Lesson: 39

Topic: Additional Accounts within the Merchandising Income Statement.

Objectives:

Students will analyze merchandising transactions within the periodic inventory system. Students will examine how inventory is purchased, how sales are recorded, and how the merchandise account is adjusted along with the closing entries at the end of the accounting period.

Students will pay particular attention to how the Merchandise account is established within the first accounting period's closing entries. Students will then note how the Merchandise account is then constantly adjusted during the closing entries of all subsequent accounting periods.

Periodic Inventory: A system of calculating the cost of goods sold by physically counting the inventory at the end of the accounting period.

Cost of Goods Sold: Refers to the total expense of inventory which has been sold. Under the "Periodic" inventory system the Cost of Goods Sold is not actually an account. Rather, it is a figure which only appears on the Income Statement. As there is no account to indicate this figure, it must be calculated based on other information.

Purchases: An expense account used only under the "Periodic" inventory system which is used to record the purchase of merchandise for resale. Its balance indicates only the value of merchandise which has been purchased throughout the fiscal period. It does not indicate how much merchandise has been sold, nor does it indicate how much merchandise has not been sold.

Merchandise: A current asset account which is used to record the value of merchandise which remains unsold by the end of the accounting period.

Typical Purchase and Sale Transaction Entries for a Merchandising Firm Which Uses the Periodic Inventory System

Step	Objective
1	Purchase of Merchandise.
2	Sale of Merchandise.

The Closing Entries for a Merchandising Firm Which Uses the Periodic Inventory System

The closing entries for a merchandising firm which uses the periodic inventory system is still a four-step process. However, you will notice the closing entries take on some additional tasks compared to the closing entries for a service firm. To begin with, the Merchandise account is adjusted within the closing entries. You will also notice that the Purchases account is closed along with all of the other expense accounts.

Step	Objective
1	Close the Sales account AND establish the current balance of the merchandise account.
2	Close the expense accounts (including the purchases account) AND erase the previous balance of the merchandise account.
3	Close the Revenue and Expense Summary to the Capital account.
4	Close the Drawings account to the Capital account.

A Typical Purchase of Merchandise

• We debit an expense account which we call Purchases, and we credit Cash (assuming that we paid cash). We expense the purchase of the merchandise as soon as we buy it because we assume that it will be sold by the end of the period. (Any merchandise that remains unsold will be dealt with in an adjusting entry at the end of the period.)

  
  

Date	Account	Debit	Credit
Dec. 31	Purchases	10,000.00
	Cash		10,000.00

A Typical Sale of Merchandise

• We debit Cash, and we credit Sales - it's just that simple. Notice that we in no way record the loss of inventory resulting from this sale. This is for two reasons: 1) the cashier has no way of knowing how much the item which is being sold actually cost the business, and 2) we already assumed that all of the inventory would be sold when we bought it, so to record it as leaving the business AGAIN would cause a double counting error. (The only way we will know how much merchandise has left our business is to perform an inventory count at the end of the period. That is why we refer to this as the "periodic" system.

  
  

Date	Account	Debit	Credit
Dec. 31	Cash	600.00
	Sales		600.00

Step 1

• Transfer the balance of the Sales account to the Revenue and Expense Summary.

• Add the value of this period's ending inventory within both the Merchandise account and the Revenue and Expense Summary.

  
  

Date	Account	Debit	Credit
Dec. 31	Sales	50,000.00
	Merchandise	6,000.00
	Revenue & Expense Summary		56,000.00

Step 2

• Transfer the balance of the expense accounts (including the Purchases account) to the Revenue and Expense Summary.

• Deduct the value of this period's beginning inventory from the Merchandise account.

  
  

Date	Account	Debit	Credit
Dec. 31	Revenue and Expense Summary	27,000.00
	Merchandise		3,500.00
	Purchases		17,000.00
	Rent Expense		2,000.00
	Wages Expense		4,000.00
	Hydro Expense		500.00

Step 3

Transfer the balance of the Revenue and Expense Summary to the Capital account:

Date	Account	Debit	Credit
Dec. 31	Revenue and Expense Summary	29,000.00
	Capital		29,000.00

Step 4

Transfer the balance of the Drawings account to the Capital account.

Date	Account	Debit	Credit
Dec. 31	Capital	700.00
	Drawings		700.00

Method of Instruction and Evaluation Exercise:

The class will view a Power Point presentation which explains the accounting principles associated with maintaining a "Periodic" inventory system.

After a brief discussion of the concepts outlined within the presentation, students will complete exercise #1 on page 433.

Expectations Addressed:

The "Advanced Accounting Practices" strand of the BAF3M Ministry of Education Curriculum Guidelines outlines all of the following specific expectations. The expectations addressed by this lesson have been highlighted below.

• The Accounting Cycle for a Merchandising Business:
  • describe the principal accounting elements particular to a merchandising business (e.g., new accounts, cost of goods sold section, returns, discounts);
  • identify and describe the periodic and perpetual inventory systems and journalize transactions using both systems;
  • assess the effects that transactions have on the accounts and financial statements of a merchandising business;
  • record transactions in the journals and ledgers of a merchandising business;
  • prepare a trial balance and the financial statements, including a detailed cost of goods sold section, for a merchandising business;
  • record the adjusting and closing entries for a merchandising business (e.g., accruals, inventory adjustment);
  • describe the impact of year-end procedures, including adjusting and closing entries, on the financial statements of a merchandising business;
  • describe alternative accounting practices (e.g., special journals and ledgers).
• Accounting for Sales Tax:
  • describe the accounting practices particular to sales tax (e.g., accounts required, financial statement presentation);
  • record transactions related to provincial sales tax (e.g., collections, remittance);
  • record transactions related to federal sales tax (e.g., collections, remittance).
• Computer Applications in Accounting:
  • use accounting or application software to record transactions for a service business;
  • use accounting or application software to record transactions for a merchandising business;
  • use accounting or application software to prepare financial statements.

References:

• Text, chapter #11, pages 431 - 433.
• Power Point Presentation: The Mystery of Periodic Inventory.