This adds the cost of the discount taken back to the cost of the Merchandise Inventory. The following illustration, therefore, assumes that all selling and administrative expenses have been adjusted. That accomplished, how to choose an accounting method for business the only account, which remains to be adjusted, is the Merchandise Inventory account. In this section, we will see how those transactions are summarized and reported on the financial statements.

If merchandise is later returned, the returned amount must be deducted from the invoice price before calculating discounts. Notice how the ending inventory balance equals physical inventory of $31,000 (unadjusted balance $24,000 + net purchases $166,000 – cost of goods sold $159,000). Trade discounts are not recorded in the seller’s accounting records; they are only used to calculate the gross selling price.

Accounting for Merchandising Business

It is, therefore, shown on the income statement as a selling expense. As a seller, you would usually want to be paid as soon as possible. This is because, as you can imagine, you can use the money for various purposes once you have been paid.

On April 1, CBS purchases 10 electronic hardware packages at a cost of $620 each. Under FOB Destination, ownership of the merchandise passes to the buyer when it is delivered. That delivery point could be a warehouse, an auto dealership, or your mailbox. If the merchandise is damaged on its way, the damage belongs to the seller. If the invoice is not paid during the discount period, an adjustment needs to be made to record the lost discount.

What is the Difference Between Periodic and Perpetual Inventory?

Once the quantity of goods on hand has been determined, it is multiplied by the unit price of those goods to determine the cost of goods on hand. The chart in Figure 6.10 represents the journal entry requirements based on various merchandising purchase transactions using the perpetual inventory system. Accounts Payable decreases (debit) and Cash decreases (credit) for $4,020.

• Merchandise inventory refers to goods bought by a merchandising business for resale to customers.
• Therefore, if one wants to know the cost of goods on hand, it is a must that a physical inventory be conducted first.
• Expanding her business this way will require that she incur not only new costs but also increases in existing costs.
• A cash discount taken by the buyer reduces the cash that the seller actually collects from the sale of the goods, so the seller must indicate this fact in its accounting records.
• But it is better to record the reduction in sales in a separate contra Sales account.
• As a seller, you would usually want to be paid as soon as possible.

The difference between sales revenue and cost of goods sold is referred to as gross profit. Because other expenses have yet to be deducted to arrive at the net profit or net income of the business. The revenue and expenses for a law firm illustrate how the income statement for a service firm differs from that of a merchandising or manufacturing firm. Before examining the income statement, let’s look at Cost of Goods Sold in more detail. Merchandising companies have to account for inventory, a topic covered in Inventory. As you recall, merchandising companies carry inventory from one period to another.

Unit 5: Accounting For a Merchandising Enterprise

Transactions 1 through 3 are for purchases under the perpetual inventory system. A merchandising business buys product from vendors, marks it up, and sells it to customers. Since CBS already paid in full for their purchase, a cash refund of the allowance is issued in the amount of $480 (60 × $8).

The company paid on their account outside of the discount window but within the total allotted timeframe for payment. CBS does not receive a discount in this case but does pay in full and on time. •2/10/EOM, n/60—means a buyer who pays by the 10th of the month following the month of purchase https://www.bookstime.com/ may deduct a 2% discount from the invoice price. If payment is not made within the discount period, the entire invoice price is due 60 days from the invoice date. •3/EOM, n/60—means a buyer who pays by the end of the month of purchase may deduct a 3% discount from the invoice price.

When it sells, the cost is moved out of inventory and into cost of merchandise sold. Under a periodic inventory method, a business tracks inventory once a month or once a year (periodically) by taking a physical count of all merchandise. The value of the inventory is compared to the previous inventory number and what was purchased. The difference between what was on hand, what was purchased, and what is remaining, provides the amount of inventory sold. Because this method does not provide up-to-date business information, this method is only used by businesses with small amounts of inventory. Go back and study the relationships between financial statement items summarized at the end of section one of this unit.