Merchandising companies

U S I N G V A R I O U S E X A M P L E S F R O M A
F I C T I T I O U S C O M P A N Y ,
W E W I L L W A L K T H R O U G H S A L E S A N D
P U R C H A S E S O F M E R C H A N D I S E
Merchandising Companies
Accounting for Sales and Purchases

This chapter is about a new type of company which sells merchandise and not services.
We will learn about this type of company by looking at various transactions for a seller
and purchaser of merchandise.
We will use a local company named “Candy Mart” which purchases from the large candy
manufacturers and sells to local candy stores for Halloween baskets. The store’s clients
are Happy Halloween, Scary Snacks, and Gruesome Goodies.
Merchandising Companies

As a merchandiser, Candy Mart has this amount of candy at
October 1, 2014.
This is Candy Mart’s beginning inventory. Inventory is a new account. It is an asset representing what a
company owns and intends to sell. It is always a current asset. When Candy Mart purchase more
inventory, it adds it to beginning inventory

At the end of the month:
Beginning Inventory BI
+ Purchases + P
Goods Available For Sale GAFS
What can happen to Goods Available for
Sale (GAFS) during the month?
Usually, a company determines the Cost of Goods Sold as

Perpetual System of Inventory
In our example, Candy Mart has goods available for sale and uses a perpetual system of inventory. A
perpetual system of inventory updates its accounting records for each sale and purchase of inventory.
(There is another system of inventory called the “periodic system” which updates its records at the end
of the month, but we won’t be learning this system).
Inventory Transactions
Candy Mart’s accountant and the accountants for Happy Halloween, Scary Snacks, and Gruesome
Goodies will record the transactions associated with the businesses.
Happy Halloween comes to Candy Mart and buys $1,200 of merchandise with cash which cost Candy
Mart $800.
What is the JE on HH’s books?
What is the JE on Candy Mart’s book?

Perpetual System of Inventory
In our example, Candy Mart has goods available for sale and uses a perpetual system of inventory. A
perpetual system of inventory updates its accounting records for each sale and purchase of inventory.
(There is another system of inventory called the “periodic system” which updates its records at the end
of the month, but we won’t be learning this system).
Inventory Transactions
Candy Mart’s accountant and the accountants for Happy Halloween, Scary Snacks, and Gruesome
Goodies will record the transactions associated with the businesses.
Happy Halloween comes to Candy Mart and buys $1,200 of merchandise with cash which cost Candy
Mart $800.
What is the JE on HH’s books?
What is the JE on Candy Mart’s book?
Inventory 1,200
Cash 1,200
Cash 1,200
Sales 1,200
COGS 800
Inventory 800

Next, Scary Snacks comes to Candy Mart and buys $2,400 of merchandise on credit (or on account). The
merchandise cost Candy Mart $1,600. Who has the receivable and who has the payable?
What is the JE for Scary Snacks?
What is the JE for Candy Mart?

Next, Scary Snacks comes to Candy Mart and buys $2,400 of merchandise on credit (or on account). The
merchandise cost Candy Mart $1,600. Who has the receivable and who has the payable?
Twenty days later, Scary Snacks pays Candy Mart

Next day, Gruesome Goodies buys $1,200 of merchandise on credit that cost Candy Mart $800. Who
has the receivable and who has the payable?
What is the JE for Gruesome Goodies?
Eight days later, the owner of Candy Mart runs into the owner of Gruesome Goodies who tells Candy
Mart, Gruesome Goodies will pay Candy Mart now if it will offer Gruesome Goodies a purchase
discount. This sounds better to CM than waiting for payment. In fact, if Candy Mart makes this a policy,
perhaps all of their customers will pay them sooner.
So Candy Mart devises credit terms of

Candy Mart tells Gruesome Goodies about the policy, and Gruesome Goodies pays within the discount
period.

Candy Mart tells Gruesome Goodies about the policy, and Gruesome Goodies pays within the discount
period.
Gruesome Goodies has now valued inventory at the amount it paid for the inventory which is $1,176
Candy Mart will use a new account “Sales Discounts” to track the success of their discount program.
Sales Discounts is a contra sales account. Remember, Sales are credit based, and sales discounts are
debit based. The income statement will show net sales which are sales minus the sale discount much
like the balance sheet shows the cost of property, plant and equipment and the associated accumulated
depreciation.

