MERCHANDISE OPERATIONS
In prior chapters, we described and illustrated how businesses report their financial
condition and changes in financial condition using the cash and accrual bases of ac-
counting. In these prior chapters, we focused on service businesses. In this chapter, we
describe and illustrate the accounting for merchandise operations.
How do the operating activities of a service business, such as a consulting firm,
law practice, or architectural firm, differ from a merchandising business, such as Home
Depot Inc.orWal-Mart? The differences are best illustrated by focusing on the income
statements of the two types of businesses.
The condensed income statement of H&R Block Inc. is shown in Exhibit 1.^1 H&R
Block is a service business that primarily offers tax planning and preparation to its
customers.
The condensed income statement of Home Depot is shown in Exhibit 2.^2 Home
Depot is the world’s largest home improvement retailer and the second largest retailer
in the United States, based on net sales volume.
The revenue activities of a service business involve providing services to customers.
On the income statement for a service business, the revenues from services are reported
as revenues or fees earned. The operating expenses incurred in providing services are
subtracted from the revenues to arrive at operating income. Any other income or expense
is then added or subtracted to arrive at income before taxes. Net income is determined by
subtracting income taxes. Exhibit 1 shows that H&R Block earned operating profits of
$1,052 (in thousands) based upon revenue of $4,420 (in thousands). Adding other income
and subtracting income taxes results in net income of $636 (in thousands).
In contrast, the revenue activities of a merchandising business involve the buying
and selling of merchandise. A merchandise business must first purchase merchandise
to sell to its customers. The revenue received for merchandise sold to customers less
any merchandise returned or any discounts is reported as net sales. The related cost
of merchandise soldis then determined and matched against the net sales. Gross
profitis determined by subtracting the cost of merchandise sold from net sales. Gross
profit gets its name from the fact that it is the profit before deducting operating ex-
penses. Operating expenses are then subtracted in arriving at operating income. Like
a service business, other income or expense is then added or subtracted to arrive at
income before taxes. Subtracting income taxes yields net income.212 Chapter 5 Accounting for Merchandise Operations
Distinguish the activities
and financial statements of
a service business from
those of a merchandise
business.1
Q.Assume that operating
income is $45,000, gross
profit is $100,000, and
the cost of goods sold is
$525,000. What are the
net sales and the total
operating expenses?A.Net sales: $625,000
($100,000$525,000)
Operating expenses:
$55,000 ($100,000
$45,000)Exhibit 1
H&R Block Income
StatementH&R Block Inc.
Condensed Income Statement
For the Year Ending April 30, 2005
(in thousands)Revenue $4,420
Operating expenses 3,368
Operating income $1,052
Other income and (expense) (34)
Income before taxes $1,018
Income taxes 382
Net income $ 6361 Adapted from H&R Block’s 10-K filing with the Securities and Exchange Commission.
2 Adapted from Home Depot’s 10-K filing with the Securities and Exchange Commission.