Presentation on theme: "Accounting for Merchandising Businesses"— Presentation transcript:
1 Accounting for Merchandising Businesses Chapter FourAccounting for Merchandising BusinessesPrevious chapters have discussed accounting for service businesses. These businesses obtain revenue by providing some kind of service. This chapter introduces accounting practices for merchandising businesses.
2 InventoryInventory is tangible property that is held for resale or will be used in producing goods or services.Inventory is reported on the balance sheet as an asset.Types of inventory:Merchandise inventoryRaw materials inventoryWork in process inventoryFinished goods inventorymanufacturer
3 Inventory CostThe cost principle requires that inventory be recorded for the price paid or the consideration given up.What type of transaction is the purchase of inventory?Asset Exchange if cash paid.Asset Source if “on account”.
4 Inventory Cost The amount recorded for inventory should include: Invoice price (minus purchase discounts), transportation-in costs (also called “freight-in”), inspection costs, and preparation costs.The company should accumulate costs of purchases until raw materials are ready for use or until merchandise is ready for shipment to customers.
5 Income Statement Change Because of Cost of Goods Sold, the format for the Income Statement is modified:Net Sales ,500Less: Cost of goods sold ,000Gross Profit Margin ,500The difference between sales revenue and cost of goods sold is called gross margin or gross profit. Selling and administrative expenses are subtracted from gross margin to arrive at net income.
6 Product Costs Versus Selling and Administrative Costs Costs that are included in inventory.Selling & Admin. CostsCosts that are not included in inventory. They are sometimes called period costs.Part IInventory costs are shown on the balance sheet in an asset account named Merchandise Inventory. Inventory costs are frequently called product costs. Examples of inventory costs include the price of the goods purchased, shipping and handling costs, transit insurance, and storage costs.Part IICosts that are not included in inventory are usually called selling and administrative costs or period costs. Examples of period costs include advertising, administrative salaries, sales commissions, insurance and interest.
7 Cost of Goods SoldCost of goods sold is calculated as the number of units sold during the period multiplied by their unit costs.Cost of goods sold is a major expense item for most non-service businesses.The measurement of cost of goods sold is an excellent example of the application of the matching principle Why?The Cost of Goods Sold EXPENSE is recorded in the period the units are SOLD (REVENUE is recognized), regardless of when the units are paid for. So, the EXPENSE is MATCHED against the related REVENUE.
8 Cost of Goods Sold Beginning inventory Add: Purchases (net) Cost of Goods Available for SaleDeduct: Ending inventoryCost of goods soldCost of Goods Available for Sale expresses the total cost of what has been available for sale throughout a given time period.
9 Allocation of Inventory Cost Between Asset and Expense Accounts Cost of Goods Available for SaleMerchandise Inventory (Balance Sheet)Cost of Goods Sold (Income Statement)Part IThe amount of inventory that is available for sale during a specific accounting period is calculated as beginning inventory plus purchases.Part IIThe cost of goods available for sale is allocated between the asset account Merchandise Inventory and an expense account called Cost of Goods Sold. The Merchandise Inventory account reports the cost of inventory items that have not been sold during the period. The cost of items sold is reported in the expense account, Cost of Goods Sold.5-99
10 Purchase $4,000 of Office Supplies Date Account Title Debit CreditJan. 6 Supplies 4,000Cash ,000Post from General Journal to the General LedgerSuppliesCash4,0004,000
11 Record use of $3,000 of Supplies $1,000 of Supplies left over at the end of the monthDate Account Title Debit CreditJan. 30 Supplies Expense 3,000Supplies ,000Record use of $3,000 of SuppliesPost from General Journal to the General LedgerSupplies ExpenseSupplies3,0003,000
12 Purchase 1,000 units of Inventory for $4,000 Date Account Title Debit CreditJan. 6 Inventory 4,000Cash ,000Purchase 1,000 $4.00 eachPost from General Journal to the General LedgerInventoryCash4,0004,000
13 Record sale of 750 units of Inventory $1,000 of Inventory left over at the end of the monthDate Account Title Debit CreditJan. 30 Cost of Goods Sold 3,000Inventory ,000Record sale of 750 units of InventoryPost from General Journal to the General LedgerCost of Goods SoldInventory3,0003,000
14 Record sale of Inventory @ $10 each $3,000 of Inventory was sold for $7,500 CashDate Account Title Debit CreditJan. 30 Cash ,500Revenue ,500Record sale of $10 eachPost from General Journal to the General LedgerCashSales Revenue7,5007,500
15 Cash DiscountsA deduction from the invoice price granted to induce early payment of the amount due.TermsTimeDueDiscount PeriodFull amountless discountCredit PeriodFull amount duePurchase or SaleCash discounts are a deduction from the invoice price granted to induce early payment of the amount due.If payment is made within the discount period, a reduction is given. If payment is not made within the discount period, the full amount of the invoice is due.
