Chapter 6.4® - Accounting for Merchandise Sales, Sales Discounts, Sales Returns & Allowances & Shrink – Perpetual Inventory System

• 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

i) Accounting for Merchandise Sales

Merchandising companies also have to account for the sales side of things, including sales, sales discounts, sales returns and allowances, and cost of goods sold. Accounting for the sale of merchandise needs 2 critical pieces of information:

As an example, consider Binti Kiziwi Corp. records a purchase of $1,500 Sony camera on credit on September 14th, 2009 and also sells this camera for $2,200 on September 27th, 2009 on credit. Here is the journal entry to record the sale:

With this journal entry, there is an increase on the Current assets side (Debit to AR) as well as an increase to revenue (credit to sales). The expense or cost of the merchandise sold is accounted for via the journal entry below:

This journal entry records the cost of the camera sold and credits Merchandise inventory as we are reducing it, and debits an expense (Cost of Goods sold) that is reported on the income statement.

ii) Accounting for Sales Discounts

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.

A seller does not know whether a customer will pay within the discount period and take advantage of any cash discounts, thus a sales discount is not recorded until it is taken by the customer. As an example, consider Binti Kiziwi Corp. records a purchase of $1,500 Sony camera on credit on September 14th, 2009 and also sells this camera for $2,200 on September 27th, 2009 on credit on 2/10 n60 days terms. Here is the journal entry to record the sale:

With this journal entry, there is an increase on the Current assets side (Debit to AR) as well as an increase to revenue (credit to sales). The expense or cost of the merchandise sold is accounted for via the journal entry below:

The customer has 2 options, one is to take the 2% discount and pay within the 60 day period, and the second is to pay after 60 days and forfeit the discount. In scenario i) when the customer pays within 60 days, here is the journal entry recorded:

In scenario ii), the customer can wait 60 days and pay after the discount period ends. In this case, the journal entry is simple enough:

Sales discount is a contra-revenue account and the set up is because management can monitor sales discounts to assess their effectiveness and costs. The sales discount is deducted from total sales to arrive at a company’s net sales in a given period. Usually the company reports the Net Sales number on their income statement as the sales discount information although useful, is not that important enough to be reported on the income statement; it is more for effective management.