Merchandising operations
Merchandising businesses buy goods and resell them. Their accounting adds inventory and cost of goods sold to the picture.
Service versus merchandising
Service businesses, such as consultancies, earn revenue from services. Merchandising businesses, such as retailers and wholesalers, buy finished goods and resell them. Manufacturers make goods from raw materials. Merchandisers' main expense is usually the cost of goods sold (COGS).
The operating cycle
A merchandiser's operating cycle runs from paying cash to buy inventory, to selling it (often on credit), to collecting cash from customers. Shorter cycles free up cash; long cycles tie it up. Grocery stores have short cycles; furniture or jewellery stores have longer ones.
The merchandiser's income statement
Net sales minus cost of goods sold equals gross profit (gross margin). Gross profit minus operating expenses gives operating income. Gross margin percentage (gross profit / net sales) shows how much of each sales dollar remains to cover operating costs and profit; it varies widely, from low margins in grocery to high margins in luxury goods.
Inventory systems
Under a perpetual inventory system, inventory and COGS are updated with every purchase and sale, often using barcode scanners and software, so the business always knows stock levels. Under a periodic system, inventory is counted only at period end and COGS is calculated as beginning inventory + purchases - ending inventory. Most businesses today use perpetual systems.
Recording purchases (perpetual)
When inventory is bought on credit, the entry is debit Merchandise Inventory, credit Accounts Payable. Returns to suppliers reduce inventory and payables. Freight costs paid to bring goods in are added to inventory, because they are part of the cost of getting goods ready for sale.
Recording sales (perpetual)
A sale under a perpetual system needs two entries. First, record revenue: debit Accounts Receivable (or Cash), credit Sales Revenue. Second, record the cost: debit Cost of Goods Sold, credit Merchandise Inventory, at the inventory's cost. The difference between the two amounts is the gross profit on the sale.
Shipping terms
FOB (free on board) shipping point means ownership passes to the buyer when goods leave the seller, so the buyer pays freight and counts goods in transit as its inventory. FOB destination means ownership passes on arrival, so the seller pays freight and owns goods in transit. These terms affect who records inventory at period end.
Worked example
A shop buys 100 lamps at 30 dollars each on credit (debit Inventory 3,000; credit Accounts Payable 3,000). It sells 40 lamps at 50 dollars each for cash: debit Cash 2,000, credit Sales 2,000; and debit COGS 1,200, credit Inventory 1,200. Gross profit on the sale is 800 dollars, and 60 lamps (1,800 dollars) remain in inventory.
Key takeaways
Merchandisers buy and resell goods; COGS is their main expense. The operating cycle runs from cash to inventory to receivables to cash. Gross profit = net sales - COGS; gross margin percentage varies by industry. Perpetual systems update inventory continuously; periodic systems use COGS = beginning inventory + purchases - ending inventory. Perpetual sales need revenue and cost entries. FOB shipping point and FOB destination decide ownership in transit.
Flashcard
Buys and resells goods
Check your understanding
Beginning inventory is 20,000, purchases are 80,000, and ending inventory is 25,000. What is cost of goods sold under a periodic system?