16 Terms of Sales & Purchases Discount Terms: 2/10, n/30 (for example)2% discount if balance paid in ten days,remainder to be paid within 30 days of saletells when and how much must be paidThere is a high interest cost of not taking purchase discounts when offered.
17 2/10, n/30 Cash Discounts Percentage of Discount Cash discount terms are typically written as this slide shows. This particular discount term would be read as “two ten net thirty.”The first number represents the discount percentage.The second number represents the discount period.The letter “n” stands for the word net.The last number represents the entire credit period.In this case, if the customer pays within 10 days, then a 2% discount may be taken. If not, then all of the amount is due within 30 days.Percentage of Discount# of Days Discount Is AvailableOtherwise, the Full Amount Is Due# of Days when Full Amount Is Due
18 Terms of Sales & Purchases F. O. B. (Free On Board) shipping point or F.O.B. destinationtells who pays for the shipping and when ownership “title” passes from the seller to the buyer.Transportation costs are sometimes included in the cost of merchandise inventory. For example, when buyers pay transportation costs to get merchandise inventory to them, the transportation costs are included in the merchandise inventory cost.F O B terms designate when title passes and who pays the transportation cost. F O B stands for Free On Board. So, if the shipping terms are Free On Board shipping point, that means that ownership transfers from the seller to the buyer when the seller provides the goods to the carrier. It also means that the buyer will pay the transportation cost.On the other hand, if the shipping terms are Free On Board destination, that means that ownership transfers from the seller to the buyer when the buyer receives the goods. It also means that seller will pay the transportation cost.So, if goods are shipped F O B shipping point, then the buyer owns the goods in transit and will pay the transportation costs. This transportation cost will be added to the Merchandise Inventory account.
19 FOB Shipping and FOB Destination FOB Shipping Point: Buyer pays the shipping costs because ownership “title” transfers to buyer at the point the shipment starts on its journey.FOB Destination: Seller pays shipping costs because title does not transfer to the buyer until the goods reach their destination (the buyer’s place of business).
20 Who Pays for FOB? Supplier Destination Business Customer Shipping PointSupplierDestination –Supplier paysDestinationBusinessShipping Pt – Business paysShipping PointDestination –Business paysDestinationShipping Pt –Customer paysCustomer
21 Purchased 1000 units for $4 each on account. (Terms: 2/10, n/30) Asset SourceTransactionLet’s see how a perpetual inventory system works by looking at the following transactions.
23 Paid a trucking company $500 to deliver the purchased units to our warehouse. Freight charges paid to get inventory to our place of business (called TRANSPORTATION IN) is part of the cost of the purchase. It is added to the Inventory account, thus increasing the asset value. It is NOT “expensed”.Recall that shipping costs incurred for inventory are product costs and are recorded as part of the inventory asset account.Asset ExchangeTransaction
27 What is the cost of each item in inventory? 3b. Record the Cost of the Goods Sold and their removal from inventory.What is the cost of each item in inventory?$4.00 invoice price + $0.50 transportation= $4.50 per unit$500 transport / 1000 units620 units sold x $4.50 cost each = $2790Group Work ex 5-4
28 620 units sold x $4.50 cost each = $2790 3b. Record the Cost of the Goods Sold and their removal from inventory.620 units sold x $4.50 cost each = $2790Cost of goods soldGroup Work ex 5-4Asset UseTransaction
29 3b. Journalize and Post the cost of the sale. Group Work exercise 5-4
30 4. The customer in Transaction #3A returned 20 units for credit. 4a. Remove the previously recorded Sales Revenue and related Account Receivable.A separate “Sales Return” contra-revenue account may be used.$6 sales price x 20 units = $120Asset UseTransaction
32 4b. Put the cost of the 20 returned units back into inventory and out of Cost of Goods Sold. (Recall, the units were “costed out” of inventory and charged to Cost of Goods Sold at $4.50 each in Tr. #3b.)Reduction in “Cost of Goods Sold”.$4.50 x 20 units = $90Asset SourceTransaction
33 4b. Journalize and Post the return to inventory.
