Accounting: The Language of Business (Part 34)

What you get out of an M.B.A. programme, no matter how much experience, is functional tools and understanding in disciplines: you'll understand economics, you'll understand marketing, finance, accounting. That, M.B.A. programmes do very well.

Henry Mintzberg

Accounting for Merchandising Businesses

(Part G)

by

Charles Lamson

The Accounting Cycle for a Merchandising Business

In preceding posts, we described and illustrated the chart of accounts and the analysis and recording of transactions for a merchandising business. We have also illustrated the preparation of financial statements for a merchandiser, NetSolutions, at the end of an accounting cycle. In the next several posts, we describe the other elements of the accounting cycle for a merchandising business. In this discussion, we will focus primarily on the elements of this cycle that are likely to differ from those of a service business.

Merchandise Inventory Shrinkage

Under the perpetual inventory system, a separate merchandise inventory account is maintained in the ledger. During the accounting period, this account shows the amount of merchandise for sale at any time. However, merchandising businesses may experience some loss of inventory due to shoplifting, employee theft, or errors in recording or counting inventory. As a result, the physical inventory taken at the end of the accounting period may differ from the amount of inventory shown in the inventory records. Normally, the amount of merchandise for sale, as indicated by the balance of the merchandise inventory account, is larger than the total amount of merchandise counted during the physical inventory. For this reason, the difference is often called inventory shrinkage or inventory shortage.

To illustrate, NetSolutions' inventory records indicate that $63,950 of merchandise should be available for sale on December 31, 2025. The physical inventory taken on December 31, 2025, however, indicates that only $62,150 of merchandise is actually available. Thus, the inventory shrinkage for the year ending December 31, 2025, is $1,800 ($63,950 - $62,150). This amount is recorded by the following adjusting entry:

After this entry has been recorded, the accounting records agree with the actual physical inventory at the end of the period. Since no system of procedures and safeguards can totally eliminate it, inventory shrinkage is often considered a normal cost of operations. If the amount of the shrinkage is abnormally large, it may be disclosed separately on the income statement. In such cases, the shrinkage may be recorded in a separate account, such as Loss from Merchandise Inventory Shrinkage.

Work Sheet

Merchandising businesses that use a perpetual inventory system are also likely to use a computerized accounting system. In a computerized system, the adjusting entries are recorded and the financial statements prepared without using a worksheet. For this reason, we illustrate the worksheet and the adjusting entries for NetSolutions in part 36.

Closing Entries

The closing entries for a merchandising business are similar to those for a service business. The first entry closes the temporary accounts with credit balances, such as Sales, to the income summary account. The second entry closes the temporary accounts with debit balances, including Sales Returns and Allowances, Sales Discounts, and Cost of Merchandise Sold, to the income summary account. The third entry closes the balance of the income summary account to the owner's capital account. The fourth entry closes the owner's drawing account to the owner's capital account.

In a computerized accounting system, the closing entries are prepared automatically. For this reason, we illustrate the closing entries for NetSolutions in part 36.

*WARREN, REEVE, & FESS, 2005, ACCOUNTING, 21ST ED., PP. 250-251*

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