Chapter 6.1® - Accounting for Merchandising Activities, Sample Balance Sheet Representation of Inventory, Perpetual & Periodic Inventory Systems & Merchandise Purchases
A merchandising company has different business operations than that of a servicing company. A merchandising company earns net income by buying and selling merchandise. A good example is Costco that buys groceries, electronics and clothes from manufacturers and resells it to customers for a margin (profit). 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. Merchandising companies can either be wholesalers like Costco or retailers like Rogers Video.
Net income for a merchandiser arises when revenue from selling merchandise exceeds both the cost of merchandise sold to customers (margin) and the cost of operations for the period, including salaries of employees working at the head office, marketing & accounting costs, costs for the Information Technology department, and more. The accounting term for revenue derived from selling merchandise is known as Sales.
The business model of a servicing company is to sell merchandise and earn revenues, and have front line employees helping customers as well as head office employees support front line employees and form part of the operating expenses. The income left over after paying operating expenses is called Net Income.
This diagram shows the revenue models of the two major types of businesses out there, i) Servicing companies and ii) Merchandising companies). Servicing companies are those that offer services such as accounting, law representation, computer programming, etc and thus they do not have any 'Cost of Goods Sold' because they do not hold inventory for resale. Merchandising companies on the other hand are those that hold inventory for resale to consumers and the best example is for instance Bestbuy in the electronics industry or Costco in the groceries industry. Notice that both merchandising & servicing companies have Operating expenses because both types of businesses must employ people in order to run their operations and pay salaries; which are then treated as operating expenses.
The condensed income statement of Calgary Sweets Ltd. above shows us the relationship between net sales, cost of goods sold and the arrival to the gross profit calculation. General and administration expenses such as employee salaries, warehouse rents, etc are then deducted from the gross profit to arrive at the net income.
Attached above is the balance sheet of Costco Wholesale as of August 31st, 2008. Notice the line item we are interested in looking at is Total Merchandise Inventory totalling $5,039.41 million dollars. That’s how much inventory Costco has for resale to customers; notice how it makes up greater than 25% of their balance sheet! The cost of merchandise inventory also includes the costs incurred to buy the goods, ship them to the stores or warehouses, and other costs necessary to make them ready for sale such as employee costs for organizing the merchandise on warehouse displays and grocery stands.