventory (Dr) XX Estimated Inventory Returns (Cr) XX

Worked Examples: Journal Entries

Purchase Transactions (Xtra Inc.)

• Jan 2: Purchased goods for $45,000 from Fundy Corp. on account, terms n/45, FOB destination. Inventory (Dr) 45,000 Accounts Payable (Cr) 45,000

• Jan 5: Freight costs of $900 paid by Fundy Corp. No entry necessary (seller pays freight).

• Jan 6: Returned $6,000 of goods. Accounts Payable (Dr) 6,000 Inventory (Cr) 6,000

• Feb 11: Paid balance owed to Fundy. Accounts Payable (Dr) 39,000 Cash (Cr) 39,000

Sales Transactions (Fundy Corp.)

• Jan 2: Sold $45,000 of goods to Xtra Inc., cost $25,200, expected return rate 15%. Accounts Receivable (Dr) 45,000 Refund Liability (Cr) 6,750 ($45,000 x 15%) Sales Revenue (Cr) 38,250 Cost of Goods Sold (Dr) 21,420 Estimated Inventory Returns (Dr) 3,780 ($25,200 x 15%) Inventory (Cr) 25,200

• Jan 5: Paid freight costs of $900. Freight Out / Delivery Expense (Dr) 900 Cash (Cr) 900

• Jan 6: Xtra returned $6,000 of merchandise, cost $3,360. Refund Liability (Dr) 6,000 Accounts Receivable (Cr) 6,000 Inventory (Dr) 3,360 Estimated Inventory Returns (Cr) 3,360

• Feb 11: Received balance due from Xtra. Cash (Dr) 39,000 Accounts Receivable (Cr) 39,000

Summary Table: Key Journal Entries in Perpetual Inventory System

Additional info:

• IFRS requires estimation and recognition of refund liabilities and inventory returns for sales with expected returns.

• Purchase discounts incentivize early payment and reduce the cost of inventory if taken.

• Sales taxes collected are liabilities, not revenues, and must be remitted to the government.