Chapter 6 - Summary
Describe the operating cycle of a merchandising company.
The operating cycle is the repeating sequence of transactions by which a company
generates revenue and cash receipts from customers. In a merchandising company,
the operating cycle consists of the following transactions: (1) purchases of
merchandise, (2) sale of the merchandise - often on account, and (3) collection
of accounts receivable from customers.
Define subsidiary ledgers and explain their usefulness.
Subsidiary ledgers provide a detailed record of the individual items comprising
the balance of a general ledger controlling account. With respect to merchandising
transactions, subsidiary ledgers are needed to keep track of the amounts receivable
from individual customers, the amounts owed to specific suppliers, and the quantities
of specific products in inventory.
Account for purchases and sales of merchandise in a perpetual inventory system.
In a perpetual inventory system, purchases of merchandise are recorded by debiting
the asset Inventory account. Two entries are required to record each sale: one
to recognize sales revenue and the second to record the cost of goods sold.
This second entry consists of a debit to Cost of Goods Sold and a credit to
Explain how a periodic inventory system operates.
In a periodic system, up-to-date records are not maintained for inventory or
the cost of goods sold. Thus less recordkeeping is required than in a perpetual
The beginning and ending inventories are determined by taking a complete physical
count at each year-end. Purchases are recorded in a Purchases account, and no
entries are made to record the cost of individual sales transactions. Instead,
the cost of goods sold is determined at year-end by a computation such as the
following (dollar amounts are provided only for purposes of example):
The amounts of inventory and the cost of goods sold are recorded in the accounting
records during the year-end closing procedures.
Discuss the factors to be considered in selecting an inventory system.
In general terms, a perpetual system should be used when (1) management and
employees need timely information about inventory levels and product sales,
and (2) the company has the resources to develop this information at a reasonable
cost. A periodic system should be used when the usefulness of current information
about inventories does not justify the cost of maintaining a perpetual system.
Perpetual systems are most widely used in large companies with computerized
accounting systems and in businesses that sell high-cost merchandise. Periodic
systems are most often used in small businesses with manual accounting systems
and that sell many types of low-cost merchandise.
Define special journals and explain their usefulness.
Special journals are accounting records or devices designed to record a specific
type of transaction in a highly efficient manner. Because a special journal
is used only to record a specific type of transaction, the journal may be located
at the transaction site and maintained by employees other than accounting personnel.
Thus special journals reduce the time, effort, and cost of recording routine
Account for additional merchandising transactions related to purchases and
Buyers should record purchases at the net cost and record any cash discounts
lost in an expense account. Sellers record sales at the gross sales price and
record in a contra-revenue account all cash discounts taken by customers.
The buyer records a purchase return by crediting the Inventory account for
the net cost of the returned merchandise. In recording a sales return, the seller
makes two entries: one debiting Sales Returns and Allowances (a contra-revenue
account) for the amount of the refund and the other transferring the cost of
the returned merchandise from the Cost of Goods Sold account back into the inventory
Buyers record transportation charges on purchased merchandise either as part
of the cost of the merchandise or as part of the cost of goods sold. Sellers
view the cost of delivering merchandise to customers as an operating expense.
Sales taxes are collected by retailers from their customers and paid to state
and city governments. Thus collecting sales taxes increases the retailer's assets
and liabilities. Paying the sales tax to the government is payment of the liability,
not an expense.
Measure the Performance of a Merchandising Business.
There are numerous measures used to evaluate the performance of merchandising
businesses. In this chapter, we introduced three of these measures: (1) comparable
store sales, which helps determine whether customer demand is rising or falling
at established locations, (2) sales per square foot of selling space, which
is a measure of how effectively a merchandising business is using its facilities
to generate revenue, and (3) gross profit percentages, which help users of financial
statements gain insight about a company's pricing policies and the demand for
You now have seen how both service-type businesses and merchandising companies
measure and report the results of their operations. Many of the illustrations,
examples, and assignments throughout the remainder of this textbook will involve