A D V E R T I S E M E N T
Merchandising means selling products to retail customers.
Merchandisers, also called retailers, buy products from wholesalers and
manufacturers, add a markup or gross profit amount, and sell the products to
consumers at a higher price than what they paid. When you go to the mall, all
the stores there are retailers, and you are a retail customer.
Retailers deal with an inventory: all the goods
(products) they have for sale. They account for inventory purchases and sales in
one of two ways: Periodic and Perpetual. As the names suggest these methods
refer to how often the inventory account balances are updated.
In a Periodic system, inventory account balances are
updated once a year (some companies may do it more often, but all must do so at
least once per year).
In a Perpetual system, inventory account balances are
updated after each sale. This type of system is much more complex. Scanning cash
registers, bar coded merchandise, and similar devices are used to update the
inventory records after each sale. Obviously, this type of system is very
expensive, but it gives managers a high degree of control over inventory, helps
purchasing agents order replacement merchandise in time, detects and deters
theft and helps identify other problems relating to inventory.
The main differences between the two relate to the journal
entries used to record purchases and sales. The system a company chooses should
be cost effective and provide the desired levels of inventory management.
Special journals are often used to record sale and purchase transactions.
You can usually tell whether a company is using the Periodic or
Perpetual system by the accounts they use to record inventory purchases. Here's
a chart that shows the differences:
[COGS = Cost of Goods Sold]
|Account used to record inventory purchases:
|When a sale is made:
|No adjustment to inventory is necessary; merchandise
cost is already on the Income Statement
|Merchandise cost is transferred from Inventory to
Cost of Goods Sold -an Income Statement account
|Adjust Inventory balance to agree with year-end
physical count and merchandise value
|Adjust Inventory balance to agree with year-end
physical count and merchandise value
|Transfer Purchases balance to Cost of Goods Sold
|Balances should now be correct
The "physical inventory" simply means the actual, real,
tangible, touchable stuff the company has for resale. In the case of a
manufacturing company, the physical inventory includes raw materials, the value
of goods in the process of production, and the value of finished goods (Chapter
Taking a physical inventory means counting the number of
units of stuff you have for sale. This is usually done at the end of the year,
so the balance sheet Inventory amount accurately reflects the true value of the
ending physical inventory.
If you run a grocery store, you would count all the cans,
packages and containers of food, and everything else you have available for
sale. You would then have to assign a value to everything: it's cost to you when
you bought each item. A small piece of your inventory records might look
something like the one below.
Quantity is the number of units on the shelf, and also in
boxes in storage; this is the amount we counted in taking the physical
inventory. Unit Cost is what was paid for each unit of product. The extension
column is the total cost of each item.
|soup, tomato, can, 8 oz
|soup, chicken noodle, can, 8 oz
|soup, cream of mushroom, can, 8 oz
Once all items are counted, priced and extended, the total
cost is the ending value for Inventory.
Adjusting the Inventory Account
The Inventory account usually does not agree with the physical
count. If the Periodic method is being used, the Inventory account has the
balance as adjusted at the end of the prior year. If the Perpetual method is
being used, the Inventory account should be close to the physical value
calculated from the physical inventory count. There will always be a difference,
and the accounts must be adjusted so the Inventory account agrees with the
physical count and valuation. You will study valuation methods more in Chapter
The Inventory account is adjusted to agree with the physical
count and valuation. Let's look at an example of how the adjustment is made. The
Inventory account has a balance of $12,500. You take a physical count and
calculate the correct inventory value is $11,975. You will decrease inventory by
$525 to adjust the Inventory account the equal the actual physical inventory
|Cost of Goods Sold
|To adjust Inventory to year-end physical count and
[a Balance Sheet account]
Cost of Goods Sold
|Beginning balance forward
[an Income Statement account]
|Year-end Inventory adjustment
The adjusting entry correctly uses an Income Statement
account and a Balance Sheet account. The additional merchandise cost is
transferred to the Income Statement in this case, but the reverse adjustment
could just as easily be made.
If you throw a good wool sweater in a washing machine full of
hot water, what will happen? You ladies already know the answer to that
question. If you're a guy you may need to ask you wife, girlfriend, sister, or
mother. Go ahead.... we'll wait.......
