A merchandising company sells merchandise inventory to customers. Accounting for companies that sell inventory is more complex than for service companies.
This article is in Chapter 4: Recording Business Transactions. The chapter 4 articles include:
See all the financial accounting chapters in The Ultimate Guide to Learn Financial Accounting.
Income statement for a service company
A service company sells services for a fee. They do not sell any products. The income statement shows only revenues and expenses.
For a service company, the income statement shows the following format:
Income statement for a merchandising company
A merchandising company sells merchandise inventory to customers. Merchandisers can be manufacturers, wholesalers, or retailers.
- A manufacturer buys raw materials to produce products for sale to customers.
- A wholesaler buys inventory from manufacturers and sells it to retailers.
- A retailer buys inventory to sell to customers.
The income statement for a merchandising company shows several categories of expenses:
- Cost of sales
- Operating expenses
- Other expenses
- Income tax expenses
Cost of sales
Cost of sales is the cost of selling the products to customers. For most companies, the cost of sales is the largest expense on the income statement. The cost of sales is also called:
- cost of goods
- cost of goods sold (COGS)
- cost of revenue
Operating expenses are used to run the company. Operating expenses can also be called:
- selling, general and administrative expenses (SG&A)
- general and administrative expenses (G&A)
Typical operating expenses include:
- wages expense
- salary expense
- rent expense
- insurance expense
- depreciation expense
Other income and expenses
Other income and expenses are any nonoperating costs for the period. They are subtracted at the bottom of the income statement. These other expenses include the following items:
- interest expense
- interest revenue
- currency gains/losses
Note that other expenses can also include gains and revenue. So, if interest revenues are $40,000 and interest expenses are $25,000, other income is $15,000. If the interest expenses are $47,000, the other expense would be $7,000.
Income tax expense
Income tax expense is the last expense on the income statement. It is the cost of paying income taxes to state and federal governments.
Walmart income statement
Here is Walmart’s income statement for 2023:
Here is a summary of the 2023 income statement:
|Cost of sales||$463,721|
|Other income and expenses||$ 3,412|
|Income tax expense||$ 5,724|
Merchandise Inventory Cycle
Inventory, or merchandise inventory, is a current asset for a company. The inventory cycle for a company is:
- Purchase inventory
- Pay cash on payables
- Sell inventory
- Receive cash on receivables
There are two systems used to account for inventory:
- periodic inventory system
- perpetual inventory system
Periodic inventory records the cost of goods sold at the end of each period.
Perpetual inventory records the cost of goods sold at the time of sale. This method is easier with the increase in technology.
We will use the perpetual inventory system in the examples below.
|Inventory System||When Cost of Sales is Computed|
|Periodic inventory||at the end of each period|
|Perpetual inventory||at the time of sale|
Sellers set credit terms when extending credit to customers. Credit terms set the due date and the cash discount period.
For example, credit terms n/30 mean net 30 days. So, the total is due in 30 days.
Credit terms 2/10, n/30 give a 2% discount if paid within the first 10 days. The total is due by day 30.
For the seller, this cash discount is a sales discount. For the buyer, it is a purchase discount.
The following table shows common credit terms:
|Credit Terms||Discount||Total Due|
|1/10, n/30||1% within 10 days||30 days|
|1/15, n/45||1% within 15 days||45 days|
|2/10, n/30||2% within 10 days||30 days|
|2/10, n/60||2% within 10 days||60 days|
The seller sets the shipping terms for the sales transaction. The shipping terms show when the title of goods transfers from the seller to the buyer. The two shipping terms are FOB destination and FOB shipping point.
FOB destination means the title of the goods passes when the goods are shipped. So, the title passes to the buyer before the goods are delivered.
FOB shipping point means the title of the goods passes when the goods are received. The title passes to the buyer only when the goods arrive at their final destination.
The following table explains the shipping terms:
|Shipping Term||When Title Passes||Who Pays Shipping Costs?|
|FOB destination||when delivered||Seller|
|FOB shipping point||when shipped||Buyer|
A merchandising company buys inventory for resale. The following shows entries related to buying inventory.
These entries assume perpetual inventory and the gross method.
On June 1, John Company buys inventory and pays cash for $4,000.
Purchase with cash discount
On June 5, the company buys inventory on account. The credit terms were 2/10, n/30.
On June 11, John Company pays its account within the discount period. The case discount is $6,000 x 2% = $120.
Purchase without cash discount
John Company purchased inventory on June 14. The credit terms were 3/10, n/30. The shipping terms were FOB shipping point.
On June 15, John Company paid $200 for delivery costs for inventory.
The company paid its account on June 27 from the June 14 purchase. They did not pay within the discount period.
On June 30, John Company returned merchandise inventory costing $400. The company received cash.
The following shows entries related to selling inventory. These entries assume perpetual inventory and the gross method.
On July 1, Zachary Co. sold inventory costing $4,000 for $7,000 in cash. Hint: There are two entries.
Sale on account with cash discount
On July 6, the company sold inventory on account for $8,500. The inventory cost $5,000. The credit terms were 2/20, n/30.
Zachary Co. collected cash on account from customers from the July 6 entry. The payment was within the discount period. The cash discount is $8,500 x 2% = $170.
For Zachary Co., net sales were $8,330 (sales $8,500 – sales discounts $170).
Sale on account without cash discount
On July 14, Zachary sold inventory on account for $6,000. The inventory cost $3,000. Zachary offered credit terms of 2/10, n/30.
Zachary collected cash on account from customers from the July 14 sale. The customers missed the discount period.
On July 31, Zachary refunded $600 to customers that returned inventory. The inventory cost $300.
When a merchandising company counts inventory, there can be a loss of inventory. This is because of damage, theft, or obsolescence. The loss is termed inventory shrinkage.
Assume Link Co. has an inventory account with a $12,500 balance. The physical count of inventory showed $12,050. So, the company recorded a loss of $450. This is a write-off of inventory.
This entry reduces the balance of inventory from $12,500 to $12,050.
Financial Accounting Chapters
Here are the financial accounting chapters in The Ultimate Guide to Learn Financial Accounting:
- Introduction to Accounting
- Recording Business Transactions
- Adjusting the Accounts
- Accounting for Merchandising Activities
- Inventory and Cost of Sales
- Time Value of Money
- Cash, Fraud, and Internal Control
- Accounting for Receivables
- Accounting for Long-Term Assets
- Accounting for Current Liabilities
- Accounting for Long-Term Liabilities
- Statement of Cash Flows
- Financial Statement Analysis