Chapter 6.6® - Glossary of Merchandise Accounting Terms

• Part 6.1 - Accounting for Merchandising Activities, Balance Sheet Representation of Inventory, Perpetual & Periodic Inventory Systems & Merchandise Purchases
• Part 6.2 - Types of Merchandising Inventory Systems - Perpetual & Periodic Inventory Systems & Journal Entries for Merchandise Purchases – Perpetual Inventory System
• Part 6.3 - Transfer of Ownership, FOB Shipping & FOB Destination Points - Accounting for Transportation Costs of Merchandise Inventory
• Part 6.4 - Accounting for Merchandise Sales, Sales Discounts, Sales Returns & Allowances & Shrink – Perpetual Inventory System
• Part 6.5 - Sales Returns & Allowances & Shrink (Merchandise Adjusting Journal Entries) - Continued from Accounting for Merchandise Sales– Perpetual Inventory System
• Part 6.6 - Glossary of Merchandise Accounting Terms

Cash discount - Companies giving cash discounts to their customers recognize these discounts as ‘Sales discounts’ on their books. Why do they do this? Well to increase the number of customer walk-ins, to increase their sales during times when consumers are not buying (recession) or during periods of holiday sales when the decreases in their prices are offset with a large number of customers buying (customer walk-ins). Another advantage to offering cash discounts on sales is for prompt payment, which reduces the time needed to pay suppliers for merchandise, as well as take advantage of any supplier discounts on merchandise.

Cost of Goods Sold - Merchandise is referred to as goods that a company acquires for the purpose of reselling them to customers. The cost of this merchandise is called Cost of goods sold and is a direct expense item on the Income statement.

Credit Period – The time period that can pass before a customer’s payment becomes due.

Credit Terms - Credit terms are a listing of the amounts & timing of payments between a buyer and a seller, and the discount percent if the payment is made within a certain time period. The equation for setting up the terms is: n/10 = EOM. The EOM means “end of month” and most invoices are due for payment in 30 days, thus making the EOM 30 days. The “n” in this case means the discount percent if the payment is made within 10 days.

Discount period – The time period in which a cash discount is available and a reduced payment can be made by the buyer, taking advantage of a reduction in selling price. The equation for setting up the terms is: n/10 = EOM. The EOM means “end of month” and most invoices are due for payment in 30 days, thus making the EOM 30 days. The “n” in this case means the discount percent if the payment is made within 10 days.

EOM – EOM is an abbreviation for End of Month and is used to describe credit terms for transactions of merchandise purchases on credit.

FOB - The buyer and seller must reach an agreement on who is responsible for paying any freight costs and who bears the risk of loss during transit when the merchandise is being shipped. This question basically asks, “At what point does ownership transfer from the buyer to the seller?” The point of transfer is called the FOB point, and FOB stands for free on board.

FOB shipping point: FOB shipping point is also known as FOB factory and means the buyer accepts ownership at the seller’s place of business. The buyer is then responsible for paying shipping costs, and bears ownership and risks of damage/loss when the goods are in transit or in transport. The goods also become a part of the buyer’s merchandise inventory at the shipping point.

FOB destination: FOB destination means ownership of the goods transfers to the buyer when goods are delivered at the buyer’s place of business. This means the seller is responsible for paying shipping costs and bears the risk of damage/loss while in transit/transport. The seller also does not record revenue from this sale until the goods arrive at the destination because this transaction is not complete before that point.

Merchandise - Merchandise is referred to as goods that a company acquires for the purpose of reselling them to customers.

Periodic Inventory System - A periodic inventory system, as the name suggests, provides a periodic balance of the inventory account only at the end of an accounting period such as March 31st, 2009 which is the end of first quarter for most large corporations. Periodic inventory system does not update the inventory account after every transaction.

Perpetual Inventory System - A perpetual inventory system, as the name suggests, gives a continuous record of the amount of inventory on hand. A perpetual inventory system adds up all the merchandise purchases in the Inventory account, and removes them from this account when an item is sold, and transfers it to Cost of Goods sold. Therefore, a merchandise piece sits as Inventory on the balance sheet of Costco when it is not sold. However as soon as it is sold, it is moved from the Inventory account to Cost of goods sold, an expense item on the Income statement.

Purchase Discount - A seller offering a cash discount when the credit period is long is encouraging the buyer to make prompt payment. The buyer thus views this as a purchase discount. In the eyes of the seller, this is a sales discount.

Sales Discount - A seller offering a cash discount when the credit period is long is encouraging the buyer to make prompt payment. The buyer thus views this as a purchase discount. In the eyes of the seller, this is a sales discount.

Shrinkage - Merchandising companies using a perpetual inventory system are often required to make additional adjustments to their inventory by updating the merchandise inventory account to reflect any losses of merchandise including loss from theft, deterioration, loss in transit, loss in store, misplacement, etc; this is known as inventory shrinkage or “shrink” for short form.