OK, now that you know the sweater will shrink, or get
smaller. Guys, if you do this to your wife's favorite cashmere sweater we'll be
forwarding your mail to the doghouse for the next month or so.
Well, inventory also shrinks. But not because we washed it in
hot water. In fact inventory shrinkage occurs for a number of reasons, and it is
just as it sound - inventory gets smaller. But how should this happen? Things
happen to merchandise while the store has it available for sale. Here are some
of the things:
Theft - by employees or customers
Spoilage - milk, meat, vegetables, past the expiration date
Obsolescence - computers, software, clothing (last year's
Display - merchandise put on display often can't be sold later
or must be discounted
Grazing - customers or employees eating food available for sale
Damage - broken bottles, bent cans, frozen foods left out of the
The sum total of all these items contributes to the
difference between the Inventory account and the physical count. There might
also have been errors made in the Inventory account during the year, adding to
A true story about grazing
I used to live in Tucson, Arizona and went to school at the
University there. I lived on North Park, pretty far up the road near the north
end of town. Near me was a Lucky grocery store, where I shopped a couple of
times each week. Every time I would go there I would see people wandering around
the store posing as customers. They would push a cart down the aisles,
collecting a few items along the way.
A typical scenario I have observed with my own eyes:
The cart is abandoned, along with the empty beverage container,
and the grazer leaves the store. This may sound extreme, but I've seen this done
on a regular and repeated basis. It is a real problem is many areas, especially
in cities and in large stores. Grazing is a form of theft. If you pop a grape in
your mouth, you are grazing too.
- take a couple of slices of bread (leave the rest of the
loaf on the shelf, opened
- open a package of cold cuts, take a few slices, leave
- tear off a couple of pieces of lettuce, leave the rest
of the head behind
- get one plastic knife from a package of 20, ditch the
other 19 somewhere
- put some mayo and mustard on the sandwich, return jars
to the shelf
- get a beverage and have lunch
- top it off with a piece of fruit for dessert
Special Sales and Purchase Accounts
Merchandisers use a few special accounts. When a sale is made,
sometimes the customer returns merchandise for a refund. We do not reduce the
sales revenue account. We enter the refund in a different account. This is done
to help track the number and dollar amount of these types of transactions.
Sales accounts deal with customers and sale
Purchase accounts deal with suppliers and purchase
- Sales Returns and Refunds
- Sales Allowances
- Sales Discounts
Notice the close similarity between the account titles. They are
almost identical, but apply on opposite sides of the purchase and sales cycles.
Sales accounts are used in conjunction with selling merchandise and dealing with
customers. Purchase accounts are used in conjunction with buying merchandise and
dealing with suppliers.
- Purchase Returns and Refunds
- Purchase Allowances
- Purchase Discounts
By tracking these types of transactions in their own account
managers have the opportunity to better understand their business. Are too many
refunds being given? Why? Are we buying defective merchandise from a certain
supplier? Are Sales Allowances cutting into our gross profit too much? Are we
taking advantage of our Purchase Discounts when available?
The key to business profits is to identify each and every
item that can be improved, and then improve it. Managers can raise prices. But
they can also cut costs, reduce waste, increase efficiency, take discounts when
available, and many other things to improve the profitability of their business.
Freight In vs Delivery Expense
Freight In is the cost to have merchandise shipped to your
store. Freight In is a cost of purchasing merchandise, and becomes part of Cost
of Goods Sold in the Income Statement. Sometimes a company has to pay a separate
charge for Freight In. At other times the cost may be included in the cost of
merchandise from the supplier. In any case, the cost of Freight In is added to
the cost of the merchandise.
XYZ, Co. buys 100 units of Product R for $7500. The trucking
company charges $500 for the shipment. The total cost of the merchandise is
$8000. Each unit costs $8000 / 100 = $80. They should set their selling price
based on a cost of $80.
Delivery Expense is the cost to ship or deliver merchandise
to your customer after a sale. Delivery Expense is a Selling Expense, and is
included under that caption in the Income Statement.