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Merchandising Activities

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.

Periodic and Perpetual Inventory Systems

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.

Accounts Used in Merchandising Activities

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]

Method >>>
Periodic
Perpetual
Account used to record inventory purchases: Purchases Inventory
Appears on: Income Statement Balance Sheet
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
Year-end procedures: 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
Other procedures: Transfer Purchases balance to Cost of Goods Sold Balances should now be correct

Physical Inventory

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.

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.

Item
Quantity
Unit Cost
Extension
soup, tomato, can, 8 oz
65
.24
15.60
soup, chicken noodle, can, 8 oz
79
.21
16.59
soup, cream of mushroom, can, 8 oz
53
.16
8.48

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 the lesson on inventory.

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 value.

General Journal

Date
Account
Debit
Credit
  Dec-31 Cost of Goods Sold
$525
 
     Inventory  
$525
  To adjust Inventory to year-end physical count and valuation    

General Ledger
Inventory
[a Balance Sheet account]

 Date  Description
 Debit
 Credit
Balance
Jan-1 Beginning balance forward
12,500
 
12,500
Dec-31 Year-end adjustment  
525
11,975
         

Cost of Goods Sold

[an Income Statement account]

 Date  Description
 Debit
 Credit
Balance
Dec-31 Balance     
100,000
Dec-31 Year-end Inventory adjustment
525
 
100,525
         

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.

Inventory Shrinkage

If you throw a good wool sweater in a washing machine full of hot water, what will happen? The sweater will shrink, or get smaller. 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 styles)
  • 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 freezer

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 the difference.

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 transactions:

  • Sales Returns and Refunds
  • Sales Allowances
  • Sales Discounts

Purchase accounts deal with suppliers and purchase transactions

  • Purchase Returns and Refunds
  • Purchase Allowances
  • Purchase 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.

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 Versus 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.

Example:
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.

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