Accounting: The Language of Business (Part 27)

Accounting rules give financial institutions flexibility about when they choose to recognize venture capital profits.

Alex Berenson

Accounting for Merchandising Businesses

(Part A)

by

Charles Lamson

Assume that you bought groceries at a store and received the receipt shown below. This receipt indicates that you purchased 3 items totaling $5.28, the sales tax was $0.32 (6%), the total due was $5.60, you gave the clerk $10, and you receive change of $4.40. The receipt also indicates that the sale was made by store number 426 of the Ingles chain, located in Athens, Georgia. The date and time of the sale and other data used internally by the store are also indicated.

When you buy groceries, books, office supplies, or an automobile, you are doing business with a retail or merchandising business. The accounting for a merchandising business is more complex than for a service business. For example, the accounting system for a merchandiser must be designed to record the receipt of goods for resale, keep track of the goods available for sale, and record the sale and cost of the merchandise sold.

In the next several posts, we will focus on the accounting principles and concepts for merchandising businesses. We begin our discussion by highlighting the basic differences between the activities of merchandising and service businesses. We then describe and illustrate financial statements for merchandising businesses and purchases and sales transactions.

Nature of Merchandising Businesses

How do the activities of NetSolutions (from preceding posts), an attorney, and an architect, which are service businesses, differ from those of Walmart or BestBuy, which are merchandising businesses? These differences are best illustrated by focusing on the revenues and expenses and the following condensed income statement:

The revenue activities of a service business involves providing services to customers. On the income statement for a service business, the revenues from services are Reported as fees earned. The operating expenses incurred in providing the services are subtracted from the fees or end to arrive at net income.

In contrast, the revenue activities of a merchandising business involve the buying and selling of merchandise. A merchandising business must first purchase merchandise to sell to its customers. When this merchandise is sold, the revenue is reported as sales, and its cost is recognized as an expense called the cost of merchandise sold. The cost of merchandise sold is subtracted from sales to arrive at gross profit. This amount is called gross profit because it is the profit before deducting operating expenses.

Merchandise on hand (not sold) at the end of an accounting period is called merchandise inventory. Merchandise inventory is reported as a current asset on the balance sheet.

In the next several posts, we illustrate merchandiser financial statements and transactions that affect the income statement (sales, cost of merchandise sold, and gross profit) and the balance sheet (merchandise inventory).

*WARREN, REEVE, & FESS, 2005, ACCOUNTING, 21ST ED., PP. 231*

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