This document outlines accounting concepts and procedures related to merchandising activities, including perpetual and periodic inventory systems. It discusses key income statement and balance sheet components for merchandising companies and how to record purchases and sales of merchandise under the perpetual inventory system. The document contains learning objectives, definitions, journal entries, exhibits, and tips for areas like inventory valuation, purchase discounts, sales returns and allowances, and cost of goods sold.

1. 1-1
Accounting for
Merchandising Activities
CHAPTER 5
Electronic Presentations in Microsoft® PowerPoint® to accompany
Fundamental Accounting Principles, 17ce
Prepared by
Regula Lewis
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Learning Objectives 1
1. Describe merchandising and identify and explain the important
income statement and balance sheet components for a
merchandising company. (LO1)
2. Describe both perpetual and periodic merchandise inventory
systems. (LO2)
3. Analyze and record transactions for merchandise purchases and sales
using a perpetual system. (LO3)
4. Prepare adjustments for a merchandising company. (LO4)

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Learning Objectives 2
5. Define, prepare and analyze merchandising income statements. (L05)
6. Calculate gross margin and mark up on inventory cost. (LO6)
7. Record and compare merchandising transactions using both periodic
and perpetual inventory systems. (Appendix 5A) (LO7)
8. Explain and record Provincial Sales Tax (PST) and Goods and Services
Tax (GST) and Harmonized Sales Tax (HST). (Appendix 5B) (LO8) NO

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LO1: Merchandising Activities
• A merchandiser earns profit by buying and selling merchandise.
• Merchandise consists of products that a company acquires for the
purpose of reselling them to customers.
• The cost of these goods is an expense presented on the income
statement as cost of goods sold (COGS).
• A wholesaler is a company that buys products from manufacturers or
other wholesalers and sells them to retailers or other wholesalers.
• A retailer is an intermediary that buys products from manufacturers or
wholesalers and sells them to consumers.

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Reporting Financial Performance
EXHIBIT 5.1

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Summarized Income Statement Information
for a Merchandiser
EXHIBIT 5.2
Lifetime Equipment Co-op
Summarized Income Statement Information
For Year Ended February 28, 2023
Net Sales $314,700
Cost of goods sold 230,400
Gross profit from sales $84,300
Total operating expenses and other revenues and
expenses
68,960
Profit $15,340

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Reporting Financial Position
Merchandise inventory, or inventory, refers to products a company
owns for the purpose of selling to customers.
EXHIBIT 5.3

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Inventory Systems
EXHIBIT 5.5

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LO2: Perpetual Inventory System 1
• Provides an up-to-date record of the amount of inventory on
hand.
• When a purchase is made under a perpetual inventory system,
the inventory account is debited for the cost of each purchase
and a corresponding accounts payable account is credited as
items are received from the supplier.
Dr. Inventory xxx
Cr. Accounts Payable xxx
Purchased merchandise on credit.

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Perpetual Inventory System 2
1) Sales Transaction:
Dr. Accounts Receivable xxx
Cr. Sales xxx
Sold merchandise on credit.
2) Perpetual inventory adjustment:
Dr. Cost of Goods Sold xxx
Cr. Inventory xxx
Record the cost of the sale of merchandise
and the reduction of inventory.

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IMPORTANT TIP
When a sale occurs in a perpetual inventory system, two key journal
entries are booked:
1) The sale to the customer is recorded, with a debit to accounts
receivable and a credit to sales.
2) The cost of the inventory is recorded as a debit to cost of goods
sold (COGS) and the item is removed from the inventory
account by crediting the inventory account.

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Periodic Inventory System 1
• Requires updating the inventory account only at the end of a
period to reflect the quantity and cost of both goods on hand and
goods sold.
• It does not require continual updating of the inventory account.
Dr. Purchases xxx
Cr. Accounts Payable xxx
Purchased merchandise on credit.

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Periodic Inventory System 2
• When merchandise is sold, revenue is recorded but the cost of the
merchandise sold is not recorded as a cost at this time.
Dr. Accounts Receivable xxx
Cr. Sales xxx
Sold merchandise on credit.

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IMPORTANT TIPS
A periodic inventory system records the cost of all new inventory in a
temporary expense account called Purchases.
Under the periodic method only one journal entry is booked at the
time of sale, debiting A/R and crediting Sales. No adjustment to
inventory or COGS is made until the end of the accounting period.

