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CHAPTER 5 ACCOUNTING FOR MERCHANDISING OPERATIONS CHAPTER STUDY OBJECTIVES 1. Identify the differences between a service enterprise and a merchandiser. Because of inventory, a merchandiser has sales revenue, cost of goods sold, and gross profit. To account for inventory, a merchandiser must choose between a perpetual inventory system and a periodic inventory system. 2. Explain the entries for purchases under a perpetual inventory system. The Merchandise Inventory account is debited for all purchases of merchandise, freight-in, and other costs, and it is credited for purchase discounts and purchase returns and allowances. 3. Explain the entries for sales revenues under a perpetual inventory system. When inventory is sold, Accounts Receivable (or Cash) is debited and Sales is credited for the selling price of the merchandise. At the same time, Cost of Goods Sold is debited, and Merchandise Inventory is credited for the cost of the inventory items sold. 4. Explain the steps in the accounting cycle for a merchandiser. Each of the required steps in the accounting cycle for a service enterprise applies to a merchandiser. A work sheet is again an optional step. Under a perpetual inventory system, the Merchandise Inventory account must be adjusted to agree with the physical count. 5. Distinguish between a multiple-step and a single-step income statement. A multiple- step income statement shows numerous steps in determining net income, including nonoperating activities sections. In a single-step income statement, all data are classified under two categories, revenues or expenses, and net income is determined by one step. 6. Explain the computation and importance of gross profit. Gross profit is computed by subtracting cost of goods sold from net sales. Gross profit represents the merchandising profit of a company. The amount and trend of gross profit are closely watched by management and other interested parties. 7. Determine cost of goods sold under a periodic inventory system. The steps in determining cost of goods sold are (a) record the purchases of merchandise, (b) determine the cost of goods purchased, and (c) determine the cost of goods on hand at the beginning and end of the accounting period. a 8. Prepare the entries for purchases and sales of inventory under a periodic inventory system. In recording purchases, entries are required for (a) cash and credit purchases, (b) purchase returns and allowances, (c) purchase discounts, and (d) freight costs. In recording sales, entries are required for (a) cash and credit sales, (b) sales returns and allowances, and (c) sales discounts. a 9. Prepare a work sheet for a merchandiser. The steps in preparing a work sheet for a merchandiser are the same as they are for a service company. The unique accounts for a merchandiser are Merchandise Inventory, Sales, Sales Returns and Allowances, Sales Discounts, and Cost of Goods Sold.

Test Bank for Financial Accounting, Fifth Edition TRUE-FALSE STATEMENTS 1. Retailers and wholesalers are both considered merchandisers. T 2. The steps in the accounting cycle are different for a merchandiser than for a service enterprise. F 3. Sales minus operating expenses equals gross profit. F 4. Under a perpetual inventory system, detailed records of the cost of each purchase and sale are continuously updated. T 5. Periodic inventory systems have traditionally been used by companies that sell merchandise with high unit values such as automobiles and major appliances. F 6. Freight terms of FOB Destination means that the seller pays the freight costs. T 7. Freight costs incurred by the seller on outgoing merchandise are an operating expense to the seller. T 8. Sales revenues are earned during the period cash is collected from the buyer. F 9. The Sales Returns and Allowances account and the Sales Discount account are both deducted from Sales Revenue to arrive at Net Sales on the Income Statement. T 10. The revenue recognition principle requires merchandisers to recognize sales revenues at the point of sale. T 11. A sales allowance is a reduction given by a seller for prompt payment of a credit sale. F 12. To grant a customer a sales return, the seller credits Sales Returns and Allowances. F 13. A company's unadjusted balance in Merchandise Inventory will usually not agree with the actual amount of inventory on hand at year-end. T 14. For a merchandiser, all accounts that affect the determination of income are closed to the Income Summary account. T 15. A merchandiser has different types of adjusting entries than a service company. T 16. Operating expenses include cost of goods sold, salaries expense and depreciation expense. F 17. Selling expenses relate to general operating activities such as personnel management. F 18. Net sales appears on both the multiple-step and single-step forms of an income statement. T 19. A multiple-step income statement provides users with more information about a company’s income performance. T 20. The multiple-step form of income statement is easier to read than the single-step form. F 5 - 2