On a new $1,000 sale to Scary Snacks which cost Candy Mart $800, Scary Snacks calls Candy Mart to say
CM sent the wrong colored candy wrapper on some of the merchandise. It should have been orange
instead of brown. Candy Mart has run out of the orange colored wrappers for this type of candy and
doesn’t want to take the candy back. Instead, CM offers a purchase allowance to Scary Snacks to make
it worth their while to keep the candy. Scary Snacks hasn’t paid its bill yet, so CM offers $100 off the bill.
SS agrees.
What are the JE’s for Scary Snacks?
Scary Snacks must reduce the cost of the inventory to the actual amount it paid for the inventory.

What are the JE’s for Candy Mart?

Candy Mart will use a new account “Sales Returns and Allowances” to track returns of merchandise and
allowances given to customers for incorrect merchandise. Sales Returns and Allowances is a contra
sales account. Remember, Sales are credit based, and sales returns and allowances are debit based.
The income statement will show net sales which are sales minus the sale discounts as well as sales
returns and allowances. Much like the balance sheet shows the cost of property, plant and equipment
and the associated accumulated depreciation, so these reductions to sales are shown on the income
statement.
The purchase discount extended in the earlier example did not reduce the amount of the AR or AP
because the buyer could have paid after the discount period. However a purchase return or purchase
allowance given means the seller has agreed to reduce the bill of the buyer. So, both the buyer and
seller must reduce the amount of the accounts payable and accounts receivable.
Tracking the purchase discount helps the seller determine how success the discount program is working
with customers. Tracking the returns and allowances helps the seller determine how many times a
customer has returned merchandise and how many times a customer received the wrong merchandise.

Next, Candy Mart sells $2,400 in merchandise to Happy Halloween on credit which cost Candy Mart
$1,600. Two days later, Happy Halloween returns some of the merchandise in the amount of $800.
(The original cost to Candy Mart for this merchandise was $600).
What are the JE’s for Happy Halloween?

Next, Candy Mart sells $2,400 in merchandise to Happy Halloween on credit which cost Candy Mart
$1,600. Two days later, Happy Halloween returns some of the merchandise in the amount of $800.
(The original cost to Candy Mart for this merchandise was $600).
What are the JE’s for Happy Halloween?
Happy Halloween must reduce inventory and its payable since the merchandise has been returned and
is no longer on their premises.
Not only must CM record the return/allowance on the sale but it must also record the fact the inventory
has returned to the store. Therefore since a portion of the sale has been rescinded, this portion of the
inventory transaction must be reversed.
AR 2,400
Sales 2,400
COGS 1,600
Inventory 1,600
Sales Returns/Allowances 800 Sales 2,400
AR 800 Less: Sales Returns/Allowances (800)
Net Sales 1,600
Inventory 600
COGS 600

How do returns and allowances affect the purchase discount
when the bill is ultimately paid?

Count is lower ($21,000) than the balance in the general ledger for inventory ($21,250) AJE is:
Transfer of Ownership
When does ownership transfer between buyer and seller? It is based on a term called “Free on Board”
which is a shipping term.
FOB Shipping Point: Buyer owns when it leaves seller’s place of business
FOB Destination: Buyer owns when it arrives at buyer’s place of business
Also affects when shipping and insurance costs attach to inventory. FOB Shipping Point – Buyer records
freight and insurance as an additional cost of inventory. These costs are debited to inventory since they
increase the cost of inventory.
Adjusting Journal Entry – Inventory
At the end of accounting period (or at least once a year), inventory is counted and the account is
adjusted for any losses such as theft, shrinkage, or damage. If after the inventory count,
Count is higher ($24,000) than the balance in the general ledger for inventory ($21,250) AJE is:

Calculation of Net Purchases for a Buyer
This is the calculation but purchase discounts and purchase returns and allowances are not in the chart
of accounts for a buyer. Remember, the buyer credits inventory for these transactions. This
information is shown to demonstrate the calculation of net purchases.
Calculation of Net Sales for a Seller
Most external financial statements start with net sales; the calculation of net sales is often maintained
internally. These accounts are used by the seller to calibrate the sales discount policy and monitor the
sales returns and allowances for purposes of quality control.

Gross Profit
Sales minus Cost of Goods Sold equals Gross Profit. The percentage of sales that equals COGS (73%)
and Gross Profit (27%) is an important component of understanding a merchandiser. The gross profit
percentage of net sales ($84,300/$314,700) means there is 27% left after deducting the cost of the
merchandise to cover all of the company’s other expenses.
(UNO students are responsible for the acid test ratio for this chapter).

Merchandising companies

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