MERCHANDISING BUSINESS

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1 MERCHANDISING BUSINESS Business that buys finished goods and resells them. Business which deals in inventory. Business that sells physical goods or products to its customers. Revenue activities of merchandising business involve the buying and selling of finished goods. Examples: WHOLESALER Buy large quantities of merchandise from several different manufacturers and then resell this merchandise to many different retailers. RETAILER Business that sells merchandise directly to the public. New Accounts on the Income Statement: Sales Cost of goods sold Income statement of a merchandising business: Business name Income statement For the year ended, December 31, 2013 Sales $ Gross Profit $ Expenses $ Net Income $

2 RECORDING SYSTEM OF MERCHANDISING BUSINESS Two type of accounting system is used in merchandising business. 1. Perpetual Inventory System 2. Periodic Inventory System Perpetual Inventory System: Inventory record kept up to date. An inventory system under which the company keeps detailed records of the cost of each inventory purchase and sale, and the records continuously show the inventory that should be on hand. The perpetual system keeps continual track of inventory balances. Under the perpetual inventory system, an entity continually updates its inventory records to account for additions to and subtractions from inventory for such activities as: Received inventory items Goods sold from stock Items scrapped Thus, a perpetual inventory system has the advantages of both providing up-to-date inventory balance information and requiring a reduced level of physical inventory counts. However, the calculated inventory levels derived by a perpetual inventory system may gradually diverge from actual inventory levels, due to unrecorded transactions or theft, so you should periodically compare book balances to actual on-hand quantities. Perpetual inventory is by far the preferred method for tracking inventory, since it can yield reasonably accurate results on an ongoing basis, if properly managed. Journal Entries: 1. Purchases Account Payable $ Inventory Debit Because of Increase in Asset. Account Payable Credit Because of Increase in Liability. 2. Sale Account Receivable $ Sales $

3 Account Receivable Debit Because of Increase in Asset. Sales credit because of Increase in Revenue. Cost of Goods Sold Debit Because of Increase in Expense. Inventory Credit Because of Decrease in Asset. 3. Inventory Shrinkage Loss 1 Cost of Goods Sold Debit because of Increase in Expense (Inventory Shrinkage Loss). Inventory Credit Because of Decrease in Asset. Periodic Inventory System: Physically count the Inventory Goods. An inventory system under which the company does not keep detailed inventory records throughout the accounting period but determines the cost of goods sold only at the end of an accounting period. The periodic inventory system only updates the ending inventory balance in the general ledger when you conduct a physical inventory count. Since physical inventory counts are time-consuming, few companies do them more than once a quarter or year. In the meantime, the inventory account in the accounting system continues to show the cost of the inventory that was recorded as of the last physical inventory count. Under the periodic inventory system, all purchases made between physical inventory counts are recorded in a purchases account. When a physical inventory count is done, you then shift the balance in the purchases account into the inventory account, which in turn is adjusted to match the cost of the ending inventory. 1 Inventory Shrinkage Loss: When Inventory in the account are greater as compare to physical count. It is due to the breakage, Spoilage and Employee theft etc. In case of Perpetual Inventory system there is less chances of Inventory shrinkage loss, but in case of Periodic Inventory system there is greater chances of Inventory shrinkage loss. 2

4 Journal Entries: 1. Purchases Purchases $ Account Payable $ Purchases Debit Because of Increase in Asset. Account Payable Credit Because of Increase in Liability. 2. Sale Account Receivable $ Sales $ Account Receivable Debit Because of Increase in Asset. Sales credit because of Increase in Revenue. 3. Inventory Shrinkage Loss Cost of Goods Sold Debit because of Increase in Expense (Inventory Shrinkage Loss). Inventory Credit Because of Decrease in Asset. Calculation of cost of goods sold under the periodic inventory system: Beginning inventory + Purchases = Cost of goods available for sale Cost of goods available for sale Ending inventory = Cost of goods sold Journal Entries: Ending Inventory Included Inventory (Beginning inventory) $ Purchases $ Ending Inventory Deducted 3

5 Inventory (Ending Inventory) $ Income Statement: Business name Income statement For the year ended, December 31, 2013 Beginning 00 Purchases $ Cost of Goods Sold Available for Sale $ Ending Difference: Periodic and Perpetual Inventory System There are a number of significant differences between the periodic and perpetual inventory systems. The periodic system relies upon an occasional physical count of the inventory to determine the ending inventory balance and the cost of goods sold, while the perpetual system keeps continual track of inventory balances. Both methods are used to track the quantity of goods on hand. The key differences between the two systems are: Accounts. Under the perpetual system, there are continual updates to either the general ledger or inventory journal as inventory-related transactions occur. Conversely, under a periodic inventory system, there is no cost of goods sold account entry at all in an accounting period until such time as there is a physical count, which is then used to derive the cost of goods sold. Computer systems. It is impossible to manually maintain the records for a perpetual inventory system, since there may be thousands of transactions at the unit level in every accounting period. Conversely, the simplicity of a periodic inventory system allows for the use of manual record keeping for very small inventories. Cost of goods sold. Under the perpetual system, there are continual updates to the cost of goods sold account as each sale is made. Conversely, under the periodic inventory system, the cost of goods sold is calculated in a lump sum at the end of the reporting period, by adding total purchases to the beginning inventory and subtracting ending inventory. Cycle counting. It is impossible to use cycle counting under a periodic inventory system, since there is no way to obtain accurate inventory counts in real time (which are used as a baseline for cycle counts). 4

6 Transaction investigations. It is nearly impossible to track through the accounting records under a periodic inventory system to determine why an inventory-related error of any kind occurred, since the information is aggregated at a very high level. Conversely, such investigations are much easier in a perpetual inventory system, where all transactions are available in detail at the individual unit level. This list makes it clear that the perpetual inventory system is vastly superior to the periodic inventory system. The only case where a periodic system might make sense is when the amount of inventory is very small, and where you can visually review it without any particular need for more detailed inventory records. The periodic system can also work well when the warehouse staff is poorly trained in the uses of a perpetual inventory system, since they might inadvertently record inventory transactions incorrectly in a perpetual system. END 5

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