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Determining Ending Inventory and Cost of
Goods Sold
• When financial statements are prepared, the company takes a
physical count of inventory by counting the quantities of
merchandise on hand.
• The accuracy of the inventory count is critical because it
determines both the dollar value of the asset “Inventory” on the
balance sheet at period end, as well as the “Cost of Goods Sold” on
the income statement.
• Cost of merchandise on hand is determined by relating the
quantities on hand to records showing each item’s original cost.
• The Merchandise Inventory account and Cost of Goods Sold is then
updated to reflect end-of-period balances through booking a
closing entry to reflect the amount from the physical count of
inventory.

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LO3: Accounting For Merchandise Purchases –
Perpetual Inventory System 1
The cost of merchandise bought for resale is recorded in the
Merchandise Inventory account.
LEC records a $1,200 credit purchase of merchandise on November
2 with this entry:
Nov. 2 Merchandise Inventory 1,200
Accounts Payable 1,200
Purchased merchandise on credit.

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Accounting For Merchandise Purchases –
Perpetual Inventory System 2
EXHIBIT 5.6

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IMPORTANT TIP
To calculate the total cost of merchandise inventory purchases, we
must adjust the invoice cost as follows:
(1) Subtract the cost of any returns and allowances for unsatisfactory
items received from a supplier;
(2) Subtract discounts given to a purchaser by a supplier for early
payment; and
(3) Add required freight costs if paid by the purchaser.

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Merchandise Returns and Allowances
• Are merchandise received by a purchaser and subsequently
returned to the supplier.
• A purchase allowance is a reduction in the cost of defective
merchandise received by a purchaser from a supplier.
Nov. 5 Accounts Payable 300
Merchandise Inventory 300
Purchase allowance re: debit memo
dated November 5.

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Trade Discounts – Provided for Volume
Purchases 1
• Are commonly used by manufacturers and wholesalers to change
selling prices without republishing their catalogues.
• When a manufacturer or wholesaler prepares a catalogue of items
that it has for sale, each item is usually given a list price, also called
a catalogue price.
• Often the intended selling price equals list price minus a given
percentage called a trade discount.
Nov. 2 Merchandise Inventory 1,200
Accounts Payable 1,200
Purchase of inventory from The North
Place.

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Trade Discounts – Provided for Volume
Purchases 2
On November 2, LEC purchased clothing for resale from The North
Place that was listed at $2,000 in the catalogue. Since LEC receives a
40% trade discount, the company records the transaction at $1,200 [=
$2,000 – (40% × $2,000)].
Nov. 2 Merchandise Inventory 1,200
Accounts Payable 1,200
Purchase of inventory from The North
Place.

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Discounts on Purchases of Merchandise
Inventory – Provided for Early Payment 1
• The purchase of goods on credit requires a clear statement of the
credit terms to avoid misunderstanding.
• Credit terms are a listing of the amounts and timing of payments
between a buyer (customer) and seller (supplier).
• The EOM refers to “end of month.”
• The 30-day period is called the credit period. Credit terms may
include a cash discount.
• A buyer views a cash discount as a purchase discount.

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Discounts on Purchases of Merchandise
Inventory – Provided for Early Payment 2
EXHIBIT 5.7

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Discounts on Purchases of Merchandise
Inventory – Provided for Early Payment 3
When LEC takes advantage of the discount and pays the amount due
on November 12, the entry to record payment is:
Nov. 12 Accounts Payable 900
Merchandise Inventory 18
Cash 882
Paid for the purchase of November 2
less the allowance of November 5 and
the discount; $1,200 - $300 = $900;
2% x $900 = $18; $900 - $18 = $882

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Discounts on Purchases of Merchandise
Inventory – Provided for Early Payment 4
LEC’s Merchandise Inventory account now reflects the net cost of
merchandise purchased. Its Accounts Payable account also shows the
debt to be satisfied.
Merchandise Inventory
Nov. 2 1,200 300 Nov. 5
18 Nov. 12
Balance 882
Accounts Payable
Nov. 5 300 1,200 Nov. 2
Nov. 12 900
-0- Balance

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Transfer of Ownership
• The point where ownership of merchandise inventory transfers
from the buyer to the seller must be identified on the invoice
because it determines who pays transportation costs and other
incidental costs of transit such as insurance.
• The party responsible for paying shipping costs is also
responsible for insuring the merchandise during transport.
• The point of transfer is called the FOB point, where FOB stands
for free on board or freight on board.

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Identifying Transfer of Ownership 1
EXHIBIT 5.8
Ownership transfers when
goods:
Transportation costs paid
by:
FOB Shipping Point Leave the seller’s warehouse. Buyer
FOB Destination Arrive at the buyer’s warehouse. Seller

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Transportation Costs
• Shipping costs on purchases are called transportation-in or freight-in
costs.
• LEC’s entry to record a $75 freight charge to an independent carrier for
merchandise purchased FOB shipping point is:
Nov. 2 Merchandise Inventory 75
Cash 75
Paid freight charges on purchased
merchandise.

