Accounting for Retail Businesses
Items covered:
• Retailer Financial Statements
• Perpetual Inventory Costing
• Accounting for Inventory Purchases and Returns (with and without discounts)
• Accounting for Retail Sales and Returns (with and without discounts)
• Accounting for freight charges
Introduction
Retailers differ from service providers in that they sell merchandise. They purchase goods from manufacturers or wholesalers and then sell the goods to the end customer at retail prices with the intent of earning a profit. Financial statements differ in that merchandisers have an interim step where they find gross profit, which is the sales revenue less cost of goods sold. Sales (or Sales Revenue) is the revenue account for retailers. Cost of Goods Sold is the expense account that records the merchandisers cost of the items sold to the consumer.
Retailer Financial Statements
Income Statement (Partial)
Service Business Retail Business
Sales $100,000 Sales $100,000
Operating Expenses ($45,000) Cost of Goods Sold (55,000)
Operating Income $65,000 Gross Profit $45,000
Operating Expenses ($20,000)
Operating Income $25,000
New Balance Sheet Accounts
Assets:
Equity:
• Inventory (sometimes called Merchandise Inventory)
• Sales (or Sales Revenue – a revenue account)
• Cost of Goods Sold (an expense account)
• Sales Discounts (a contra revenue account)
• Sales Returns and Allowances (a contra revenue account)
Perpetual Inventory Costing
There are two methods of inventory costing, perpetual and periodic. With the advent of point-of-sale systems, the perpetual method of inventory costing is more prominent as it is the easiest to administer for retailers. The perpetual inventory system records the changes in inventory as soon as the sale is made, allowing for easy access to information on sales and inventory levels. All transactions done in this tutorial follow the perpetual inventory costing system.
Accounting for the Purchase of Merchandise
Before a retailer can sell to its final customer, it must have inventory on hand to sell. The retailer acquires its inventory by purchasing from a manufacturer or wholesaler. A basic transaction to record the retailer’s cash purchase of inventory is as follows:
Amy Inc. purchases $2,000 of merchandise from Wholesaler Plus on January 1:
Date Account Debit Credit
January 1 Inventory $2,000
Cash $2,000
Purchased inventory for Cash
Assets = Liabilities + Equity
+$2,000
-$2,000
If this was, instead, a credit transaction, the journal entry would be:
Date Account Debit Credit
January 1 Inventory $2,000
Accounts Payable – Wholesaler Plus $2,000
Purchased inventory on credit
Assets = Liabilities + Equity
+$2,000
+$2,000
When manufacturers or wholesalers sell their products, they often offer incentives for expedited or cash payments. They offer credit terms and cash discounts (which the buyer calls purchase discounts and the seller calls sales discounts) in order to incentivize the buyer to pay the invoice in a timelier fashion.
When credit terms are offered, the retailer may record the transaction following either the gross or the net method. We will examine the gross method throughout this tutorial.
Let’s look at the previous example:
Amy Inc. purchases $2,000 of merchandise from Wholesaler Plus on January 1. Wholesaler Plus offers Amy Inc. credit terms of 2/10, n/30. This indicates that if Amy Inc. pays the invoice within 10 days of the invoice date, Amy Inc. can take a 2% discount on the purchase price. Otherwise, full payment is due in 30 days.
To record this purchase following the gross method, Amy Inc. would record the same as shown in the previous example:
Date Account Debit Credit
January 1 Inventory $2,000
Accounts Payable – Wholesaler Plus $2,000
Purchased inventory on credit, terms 2/10, n/30.
Assets = Liabilities + Equity
+$2,000
+$2,000
Payment made within discount period:
Date Account Debit Credit
January 11 Accounts Payable – Wholesaler Plus $2,000
Inventory $40
Cash $1,960
Purchased inventory within discount period
Assets = Liabilities + Equity
-$2,000
-$40
-$1,960
Paying within the discount period means that Amy Inc. can take a 2% reduction in the price of its inventory. As a results, instead of paying $2,000 for its inventory, it paid $1,960 for its inventory ($2,000
– ($2,000 * 2%)). The impact and final balance in the inventory T account as a result of this transaction are shown below:
Inventory
1/1 $2,000
$40 1/11
Bal $1,960
If Amy Inc. makes the final payment on January 30th instead of January 11th, it is not able to take the purchase discount. As a result, the discount is forfeited. The transaction is recorded as follows:
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