Accounting for Merchandising Operations 21. Rent revenue and rent expense are reported under other revenues and other expenses in a multiple-step income statement. F 22. Gain on sale of equipment and interest expense are reported under other revenues and gains in a multiple-step income statement. F 23. The gross profit section of a multi-step income statement includes net revenues, cost of goods sold and other operating expenses. F 24. In a multiple-step income statement, income from operations excludes other revenues and gains and other expenses and losses. T 25. A single-step income statement reports all revenues, both operating and other revenues and gains, at the top of the statement. T 26. If net sales are $800,000 and cost of goods sold is $600,000, the gross profit rate is 25%. T 27. Gross profit represents the merchandising profit of a company. T 28. Gross profit is a measure of the overall solvency of a company. F 29. Gross profit rate is computed by dividing cost of goods sold by net sales. F 30. Purchase Returns and Allowances and Purchase Discounts are both contra-revenue accounts. F 31. Freight-in is an account that is subtracted from the Purchases account to arrive at cost of goods purchased. F a 32. Under a periodic inventory system, the acquisition of inventory is charged to the Purchases account. T a 33. Under a periodic inventory system, freight-in on merchandise purchases should be charged to the Inventory account. F a 34. In a work sheet, cost of goods sold will be shown in the trial balance (Dr.), adjusted trial balance (Dr.) and income statement (Dr.) columns. T 35. Cost of goods sold is an operating expense for a merchandising company. F 36. Under a perpetual inventory system, inventory shrinkage and lost or stolen goods are more readily determined. T 37. The terms 2/10, n/30 state that a 2% discount is available if the invoice is paid within the first 10 days of the next month. F 38. The matching principle requires that the cost of the merchandise be matched against the sales revenue from the merchandise. T 39. Sales returns and allowances and sales discounts are both contra-revenue accounts and have normal credit balances. F 5 - 3

Test Bank for Financial Accounting, Fifth Edition 40. A merchandiser using a perpetual inventory system will usually need to make an adjusting entry to ensure that the recorded inventory agrees with physical inventory count. T 41. If a merchandiser sells land at more than its cost, the gain should be reported in the sales revenue section of the income statement. F 42. The major difference between the balance sheets of a service company and a merchandiser is inventory. T Answers to True-False Statements Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. 1. T 7. T 13. T 19. T 25. T 31. F 37. F 2. F 8. F 14. T 20. F 26. T a 32. T 38. T 3. F 9. T 15. T 21. F 27. T a 33. F 39. F 4. T 10. T 16. F 22. F 28. F a 34. T 40. T 5. F 11. F 17. F 23. F 29. F 35. F 41. F 6. T 12. F 18. T 24. T a 30. F 36. T 42. T MULTIPLE CHOICE QUESTIONS 43. Income from operations is gross profit less a. administrative expenses. b. operating expenses. c. other expenses and losses. d. selling expenses. 44. An enterprise which sells goods to consumers is known as a a. proprietorship. b. corporation. c. retailer. d. service firm. 45. Which of the following would not be considered a merchandiser? a. house cleaning business b. drugstore c. book store d. grocery store 46. A merchandiser that sells directly to consumers is a a. retailer. b. wholesaler. c. broker. d. service enterprise. 47. Two categories of expenses for merchandisers are a. cost of goods sold and financing expenses. b. operating expenses and financing expenses. c. cost of goods sold and operating expenses. d. sales and cost of goods sold. 5 - 4

Accounting for Merchandising Operations 48. The primary source of revenue for a wholesaler is a. investment income. b. service fees. c. the sale of merchandise. d. the sale of fixed assets the company owns. 49. Sales revenue less cost of goods sold is called a. gross profit. b. net profit. c. net income. d. marginal income. Use the following information to answer questions 50 – 52. During 2006, Salon Enterprises generated revenues of $60,000. Their expenses were as follows: cost of goods sold of $30,000, operating expenses of $12,000 and a loss on the sale of equipment of $2,000. 50. Salon’s gross profit is a. $60,000 b. $30,000 c. $18,000 d. $16,000 51. Salon’s operating income is a. $60,000 b. $30,000 c. $18,000 d. $12,000 52. Salon’s net income is a. $60,000 b. $30,000 c. $18,000 d. $16,000 53. Detailed records of goods held for resale are not maintained under a a. perpetual inventory system. b. periodic inventory system. c. double entry accounting system. d. single entry accounting system. 54. A perpetual inventory system would likely be used by a(n) a. automobile dealership. b. hardware store. c. drugstore. d. convenience store. 55. Under a perpetual inventory system, purchases of merchandise for sale are recorded in an account called: a. Inventory b. Purchases. c. Cost of goods sold. d. Finished goods. 5 - 5