Merchandising Activities (1)

Merchandising means selling products to retail customers. Merchandisers, also called retailers, buy products from wholesalers and manufacturers, add a markup or gross profit amount, and sell the products to consumers at a higher price than what they paid. When you go to the mall, all the stores there are retailers, and you are a retail customer.

Retailers deal with an inventory: all the goods (products) they have for sale. They account for inventory purchases and sales in one of two ways: Periodic and Perpetual. As the names suggest these methods refer to how often the inventory account balances are updated.

In a Periodic system, inventory account balances are updated once a year (some companies may do it more often, but all must do so at least once per year).

In a Perpetual system, inventory account balances are updated after each sale. This type of system is much more complex. Scanning cash registers, bar coded merchandise, and similar devices are used to update the inventory records after each sale. Obviously, this type of system is very expensive, but it gives managers a high degree of control over inventory, helps purchasing agents order replacement merchandise in time, detects and deters theft and helps identify other problems relating to inventory.

The main differences between the two relate to the journal entries used to record purchases and sales. The system a company chooses should be cost effective and provide the desired levels of inventory management. Special journals are often used to record sale and purchase transactions.

Accounts Used
You can usually tell whether a company is using the Periodic or Perpetual system by the accounts they use to record inventory purchases. Here's a chart that shows the differences:
[COGS = Cost of Goods Sold]

Method >>>	Periodic	Perpetual
Account used to record inventory purchases:	Purchases	Inventory
Appears on:	Income Statement	Balance Sheet
When a sale is made:	No adjustment to inventory is necessary; merchandise cost is already on the Income Statement	Merchandise cost is transferred from Inventory to Cost of Goods Sold -an Income Statement account
Year-end procedures:	Adjust Inventory balance to agree with year-end physical count and merchandise value	Adjust Inventory balance to agree with year-end physical count and merchandise value
Other procedures:	Transfer Purchases balance to Cost of Goods Sold	Balances should now be correct

Physical Inventory
The "physical inventory" simply means the actual, real, tangible, touchable stuff the company has for resale. In the case of a manufacturing company, the physical inventory includes raw materials, the value of goods in the process of production, and the value of finished goods (Chapter 16).

Taking a physical inventory means counting the number of units of stuff you have for sale. This is usually done at the end of the year, so the balance sheet Inventory amount accurately reflects the true value of the ending physical inventory.

If you run a grocery store, you would count all the cans, packages and containers of food, and everything else you have available for sale. You would then have to assign a value to everything: it's cost to you when you bought each item. A small piece of your inventory records might look something like the one below.

Quantity is the number of units on the shelf, and also in boxes in storage; this is the amount we counted in taking the physical inventory. Unit Cost is what was paid for each unit of product. The extension column is the total cost of each item.

Item	Quantity	Unit Cost	Extension
soup, tomato, can, 8 oz	65	.24	15.60
soup, chicken noodle, can, 8 oz	79	.21	16.59
soup, cream of mushroom, can, 8 oz	53	.16	8.48

Once all items are counted, priced and extended, the total cost is the ending value for Inventory.

Adjusting the Inventory Account
The Inventory account usually does not agree with the physical count. If the Periodic method is being used, the Inventory account has the balance as adjusted at the end of the prior year. If the Perpetual method is being used, the Inventory account should be close to the physical value calculated from the physical inventory count. There will always be a difference, and the accounts must be adjusted so the Inventory account agrees with the physical count and valuation. You will study valuation methods more in Chapter 8.

The Inventory account is adjusted to agree with the physical count and valuation. Let's look at an example of how the adjustment is made. The Inventory account has a balance of $12,500. You take a physical count and calculate the correct inventory value is $11,975. You will decrease inventory by $525 to adjust the Inventory account the equal the actual physical inventory value.

General Journal

Date	Account	Debit	Credit
Dec-31	Cost of Goods Sold	$525
	Inventory		$525
	To adjust Inventory to year-end physical count and valuation

General Ledger
Inventory
[a Balance Sheet account]

Date	Description	Debit	Credit	Balance
Jan-1	Beginning balance forward	12,500		12,500
Dec-31	Year-end adjustment		525	11,975

Cost of Goods Sold
[an Income Statement account]

Date	Description	Debit	Credit	Balance
Dec-31	Balance			100,000
Dec-31	Year-end Inventory adjustment	525		100,525

The adjusting entry correctly uses an Income Statement account and a Balance Sheet account. The additional merchandise cost is transferred to the Income Statement in this case, but the reverse adjustment could just as easily be made.