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Accounting For Merchandise Sales -
Perpetual Inventory System
Merchandising companies also must account for sales, sales
discounts, sales returns and allowances, and cost of goods sold.
Gross Profit Section of Income Statement:
Lifetime Equipment Co-op Calculation of Gross Profit
For Year Ended February 23, 2023
Sales $321,000
Less: Sales Discounts $4,300
Sales returns and allowances 2,000 6,300
Net Sales $314,700
Cost of goods sold 230,400
Gross profit from sales $84,300
EXHIBIT 5.10

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Sales Transactions 1
Involves capturing information about two related parts:
1. Receiving revenue in the form of an asset from a customer, and
2. Recognizing the cost of merchandise sold to a customer.
LEC sold $2,400 of merchandise on credit on November 3. The
revenue part of this transaction is recorded as:
Nov. 3 Accounts Receivable 2,400
Sales 2,400
Sold merchandise on credit.

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Sales Transactions 2
The expense or cost of the merchandise sold by LEC on November 3 is
$1,600.
The entry to record the cost part of this sales transaction (under a
perpetual inventory system) is:
Nov. 3 Cost of Goods Sold 1,600
Merchandise Inventory 1,600
To record the cost of Nov. 3 sale and
reduce inventory.

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Sales Discounts 1
Can encourage prompt payments to customers for early payment,
improve cash flow, and also reduce future efforts and costs of billing
customers.
LEC completed a credit sale for $1,000 on November 12, subject to terms
of 2/10, n/60 (the cost of the inventory sold was $600). The entry to
record this sale is:
Nov. 12 Accounts Receivable 1,000
Sales 1,000
Sold merchandise under terms of 2/10, n/60.
12 Cost of Goods Sold 600
Merchandise Inventory 600
To record the cost of the Nov.12 sale and
reduce inventory.

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Sales Discounts 2
The customer has two options.
One option is to wait 60 days until January 11 and pay the full $1,000.
LEC records the payment as:
Jan. 11 Cash 1,000
Accounts Receivable 1,000
Received payment for Nov. 12 sale.

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Sales Discounts 3
The customer’s second option is to pay $980 within a 10-day period
that runs through November 22.
LEC records the payment as:
Nov. 22 Cash 980
Sale Discounts 20
Accounts Receivable 1,000
Received payment for Nov. 12 sale less
the discount; $1,000 x 2% = $20

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Sales Returns and Allowances 1
Sales returns refer to merchandise that customers return to the seller
after a sale. Sales allowances refer to reductions in the selling price of
merchandise sold to customers.
LEC sold merchandise on November 3. As already recorded, the
merchandise is sold for $2,400 and cost $1,600, but what if the customer
returns part of the merchandise on November 6, when returned items
sell for $800 and cost $600? The revenue part of this transaction must
reflect the decrease in sales from the customer’s return:
Nov. 6 Sales Returns and Allowances 800
Accounts Receivable 800
Customer returned merchandise.

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Sales Returns and Allowances 2
If the merchandise returned to LEC is not defective and can be resold
to another customer, then LEC returns these goods to its inventory.
The entry necessary to restore the cost of these goods to the
Merchandise Inventory account is:
Nov. 6 Merchandise Inventory 600
Cost of Goods Sold 600
Returned goods to inventory.

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Sales Returns and Allowances 3
$800 of the merchandise sold by LEC on November 3 is defective but
the customer decides to keep it because LEC grants the customer a
price reduction of $500.
The only entry that LEC must make in this case is one to reflect the
decrease in revenue:
Nov. 6 Sales Returns and Allowances 500
Accounts Receivable 500
To record sales allowance.

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LO4: Adjusting Entries1
• Merchandising companies can lose merchandise in several ways,
including theft by employees and customers, accounting errors
such as input errors or inventory counting errors, and damage.
• Referred to as shrinkage and calculated by comparing the
recorded quantities of inventory in the accounting system with
quantities recorded during the physical inventory count.
• Companies perform regular cycle counts of portions of their
inventory (daily, weekly, or monthly) or do a thorough and
detailed count once a year.
• Most companies record any necessary adjustment due to
shrinkage by charging it to Cost of Goods Sold, assuming that
shrinkage is not abnormally large.

