From service business to merchandiser

Learning goals

• Explain how a merchandising business differs from a service business.
• Calculate net sales, net purchases, cost of goods sold, and gross profit.
• Distinguish periodic and perpetual inventory systems.
• Interpret the inventory flow before journalizing it.

Prerequisite check

Revenue $40,000 minus expenses $31,000 equals what net income? In a merchandiser, why must the cost of items sold be recognized before profit is known?

Vocabulary

• Merchandising business: earns revenue mainly by selling goods acquired for resale.
• Merchandise Inventory: goods held for resale.
• Cost of goods sold (COGS): cost assigned to inventory sold during the period.
• Gross profit: net sales minus cost of goods sold.
• Net sales: sales less sales returns/allowances and sales discounts.
• Net purchases: purchases plus freight-in, less purchase returns/allowances and purchase discounts in a periodic system.
• Periodic system: updates Inventory through a count and period-end calculation rather than after every sale.
• Perpetual system: updates Inventory and COGS continuously for purchases and sales.

Core idea

A merchandiser has two flows: goods and money. A sale creates revenue at the selling price and transfers inventory cost into COGS. Gross profit measures the amount left after the cost of the goods sold, before operating expenses.

Why this treatment makes sense

The $80 selling price of an item is not all profit if the item cost $50. Reporting Sales $80 and COGS $50 produces gross profit $30. Inventory still on hand remains an asset for future periods.

A repeatable method

For a periodic COGS schedule:

1. Beginning Inventory + Net Purchases = Cost of Goods Available for Sale.
2. Net Purchases = Purchases + Freight-in − Purchase Returns − Purchase Discounts.
3. Goods Available − Ending Inventory = COGS.
4. Net Sales = Sales − Sales Returns − Sales Discounts.
5. Net Sales − COGS = Gross Profit.
6. Gross Profit − Operating Expenses = Net Income.

Worked example

Lake Effect Outdoor Goods reports:

• beginning inventory $8,000;
• purchases $31,000;
• freight-in $1,200;
• purchase returns $1,500;
• purchase discounts $500;
• ending inventory count $7,400;
• sales $52,000;
• sales returns $2,000;
• sales discounts $500.

Net purchases = $31,000 + $1,200 − $1,500 − $500 = $30,200.

Goods available = $8,000 + $30,200 = $38,200.

COGS = $38,200 − $7,400 = $30,800.

Net sales = $52,000 − $2,000 − $500 = $49,500.

Gross profit = $49,500 − $30,800 = $18,700.

Check: beginning goods plus net incoming goods must split into goods sold and goods remaining: $38,200 = $30,800 + $7,400.

Journal, ledger, and statement connection

Under periodic accounting, Purchases, Freight-in, Purchase Returns, and Purchase Discounts collect activity; ending Inventory comes from a count and COGS is calculated at period-end. Under perpetual accounting, the Inventory ledger changes with each purchase, discount, freight cost, return, sale cost, and customer return. Both systems should support the ending inventory and COGS under their stated assumptions.

Common mistakes

• Subtracting freight-in from purchases. Buyer-paid freight that brings goods in is added under the stated terms.
• Adding purchase returns or discounts.
• Using selling price in COGS.
• Subtracting ending inventory before adding beginning inventory and net purchases.
• Treating gross profit as net income before operating expenses.
• Assuming the perpetual record makes a physical count unnecessary. Counts can reveal shrinkage and errors.

Guided practice

Beginning inventory $5,600; purchases $18,000; freight-in $700; purchase returns $900; discounts $300; ending inventory $4,800; sales $32,000; sales returns $1,200; sales discounts $400.

Calculate net purchases, COGS, net sales, and gross profit.

Independent practice

Northern Notebook Co. reports beginning inventory $12,500; purchases $46,000; freight-in $1,800; purchase returns $2,400; purchase discounts $900; ending inventory $10,700; sales $79,000; sales returns $3,100; sales discounts $1,000; operating expenses $21,500.

Prepare a complete calculation from net purchases to net income.

Self-check and solutions

Guided practice: Net purchases = $18,000 + $700 − $900 − $300 = $17,500. Goods available = $5,600 + $17,500 = $23,100. COGS = $23,100 − $4,800 = $18,300. Net sales = $32,000 − $1,200 − $400 = $30,400. Gross profit = $12,100.

Independent practice: Net purchases = $46,000 + $1,800 − $2,400 − $900 = $44,500. Goods available = $12,500 + $44,500 = $57,000. COGS = $57,000 − $10,700 = $46,300. Net sales = $79,000 − $3,100 − $1,000 = $74,900. Gross profit = $28,600. Net income = $28,600 − $21,500 = $7,100.

Retrieval practice

Write the five linked formulas without notes. Explain what beginning inventory, purchases, COGS, and ending inventory each represent.

Exam-style application

Ending inventory was counted as $9,400 but should have been $8,900. State the effect on COGS, gross profit, net income, assets, and equity.

Answer outline: Inventory is overstated $500. Because COGS = goods available − ending inventory, COGS is understated $500. Gross profit and net income are overstated $500. Assets and equity are overstated $500. Liabilities are unaffected by this error alone.

Lesson summary

Merchandising profit requires both selling price and inventory cost. Use the inventory flow to calculate COGS and distinguish goods sold from goods still held.