Accounting for Merchandising Businesses

Merchandising Transactions

Merchandising businesses record their transactions much like any other type of business. They do, however, have a few accounts and transactions that are unique to their business type in order to record the purchase of merchandise and freight charges, make entries to track inventory, and record the cost of the merchandise when it is sold.
The purchase of inventory items for sale to consumers is recorded in the merchandise inventory account. Merchandise inventory is the merchandise on hand and is a current asset. For example, Happy T's, a local retailer, buys and resells T-shirts. When the business purchases an order of T-shirts on account from their supplier for $1,000, it would make an entry to properly record the purchase.

Inventory Purchase Journal Entry

General Ledger
Date Account Title Debit Credit
June 18 Merchandise Inventory $1,000
      Accounts Payable $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

General Ledger
Date Account Title Debit Credit
June 5 Merchandise Inventory $50
       Cash $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

General Ledger
Date Account Title Debit Credit
June 15 Cash $10
       Sales $10
To record a cash sale

If cash is not collected at the time of the sale and the customer agrees to pay for the sale at a later time, this is known as a sale on account. If Happy T's sells a large order of shirts for $500 to a local customer for its company picnic and agrees to let the customer pay in 30 days, it would make an entry for accounts receivable.

Sale on Account Entry

General Ledger
Date Account Title Debit Credit
June 15 Accounts Receivable $500
       Sales $500
To record a sale on account

Later, when the customer pays Happy T's the $500 they owe them, Happy T's would make an entry to record the payment.

Payment on Account Entry

General Ledger
Date Account Title Debit Credit
June 30 Cash $500
       Account Receivable $500
To record payment of account

Under the periodic inventory system, no additional entry would be made at the time of sale because inventory is not tracked on a real-time basis. Under the perpetual inventory system, a second entry would be made at the time of sale to record the inventory and cost of merchandise sold. The shirts that Happy T's just sold for $500 to their customer actually cost Happy T's $400 when they purchased the shirts for resale. When Happy T's sold the $500 order to a local customer for their company picnic, it would also have to make an entry.

Cost of Merchandise Sold Entry

General Ledger
Date Account Title Debit Credit
June 15 Cost of Merchandise Sold $400
       Merchandise Inventory $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

General Ledger
Date Account Title Debit Credit
June 21 Cash $490
Sales Discounts $10
       Account Receivable $500
To record payment of account

Merchandise businesses may also be offered discount terms from their suppliers, just like the discount terms they could offer to their customers. Any discounts related to prompt payment will be recorded in an account titled "purchases discounts" (contra account). For example, if Happy T's had received 1% 10-day, net 30 terms on the purchase of a shipment of T-shirts costing $2,000, the business would record two entries—the first when the order is placed and the second when the amount due is paid within the discount period.

Merchandise Purchase Entry

General Ledger
Date Account Title Debit Credit
June 5 Merchandise Inventory $2,000
       Accounts Payable $2,000

Payment on Account with Discount Entry

General Ledger
Date Account Title Debit Credit
June 10 Accounts Payable $2,000
       Purchases Discounts $20
       Cash $1,980