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Adjusting Entries2
LEC’s Merchandise Inventory account at the end of 2023 had an
unadjusted balance of $21,250, but a physical count of inventory
revealed only $21,000 of inventory on hand. The adjusting entry to
record this $250 shrinkage is:
Dec. 31 Cost of Goods Sold 250
Merchandise Inventory 250
To adjust for $250 shrinkage
determined by physical count of
inventory.

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Adjusted Trial Balance for a Merchandising
Company – Perpetual Inventory System 1
The year-end adjustments required for LEC include the following
entries:
a. Expiration of $600 of prepaid insurance.
b. Use of $1,200 of store supplies.
c. Use of $1,800 of office supplies.
d. Depreciation of store equipment for $3,000.
e. Depreciation of office equipment for $700.
f. Accrual of $300 of unpaid office salaries and $500 of unpaid store
salaries.
g. Physical count of merchandise inventory revealed $21,000 on
hand.

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Adjusted Trial Balance for a Merchandising
Company – Perpetual Inventory System 2
EXHIBIT 5.12

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Income Statement Formats – Perpetual
Inventory System 2
• Selling expenses include the expenses of promoting sales through
displaying and advertising merchandise, making sales, and delivering
goods to customers.
• General and administrative expenses support the overall operations of a
company and include expenses related to accounting, human resource
management, and financial management.

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Income Statement Formats – Perpetual
Inventory System IMPORTANT
Income statements may be formatted in a variety of ways.
Typical formats are:
• Multiple-Step.
• Classified, Multiple-Step.
• Single-Step.

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Classified Multi-Step Format
(for Internal Reporting)
EXHIBIT 5.13

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Multi-Step Format
(for External Reporting)
EXHIBIT 5.14

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Single-Step Income Statement
EXHIBIT 5.15

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Gross Profit Margin KEY
• Identifies the percentage of sales dollars left over after covering cost of
goods sold.
• A merchandising company needs sufficient gross profit to cover
operating expenses or it will not be able to remain competitive.
• The higher the gross profit margin, the better the company is at
achieving a combination of good pricing on its products and managing
its costs of inventory.
EXHIBIT 5.16

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Gross Profit Margin
Gross profit ratios of LEC based on fictitious data for the years 2021, 2022,
and 2023:
2023 2022 2021
Units sold 214,000 160,000 100,000
Gross profit from sales $84,300 $69,440 $46,400
Net sales $314,700 $248,000 $160,000
Gross profit ratio 26.8% 28.0% 29.0%
EXHIBIT 5.17

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Gross Profit Margin
A snapshot of gross margins of several Canadian and US public companies.
Notice the differences in gross margins achieved by the different
companies.
Year End GM% Prior Year GM% Change
Lululemon Athletica Inc. 2-Feb-20 56% 3-Feb-19 55% +1%
Canadian Tire Corp. Limited 2-Jan-21 34% 28-Dec-19 33.5% +0.5%
Loblaw Companies Limited 2-Jan-21 30% 28-Dec-19 31% -1%
Costco Wholesale
Corporation
30-Aug-20 11% 1-Sep-19 11% 0%
Apple Inc. 26-Sep-20 38% 28-Sep-19 38% 0%
Amazon.com Inc. 31-Dec-19 41% 31-Dec-18 40% 1%
EXHIBIT 5.18

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Markup On Inventory Cost 1
• A markup percentage is the average increase in selling price of a
product over the cost.
• If your product cost is $10 and your retail selling price is $15, your
markup is $5, or 5/10 = 50%. A company that has a set markup
percentage can determine selling price for a specific item through the
formula presented below.

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Markup On Inventory Cost 2
You work for Best Buy Canada as a sales director for the Apple product
line. You have been asked to determine how much each iPad Mini sale
contributes to gross profit. The selling price set by Apple is $319. Assume
Apple Inc. charges Best Buy $269 for each iPad Mini it purchases.
What is the markup percentage on the product?

52. 1-52
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Markup On Inventory Cost 3
Target gross margin is a fixed percentage markup that is concerned with
gross margin achieved on a specific product based on the final selling
price. If you know that your cost is $10 and you know you must achieve a
gross margin of 50%, the required selling price can be calculated using the
following formula:

53. 1-53
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reproduction or further distribution permitted without the prior written consent of McGraw-Hill
Education.
Appendix 5A
Transportation-In
LEC paid a $75 freight charge to haul merchandise to its store. In
the periodic system, this cost is charged to an expense account
known as Transportation-In. Transportation-in is included as part of
the $232,400 total cost of merchandise purchased:
Periodic
Transportation-In 75
Cash 75
Perpetual
Merchandise
Inventory
75
Cash 75

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