Chapter 6
Merchandising Activities

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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.

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.
 

Inventory Shrinkage
If you throw a good wool sweater in a washing machine full of hot water, what will happen? You ladies already know the answer to that question. If you're a guy you may need to ask you wife, girlfriend, sister, or mother. Go ahead.... we'll wait.......

OK, now that you know the sweater will shrink, or get smaller. Guys, if you do this to your wife's favorite cashmere sweater we'll be forwarding your mail to the doghouse for the next month or so. 

Well, inventory also shrinks. But not because we washed it in hot water. In fact inventory shrinkage occurs for a number of reasons, and it is just as it sound - inventory gets smaller. But how should this happen? Things happen to merchandise while the store has it available for sale. Here are some of the things:

Theft - by employees or customers
Spoilage - milk, meat, vegetables, past the expiration date
Obsolescence - computers, software, clothing (last year's styles)
Display - merchandise put on display often can't be sold later or must be discounted
Grazing - customers or employees eating food available for sale
Damage - broken bottles, bent cans, frozen foods left out of the freezer

The sum total of all these items contributes to the difference between the Inventory account and the physical count. There might also have been errors made in the Inventory account during the year, adding to the difference.
 

A true story about grazing
I used to live in Tucson, Arizona and went to school at the University there. I lived on North Park, pretty far up the road near the north end of town. Near me was a Lucky grocery store, where I shopped a couple of times each week. Every time I would go there I would see people wandering around the store posing as customers. They would push a cart down the aisles, collecting a few items along the way. 

A typical scenario I have observed with my own eyes: 

• take a couple of slices of bread (leave the rest of the loaf on the shelf, opened
• open a package of cold cuts, take a few slices, leave the package
• tear off a couple of pieces of lettuce, leave the rest of the head behind
• get one plastic knife from a package of 20, ditch the other 19 somewhere
• put some mayo and mustard on the sandwich, return jars to the shelf
• get a beverage and have lunch
• top it off with a piece of fruit for dessert

Special Sales and Purchase Accounts 
Merchandisers use a few special accounts. When a sale is made, sometimes the customer returns merchandise for a refund. We do not reduce the sales revenue account. We enter the refund in a different account. This is done to help track the number and dollar amount of these types of transactions.

Sales accounts deal with customers and sale transactions

• Sales Returns and Refunds
• Sales Allowances
• Sales Discounts

• Purchase Returns and Refunds
• Purchase Allowances
• Purchase Discounts

By tracking these types of transactions in their own account managers have the opportunity to better understand their business. Are too many refunds being given? Why? Are we buying defective merchandise from a certain supplier? Are Sales Allowances cutting into our gross profit too much? Are we taking advantage of our Purchase Discounts when available?

The key to business profits is to identify each and every item that can be improved, and then improve it. Managers can raise prices. But they can also cut costs, reduce waste, increase efficiency, take discounts when available, and many other things to improve the profitability of their business.

Freight In vs Delivery Expense
Freight In is the cost to have merchandise shipped to your store. Freight In is a cost of purchasing merchandise, and becomes part of Cost of Goods Sold in the Income Statement. Sometimes a company has to pay a separate charge for Freight In. At other times the cost may be included in the cost of merchandise from the supplier. In any case, the cost of Freight In is added to the cost of the merchandise.

example:
XYZ, Co. buys 100 units of Product R for $7500. The trucking company charges $500 for the shipment. The total cost of the merchandise is $8000. Each unit costs $8000 / 100 = $80. They should set their selling price based on a cost of $80. 

Delivery Expense is the cost to ship or deliver merchandise to your customer after a sale. Delivery Expense is a Selling Expense, and is included under that caption in the Income Statement.