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5.5: Merchandise Inventory: Sales and Collection (Perpetual)

  • Page ID
    20096
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    • Contributed by Henry Dauderis and David Annand
    • Athabasca University
    • Sourced from Lyryx Learning

    learning objective

    LO3 – Analyze and record sales transactions for a merchandiser.

    In addition to purchases on account, a merchandising company's operating cycle includes the sale of merchandise inventory on account or on credit as highlighted in Figure 5.5.1.

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    Figure \(\PageIndex{1}\): Sales and Collection Portion of the Operating Cycle

    There are some slight recording differences when revenue is earned in a merchandising company. These are discussed below.

    Recording the Sale of Merchandise Inventory (Perpetual)

    The sale of merchandise inventory is recorded with two entries:

    1. recording the sale by debiting Cash or Accounts Receivable and crediting Sales, and
    2. recording the cost of the sale by debiting Cost of Goods Sold and crediting Merchandise Inventory.

    Assume the vehicle purchased by Excel is sold for $4,000 on account. Recall that the cost of this vehicle in the Excel Merchandise Inventory account is $2,798, as shown below.

    The entries to record the sale of the merchandise inventory are:

    General Journal
    Date Account/Explanation F Debit Credit
    Accounts Receivable 4,000
    Sales 4,000
    To record the sale of merchandise on account.
    General Journal
    Date Account/Explanation F Debit Credit
    Cost of Goods Sold 2,798
    Merchandise Inventory 2,798
    To record the cost of the sale.

    The first entry records the sales revenue. The second entry is required to reduce the Merchandise Inventory account and transfer the cost of the inventory sold to the Cost of Goods Sold account. The second entry ensures that both the Merchandise Inventory account and Cost of Goods Sold account are up to date.

    Sales Returns and Allowances

    When merchandise inventory that has been sold is returned to the merchandiser by the customer, a sales return and allowance is recorded. For example, assume some damage occurs to the merchandise inventory sold by Excel while it is being delivered to the customer. Excel gives the customer a sales allowance by agreeing to reduce the amount owing by $100. The entry is:

    General Journal
    Date Account/Explanation F Debit Credit
    Sales Returns and Allowances 100
    Accounts Receivable 100
    To record allowance for damage to merchandise inventory during delivery.

    Accounts receivable is credited because the original sale was made on account and has not yet been paid. The amount owing from the customer is reduced to $3,900. If the $3,900 had already been paid, a credit would be made to Cash and $100 refunded to the customer. The Sales Returns and Allowances account is a contra revenue account and is therefore deducted from Sales when preparing the income statement.

    If goods are returned by a customer, a sales return occurs. The related sales and cost of goods sold recorded on the income statement are reversed and the goods are returned to inventory. For example, assume Max Corporation sells a plastic container for $3 that it purchased for $1. The dual entry at the time of sale would be:

    General Journal
    Date Account/Explanation F Debit Credit
    Accounts Receivable 3
    Sales 3
    To record sale on credit.
    General Journal
    Date Account/Explanation F Debit Credit
    Cost of Goods Sold 1
    Merchandise Inventory 1
    To record the cost of the sale.

    If the customer returns the container and the merchandise is restored to inventory, the dual journal entry would be:

    General Journal
    Date Account/Explanation F Debit Credit
    Sales Returns and Allowances 3
    Accounts Receivable 3
    To record sales return.
    General Journal
    Date Account/Explanation F Debit Credit
    Merchandise Inventory 1
    Cost of Goods Sold 1
    To record sales return being restored to inventory.

    The use of a contra account to record sales returns and allowances permits management to track the amount of returned and damaged items.

    Sales Discounts

    Another contra revenue account, Sales Discounts, records reductions in sales amounts when a customer pays within a certain time period. For example, assume Excel Cars Corporation offers sales terms of "2/10, n30." This means that the amount owed must be paid by the customer within 30 days ('n' = net); however, if the customer chooses to pay within 10 days, a 2% discount may be deducted from the amount owing.

    Consider the sale of the vehicle for $3,900 ($4,000 less the $100 allowance for damage). Payment within 10 days entitles the customer to a $78 discount ($3,900 x 2% = $78). If payment is made within the discount period, Excel receives $3,822 cash ($3,900 - 78) and prepares the following entry:

    General Journal
    Date Account/Explanation F Debit Credit
    Cash 3,822
    Sales Discounts 78
    Accounts Receivable 3,900
    To record payment on account and sales discount applied.

    This entry reduces the accounts receivable amount to zero which is the desired result. If payment is not made within the discount period, the customer pays the full amount owing of $3,900.

    As was the case for Sales Returns and Allowances, the balance in the Sales Discounts account is deducted from Sales on the income statement to arrive at Net Sales. Merchandisers often report only the net sales amount on the income statement. Details from sales returns and allowances, and sales discounts, are often omitted because they are immaterial in amount relative to total sales. However, as already stated, separate general ledger accounts for each of sales returns and allowances, and sales discounts, are useful in helping management identify potential problems that require investigation.