Inventory Purchase Journal Entry
|June 18||Merchandise Inventory||$1,000|
|To record the purchase of merchandise inventory|
Happy T's has successfully recorded the cost of the inventory it purchased. However, the shirts did not get shipped for free. When goods are shipped, either the supplier or the retailer has to pay for the shipping. Shipping terms are established to clarify who is responsible for the cost of shipment. Shipping terms also clarify who owns and is responsible for the goods while they are in transit. There are two types of shipping used by merchandising businesses:
1. Free on board (FOB) shipping point
2. Free on board (FOB) destination point
Free on board (FOB) shipping point is a shipping term indicating the buyer is paying for freight costs for the shipping and that the title of ownership passes from the seller to the buyer when the item has been picked up by a third-party shipper. As a result, the shipping costs are added to the cost of inventory (see the journal entry below). Free on board (FOB) destination point is a shipping term indicating the seller is paying for shipping costs and that the title of ownership does not pass from the seller to the buyer until the item arrives at the buyer's place of business.
Happy T's purchased its T-shirts with FOB shipping point terms. This means that Happy T's owned the T-shirts as soon as the carrier picked up the T-shirts from the supplier and that Happy T's is responsible for paying for the shipping. Happy T's would make an entry to record the $50 cost of shipping.
Shipping Costs Entry
|June 5||Merchandise Inventory||$50|
If Happy T's had purchased its T-shirts with FOB destination terms, it would have owned the T-shirts when they arrived rather than when the seller shipped them. Happy T's also would not be responsible for the cost of shipping and would not make a journal entry.
Sales are the primary source of revenue for merchandising businesses. Merchandising businesses can generate cash sales or sales on account. If cash is collected at the time of the sale, this is known as a cash sale. For example, if Happy T's sells a T-shirt to a customer for $10 and the customer pays them in cash, the business would make an entry to record the transaction.
Cash on Account Entry
|To record a cash sale|
Sale on Account Entry
|June 15||Accounts Receivable||$500|
|To record a sale on account|
Payment on Account Entry
|To record payment of account|
Cost of Merchandise Sold Entry
|June 15||Cost of Merchandise Sold||$400|
|To record the cost of merchandise sold|
Notice that Happy T's recorded sales of $500 and costs of $400. This means that on this particular sale, Happy T's has a gross margin, which is revenue minus cost of goods sold, of $100 ($500 − $400).
Sales discounts are early payment discounts provided to the buyer from the seller, offered to encourage customers to make early payments. This incentive is recorded in the sales discounts account. Sales discounts is a contra revenue account and is used to reduce the total sales to arrive at net sales in the multiple-step income statement. A contra account is an account that has a balance opposite of the normal balance. Revenue accounts normally have a credit balance. The sales discount contra revenue account has a normal debit balance and reduces total sales. In order to determine the amount of the discount provided, the seller will issue credit terms to the buyer. For example, in the sale to the local business having a company picnic, Happy T's might have offered a 2% 10-day, net 30 (2/10, n/30) discount. This means that if the customer pays Happy T's within 10 days of the invoice date, they can take advantage of a 2% discount; otherwise, the full amount is due 30 days from the invoice date. In this case, the customer would pay $490 if they pay within 10 days or pay the full $500 if they pay in 11 to 30 days. If the customer paid within the 10-day discount period, Happy T's would make an entry to record the transaction.
Sales Discount Entry
|To record payment of account|
Merchandise Purchase Entry
|June 5||Merchandise Inventory||$2,000|
Payment on Account with Discount Entry
|June 10||Accounts Payable||$2,000|