34 5a. The Transaction #3a customer paid within the ten day discount period. Record the Sales Discount. (1/10, n/30)Original Account Receivable (Transaction 3a) $3,720Less: Sales Return (Transaction 4a)Amount owed by customer before discount 3,600x 1% sales discount %Sales Discount $Asset SourceTransaction
36 5b. The Transaction #3a customer paid within the ten day discount period Record the cash collection.Original Account Receivable (Transaction 3a) $3,720Less: Sales Return (Transaction 4a) (120)Less: Sales Discount (Transaction 5a) (36)Cash receipt that will satisfy the account $3,564Asset ExchangeTransaction
38 Returned 50 units to our supplier who granted us credit for the cost of the items but not for any transportation costs.Supplier cost was $4.00 per unit x 50 = $200. Transportation cost recorded when units were purchased was $0.50 per unit x 50 = $25.Technically, this LOSS should be reported in the operating expense section of the income statement. However, this loss is usually NOT MATERIAL, so most companies record it as an increase in the COST OF GOODS SOLD expense account.That’s what we’ll do here.
39 6. Returned 50 units to our supplier who granted us credit for the cost of the items but not for any transportation costs.
40 7. A physical inventory count shows 340 units on-hand, indicating 10 units have been lost. Units in Beginning Inventory+ Units Purchased this period ( purchase returns)= Units Available for SaleUnits Sold (620 – 20 sales returns) (600)= Units that should be in ending inventoryActual ending inventory from count (340)= Units missingx $4.50 cost per unit $45.00
41 7. A physical inventory count shows 340 units on-hand, indicating 10 units have been lost. Technically, this LOSS should be reported in the operating expense section of the income statement. However, this loss is usually NOT MATERIAL, so most companies record it as an increase in the COST OF GOODS SOLD expense account.That’s what we’ll do here.
42 7. A physical inventory count shows 340 units on-hand, indicating 10 units have been lost.
43 8a. Paid within discount period, so record the % discount on the $4000 Tran. #1 purchase less $200 Tran. #6 return.Purchase (Transaction #1) $4000Less Purchase Return (Trans. #6)Amount owedX discount % %Amount of Purchase Discount $ 76This reduces the cost of the inventory and the amount we owe the supplier.
44 8a. Paid within discount period, so record the discount on the $4000 Tr. #1 purchase less $200 Tr. #6 return.
45 8b. Paid the remaining balance on the Transaction #1 inventory purchase. $4000 purchase (Trans. #1) purchase return (Trans. #6) purchase discount (Trans. #8a) $3724 remainder to pay supplier
46 8b. Paid the remaining balance on the Transaction #1 inventory purchase. ($4000-200-76=$3724 to pay)
47 9. The Sale recorded in Transaction #3a was made with terms of F. O. B 9. The Sale recorded in Transaction #3a was made with terms of F.O.B. destination Record payment of the $340 shipping cost.Transportation charges on PURCHASES are added to the cost of the asset, INVENTORY. (Transportation IN)Transportation charges to ship products TO CUSTOMERS are reported as operating expenses on the income statement. The appropriate account title is TRANSPORTATION OUT (or FREIGHT OUT or SHIPPING EXPENSE).
48 9. The Sale recorded in Transaction #3a was made with terms of F. O. B 9. The Sale recorded in Transaction #3a was made with terms of F.O.B. destination. Record payment of the $340 shipping cost.
49 Clock Company Ending Balances of LEDGER Accounts
50 Transaction AnalysisThe following selected events occurred during 2004 at Clock Company which uses the PERPETUAL INVENTORY SYSTEM.For each event:Determine the effect on the financial statements.Record the event in the journal and ledger.
