Recording Sales

Sales invoices are source documents that provide a record for each sale. For control purposes, sales invoices should be sequentially prenumbered to help the accounting department determine the disposition of every invoice. Sales revenues equal the selling price of all products that are sold. In accordance with the revenue recognition principle, sales revenue is recognized when a customer receives title to the merchandise, regardless of when the money changes hands. If a customer purchases merchandise at a sales counter and takes possession of the goods immediately, the sales invoice or cash register receipt is the only source document needed to record the sale. However, if merchandise is shipped to the customer, a delivery record or shipping document is matched with the invoice to prove that the merchandise has been shipped to the customer.

Suppose a company named Music Suppliers, Inc., sells merchandise worth $1,000 on account to a retail store named Music World. Music Suppliers, Inc., records the sale with the journal entry below.







For reference purposes, the journal entry's description often includes the invoice number.

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Purchases Discounts

Companies that take advantage of sales discounts usually record them in an account named purchases discounts, which is another contra‐expense account that is subtracted from purchases on the income statement. If Music Suppliers, Inc., offers the terms 2/10, n/30 and Music World pays the invoice's outstanding balance of $900 within ten days, Music World takes an $18 discount. To record this payment to Music Suppliers, Inc., Music World makes a compound journal entry that decreases (debits) accounts payable for $900, decreases (credits) cash for $882, and increases (credits) purchases discounts for $18.

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Accounting Inventory

Although the accounting cycle and the basic accounting principles are the same for companies that sell merchandise and companies that provide services, merchandising companies use several accounts that service companies do not use. The balance sheet includes an additional current asset called merchandise inventory, or simply inventory, which records the cost of merchandise held for resale. On balance sheets, the inventory account usually appears just below accounts receivable because inventory is less liquid than accounts receivable.

Music World Partial Balance Sheet June 30, 20X3


ASSETS


Current Assets


Cash

$10,000


Accounts Receivable

2,000


Inventory

37,000


Supplies

1,000


Prepaid Insurance

2,000


Total Current Assets

$52,000




Merchandising companies also have several specific income statement accounts designed to provide detailed information about revenues and expenses associated with salable merchandise.

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Returns and Allowances

When a purchaser receives defective, damaged, or otherwise undesirable merchandise, the purchaser prepares a debit memorandum that identifies the items in question and the cost of those items. The purchaser uses the debit memorandum to inform the seller about the return and to prepare a journal entry that decreases (debits) accounts payable and increases (credits) an account named purchases returns and allowances, which is a contra‐expense account. Contra‐expense accounts normally have credit balances. On the income statement, the purchases returns and allowances account is subtracted from purchases.

If Music World discovers $100 worth of defective merchandise in the shipment from Music Suppliers, Inc., Music World prepares a debit memorandum, returns the merchandise, and makes a journal entry that decreases (debits) accounts payable for $100 and that increases (credits) purchases returns and allowances for $100.







For reference purposes, the journal entry's description may include the debit memorandum number and the seller's invoice number.

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Recording Purchases

Under the periodic system, a temporary expense account named merchandise purchases, or simply purchases, is used to record the purchase of goods intended for resale. The source documents used to journalize merchandise purchases include the seller's invoice, the company's purchase order, and a receiving report that verifies the accuracy of the inventory quantities. When Music World receives a shipment of merchandise worth $1,000 on account from Music Suppliers, Inc., Music World increases (debits) the purchases account for $1,000 and increases (credits) accounts payable for $1,000.






For reference purposes, the journal entry's description usually includes the invoice number.

When a seller pays to ship merchandise to a purchaser, the seller records the cost as a delivery expense, which is considered an operating expense and, more specifically, a selling expense. When a purchaser pays the shipping fees, the purchaser considers the fees to be part of the cost of the merchandise. Instead of recording such fees directly in the purchases account, however, they are recorded in a separate expense account named freight‐in or transportation‐in, which provides management with a way to monitor these shipping costs.

If Music World pays a shipping company $30 for delivering the merchandise from Music Suppliers, Inc., Music World increases (debits) freight‐in for $30 and decreases (credits) cash for $30.









Freight terms, which indicate whether the purchaser or seller pays the shipping fees, are often specified with the abbreviations FOB shipping point or FOB destination. FOB means free on board. FOB shipping point means the purchaser pays the shipping fees and gains title to the merchandise at the shipping point (the seller's place of business). FOB destination means the seller pays the shipping fees and maintains title until the merchandise reaches its destination (the purchaser's place of business).

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Inventory Systems

There are two systems to account for inventory: the perpetual system and the periodic system. With the perpetual system, the inventory account is updated after every inventory purchase or sale. Before computers became widely available, only companies that sold a relatively small number of high‐priced items used this system. Under the periodic system, a careful evaluation of inventory occurs only at the end of each accounting period. At that time, each product available for sale is counted and multiplied by its per unit cost, and the total of all such calculations equals the value of inventory.

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Net Sales

Net sales is calculated by subtracting sales returns and allowances and sales discounts from sales. Suppose Music Suppliers, Inc., sells merchandise worth $116,500 during June and, in conjunction with these sales, handles $9,300 in returns and allowances and $1,200 in sales discounts. The company's net sales for June equal $106,000.

Music Suppliers, Inc. Calculation of Net Sales For the Month Ended June 30, 20X3

Sales		$116,500
Less: Sales Returns and Allowances	$9,300
Sales Discounts	1,200	10,500
Net Sales		$106,000

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Sales Discounts

A sales discount is an incentive the seller offers in exchange for prompt payment on credit sales. Sales discounts are recorded in another centra‐revenue account, enabling management to monitor the effectiveness of the company's discount policy. Invoices generally include credit terms, which specify when the customer must pay and define the sales discount if one is available. For example, the credit terms on the invoice below are 2/10, n/30, which is read “two‐ten, net thirty.”

The terms 2/10, n/30 mean the customer may take a two percent discount on the outstanding balance (original invoice amount less any returns and allowances) if payment occurs within ten days of the invoice date. If the customer chooses not to take the discount, the outstanding balance is due within thirty days. An abbreviation that sometimes appears in the credit terms section of an invoice is EOM, which stands for end of month. The terms n/15 EOM indicate that the outstanding balance is due fifteen days after the end of the month in which the invoice is dated.

If Music World returns merchandise worth $100 after receiving a $1,000 order, they still owe Music Suppliers, Inc., $900. Assuming the credit terms are 2/10, n/30 and Music World pays the invoice within ten days, the payment equals $882, an amount calculated by subtracting $18 (2% of $900) from the outstanding balance. To record this payment from Music World, Music Suppliers, Inc., makes a compound journal entry that increases (debits) cash for $882, increases (debits) sales discounts for $18, and decreases (credits) accounts receivable for $900.

 

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