51 Lost, Damaged, or Stolen Inventory Most merchandise companies experience some level of inventory shrinkage, a term that reflects decreases in inventory for reasons other than sales to customers.Most merchandise companies experience some level of inventory shrinkage, a term that reflects decreases in inventory for reasons other than sales to customers.
52 Lost, Damaged, or Stolen Inventory Assume a company determined that $500 of inventory was lost through shrinkage. Here is how it would effect the statements:Part IAssume a company determined $500 of inventory was lost through shrinkage. Here is how it would effect the statements: Assets would decrease $500 and equity would decrease $500.Part IIIn general journal form, the entry would be debit Inventory Loss (or Cost of Goods Sold) and credit Inventory for $500.Part IIITheoretically, inventory losses are operating expenses. However, because such losses are normally immaterial in amount, they are usually added to cost of goods sold for external reporting purposes.In general journal form, the entry is as follows:
53 Timing is EVERYTHING... Recognize revenue when “earned” earned when an exchange (seller to buyer) occursThree levels of the matching principleProduct costs (e.g., inventory costs): assets until produce revenuedirect cause & effect relationship between revenue and expensePeriod costs: systematic & rational allocatione.g., depreciation costsPeriod costs: recognize as expense as incurrede.g., advertising costs
54 Perpetual Inventory Systems The inventory account is continuously updated for the following events:PurchasesPurchase Discounts TakenPurchase Returns & AllowancesSales (remove from inventory the COST of the units sold)Sales Returns (add to inventory the COST of units returned)The necessary detailed record-keeping required by the perpetual system has become much easier with current computer technology.A physical count of the inventory is still required at the end of the accounting period to assure accurate inventory records in case of errors or theft.Most modern companies maintain their inventory records using the perpetual inventory system. This inventory system adjusts the inventory account perpetually (continually) throughout the accounting period for each purchase or sale of inventory.
55 Perpetual Inventory Systems Cost of Goods Sold . . .Contains the cost of units that have been sold to customers.Is a temporary account.(It will be closed out atthe end of the period.)Is an expense account.
56 Periodic Inventory System Separate Accounts Used Let’s look at another Inventory system.Periodic Inventory System Separate Accounts UsedWhen using the Periodic system, inventory transactions are not recorded directly in the INVENTORY account. Instead, separate accounts are used forPURCHASESPURCHASE RETURNS & ALLOWANCESPURCHASE DISCOUNTSTRANSPORTATION INIn certain businesses, it is impractical to maintain perpetual inventory records. A periodic inventory system provides an alternative procedure for recording inventory purchases and sales.In a periodic system, purchases of inventory are recorded in a Purchases account. Other inventory-related transactions, such as transportation-in and purchase discounts, returns, and allowances are recorded in separate temporary accounts.Ending inventory is determined by a year-end physical account, and cost of goods sold is calculated using a Schedule of Cost of Goods Sold.
57 Periodic Inventory Systems Because entries are not made to the inventory account during the accounting period, the amount of inventory is not known until the end of the period when the inventory count is done.The PERIODIC system is being used less and less due to advancements in technology that make the extra record keeping of the perpetual system easy and inexpensive.Periodic inventory systems require more closing entries at the end of the period. (Purchases, Purchase Returns and Allowances, Purchase Discounts, and Transportation In are all separate TEMPORARY accounts that must be closed out at the end of the period.)The Cost of Goods Sold schedule is used for internal purposes only! It is not shown on the financial statements. Cost of goods sold is reported as one line on the income statement, just as it would be in a perpetual system.
58 Periodic Inventory System Purchases and Purchase Returns and Allowances Purchases is an account that holds the current period’s inventory purchases (a debit balance) and is used in the calculation of Cost of Goods Sold on the Income Statement.The Purchase Returns and Allowances account also is used to calculate Cost of Goods Sold on the income statement. It is a deduction from the cost of purchases in a periodic inventory system.Bar codes/scanners
59 Periodic Inventory System Purchase Discounts When using the Periodic system Purchase Discounts are recorded in a separate account. This helps managers keep track of the company’s performance in taking advantage of discounts.
60 Periodic Inventory Systems The ending inventory is determined at the end of the period by taking a physical count of the goods remaining on hand.Cost of goods sold is calculated at the end of the accounting period by subtracting the ending inventory (determined from the physical count) from the Cost of Goods Available for Sale.Beginning Inventory $ Purchases, net= Goods Available for SaleEnding Inv. (from count)= Cost of Goods Sold $1900
61 Gross Margin Percentage This measure indicates how muchof each sales dollar is left after deducting the cost of goods sold to cover expenses and provide a profit.Gross MarginNet SalesThe gross margin percentage indicates how much of each sales dollar is left after deducting the cost of goods sold to cover expenses and provide a profit.It is calculated as gross margin divided by net sales.Other things being equal, the company with the higher gross margin percentage is pricing its products higher.Other things being equal, the company with the higher gross margin percentage is pricing its products higher.
62 Ratios: Gross Margin Percentage Gross margin as a percent of salesNet sales – CGS gross marginNet sales net sales=Net sales = $1, Each Dollar of Sales contributes $.60 (600 / 1,000) to theCGS = (400) Gross Margin (profit before GS & A expenses).GM = $ 600
63 Ratios: Gross Margin Percentage Net sales – CGS = $1,000 – 400Net sales $1,000= $600___ = % or $.60$1,000This tells us that each dollar of salescontributes 60 cents to theGross Margin.Net sales = $1, Each Dollar of Sales contributes $.60 (600 / 1,000) to theCGS = (400) Gross Margin (profit before GS & A expenses).GM = $ 600
64 Return on Sales Net Income Net Sales Net income expressed as a percentage of sales provides insight as to how much of each sales dollar is left as net income after all expenses are paid.Net IncomeNet SalesIn practice, the net income percentage is frequently called the return on sales ratio.Return on sales expresses net income as a percentage of sales and provides insight as to how much of each sales dollar is left as net income after all expenses are paid.It is calculated as net income divided by net sales.Other things being equal, the company with the higher return on sales percentage is doing a better job of controlling costs.Other things being equal, the company with the higher return on sales percentage is doing a better job of controlling costs.
65 Ratios: Return on sales Net incomeNet salesRevenues - expensesNet Income = $500 Net Sales = $1,000Each dollar of Sales generates $.50 (500 / 1,000) of net income
66 Ratios: Return on sales Net income =Net sales$500___ = 50% or $.50$1,000Each dollar of sales is generating 50 cents of Net IncomeNet Income = $500 Net Sales = $1,000Each dollar of Sales generates $.50 (500 / 1,000) of net income
67 Income Statement Formats Single Step -with detailscondensedMulti-step -with detailscondensedLet’s look at examples…..
68 Income Statement Formats Multi-step with detailsMulti-step: condensedNet SalesLess: Cost of goods soldGross Profit MarginOperating Expenses:Selling:Sales SalariesAdvertisingTotal SellingAdministrative:Admin. SalariesBuilding RentTotal Adm. ExpTotal Operating ExpOperating Income 19Non-Operating Rev. (Exp.)Interest Expense (1)Income before tax 18Income Tax expense 3Net IncomeNet SalesLess: Cost of goods SoldGross Profit MarginOperating Expenses:Selling ExpensesAdministrative ExpTotal Operating Exp Operating IncomeNon-Operating Rev. (Exp.)Interest Expense (1)Income before tax 18Income Tax expenseNet IncomeNotice that a multistep income statement is more informative than one which simply subtracts expenses from revenues. Income statements that display a single comparison of total revenues and total expenses are called single-step income statements.A multistep income statement separates cost of goods sold from other expenses in order to show the company’s gross margin. Also note that operating income is reported separately from net income. Nonoperating items, which include interest revenue or expenses and gains or losses on the sale of assets, are reported after operating income to arrive at net income.
69 Income Statement Formats The multi-step INCOME Statement format classifies interest as a NON-operating item. But, interest is still an OPERATING ACTIVITY on the CASHFLOW Statement.Multi-step with detailsMulti-step: condensedNet SalesLess: Cost of goods soldGross Profit MarginOperating Expenses:Selling:Sales SalariesAdvertisingTotal SellingAdministrative:Admin. SalariesBuilding RentTotal Adm. ExpTotal Operating ExpOperating Income 19Non-Operating Rev. (Exp.)Interest Expense (1)Income before tax 18Income Tax expense 3Net IncomeNet SalesLess: Cost of goods SoldGross Profit MarginOperating Expenses:Selling ExpensesAdministrative ExpTotal Operating Exp Operating IncomeNon-Operating Rev. (Exp.)Interest Expense (1)Income before tax 18Income Tax expenseNet Income
70 Income Statement Formats Single-step with detailsSingle-step: condensedNet SalesLess Expenses:Cost of goods sold 60SellingAdministrativeInterest ExpenseIncome Tax Expense 3Total ExpensesNet Income 15Net SalesLess Expenses:Cost of goods soldSales SalariesAdvertisingAdmin. SalariesBuilding RentInterest ExpenseIncome Tax Expense 3Total ExpensesNet Income
71 Income Statement Formats Single-step with detailsSingle-step: condensedA common modification of the single-step method is to have the income tax expense separated out.Net SalesLess Operating Exp.Cost of goods soldSales SalariesAdvertisingAdmin. SalariesBuilding RentInterest ExpenseTotal Oper. ExpIncome before taxesIncome Tax ExpenseNet IncomeNet SalesLess Expenses:Cost of goods sold 60SellingAdministrativeTotal Oper. ExpIncome before taxesIncome Tax ExpenseNet Income
72 Common-size Income Statement Each item on the income statement is expressed as a % of that year’s Net Sales.Comparisons are made to:BudgetPrevious year(s)Competitors%Net Sales- Cost=G.P
73 Comparative Common-size Income Statements Net Sales $3, $2,000Cost of Goods Sold , ,200Gross Profit ,Operating Expenses:Selling ExpensesAdministrative ExpTotal Oper. Exp ,Net Income ($300) $100% of N.Sales100.0% of N.Sales100.0
74 Comparative Common-size Income Statements Net Sales $3, $2,000Cost of Goods Sold , ,200Gross Profit ,Operating Expenses:Selling ExpensesAdministrative ExpTotal Oper. Exp ,Net Income ($300) $100% of N.Sales100.066.733.320.023.343.3(10.0)% of N.Sales100.060.040.020.015.035.05.0This exhibit contains 2012 and 2013 income statements. These are called common size financial statements. In common size income statements, all items on the income statement are stated as a percentage of net sales.Express the percent column as dollar and cents. (It makes more sense that way). So, for 2013, for every $1.00 of sales, we spent $0.60 on inventory and $0.15 on Administrative expenses.In 2013, for every $1.00 in sales, we spent $0.667 on inventory as well as 23.3 cents for Administrative expenses. Even though more were spent on Selling expenses, it was still $.20 for every dollar of sales earned. This tells me that higher inventory cost decreased our profitability in 2013 (probably explains some of the increase in sales). Also, Administrative expenses increased at a faster pace compared to These two factors contributed to a loss in Since Sales stayed at $0.20 for every dollar earned, it did not contribute to the loss in 2013.
75 Income Statement Trend Analysis Trend Analysis shows both Dollar and % changes from one year to the next year for each item on the income statement.Example:From 2012 to 2013 Net Sales increasedfrom $2,000 to $3,000. So……Net Sales increased $1,000 which is a 50% increase over 2012 Net Sales.($1,000 incr./$2,000 Net Sales of 2012 = 50%)
76 Income Statement Trend Analysis Net Sales $3,000 $2,000Cost of Goods Sold , ,200Gross Profit ,Operating Expenses:Selling ExpensesAdministrative ExpTotal Oper. Exp ,Net Income ($300) $100$ inc.(dec.)$1,000800200400600($400)% inc.(dec)50.066.725.0133.385.7(400.0)
77 How about analyzing the Balance Sheet? The same techniques are used to analyze the Balance Sheet.Common-size Analysis:Use the TOTAL ASSETS amount as the 100% figure. So, …….. Express each Balance Sheet item as a % of Total Assets.Trend Analysis:Same approach as used on the income statement.1. Calculate the $ change for each bal. sheet item Express the $ change as a % of the previousyear’s (or base year’s) amount.
78 End of Chapter 4 Remember, Your objectives are to understand what you are doing and to be able to analyze the financial information.Memorization without understandingis meaningless!