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5-1 MERCHANDISING OPERATIONS AND THE MULTIPLE-STEP INCOME STATEMENT Financial Accounting, Sixth Edition 5.

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Presentation on theme: "5-1 MERCHANDISING OPERATIONS AND THE MULTIPLE-STEP INCOME STATEMENT Financial Accounting, Sixth Edition 5."— Presentation transcript:

1 5-1 MERCHANDISING OPERATIONS AND THE MULTIPLE-STEP INCOME STATEMENT Financial Accounting, Sixth Edition 5

2 Identify the differences between a service company and a merchandising company Explain the recording of purchases under a perpetual inventory system Explain the recording of sales revenues under a perpetual inventory system Distinguish between a single-step and a multiple-step income statement Determine cost of goods sold under a periodic system Explain the factors affecting profitability. Study Objectives

3 5-3 Merchandising Operations SO 1 Identify the differences between service and merchandising companies. Merchandising Companies Buy and Sell Goods WholesalerRetailerConsumer The primary source of revenues is referred to as sales revenue or sales.

4 5-4 Merchandising Operations SO 1 Identify the differences between service and merchandising companies. Income Measurement Cost of goods sold is the total cost of merchandise sold during the period. Not used in a Service business. Net Income (Loss) Less Equals Sales Revenue Cost of Goods Sold Gross Profit Operating Expenses Illustration 5-1 Income measurement process for a merchandising company

5 5-5 The operating cycle of a merchandising company ordinarily is longer than that of a service company. Illustration 5-2 SO 1 Identify the differences between service and merchandising companies. Operating Cycles Merchandising Operations

6 5-6 Flow of Costs Companies use either a perpetual inventory system or a periodic inventory system to account for inventory. SO 1 Identify the differences between service and merchandising companies. Merchandising Operations Illustration 5-3

7 5-7 Perpetual System SO 1 Identify the differences between service and merchandising companies. Merchandising Operations  Maintain detailed records of the cost of each inventory purchase and sale.  Records continuously show inventory that should be on hand.  Company determines cost of goods sold each time a sale occurs. Flow of Costs

8 5-8 Periodic System  Do not keep detailed records of the goods on hand.  Cost of goods sold determined by count at the end of the accounting period.  Calculation of Cost of Goods Sold: Beginning inventory$ 100,000 Add: Purchases, net800,000 Goods available for sale900,000 Less: Ending inventory125,000 Cost of goods sold$ 775,000 SO 1 Merchandising Operations Flow of Costs

9 5-9 Additional Consideration Perpetual System: ► Traditionally used for merchandise with high unit values. ► Provides better control over inventories. ► Requires additional clerical work and additional cost to maintain inventory records.  Easier now with bar codes and inexpensive software. SO 1 Identify the differences between service and merchandising companies. Merchandising Operations Flow of Costs

10 5-10  Made either cash or credit (on account). Recording Purchases of Merchandise SO 2 Explain the recording of purchases under a perpetual inventory system. Illustration 5-5  Normally recorded when goods are received.  Purchase invoice should support each credit purchase.

11 5-11 Illustration: Sauk Stereo (the buyer) uses as a purchase invoice the sales invoice prepared by PW Audio Supply, Inc. (the seller). Prepare the journal entry for Sauk Stereo for the invoice from PW Audio Supply. Inventory3,800May 4 Accounts payable 3,800 SO 2 Explain the recording of purchases under a perpetual inventory system. Recording Purchases of Merchandise Illustration 5-5

12 5-12 Illustration 5-6 Shipping terms Ownership of the goods passes to the buyer when the public carrier accepts the goods from the seller. Ownership of the goods remains with the seller until the goods reach the buyer. Recording Purchases of Merchandise Freight Costs – Terms of Sale Freight costs incurred by the seller are an operating expense.

13 5-13 Illustration: Assume upon delivery of the goods on May 6, Sauk Stereo pays Haul-It Freight Company $150 for freight charges, the entry on Sauk Stereo’s books is: Inventory150May 6 Cash 150 Recording Purchases of Merchandise SO 2 Explain the recording of purchases under a perpetual inventory system. Assume the freight terms on the invoice in Illustration 5-5 had required PW Audio Supply to pay the freight charges, the entry by PW Audio Supply would have been: Freight-out 150May 4 Cash 150

14 5-14 Purchaser may be dissatisfied because goods are damaged or defective, of inferior quality, or do not meet specifications. Purchase Returns and Allowances Recording Purchases of Merchandise Return goods for credit if the sale was made on credit, or for a cash refund if the purchase was for cash. May choose to keep the merchandise if the seller will grant an allowance (deduction) from the purchase price. Purchase Return Purchase Allowance SO 2 Explain the recording of purchases under a perpetual inventory system.

15 5-15 Recording Purchases of Merchandise SO 2 Explain the recording of purchases under a perpetual inventory system. Illustration: Assume that on May 8 Sauk Stereo returned to PW Audio Supply goods costing $300. Accounts payable300May 8 Inventory 300

16 5-16 Credit terms may permit buyer to claim a cash discount for prompt payment. Advantages:  Purchaser saves money.  Seller shortens the operating cycle. Purchase Discounts Recording Purchases of Merchandise Example: Credit terms may read 2/10, n/30. 2% cash discount offered if payment is made within 10 days of invoice date; otherwise full (net) amount is due within 30 days. SO 2 Explain the recording of purchases under a perpetual inventory system.

17 5-17 Accounts payable3,500May 14 Cash 3,430 Recording Purchases of Merchandise Inventory 70 (Discount = $3,500 x 2% = $70) SO 2 Explain the recording of purchases under a perpetual inventory system. Illustration: Assume Sauk Stereo pays the balance due of $3,500 (gross invoice price of $3,800 less purchase returns and allowances of $300) on May 14, the last day of the discount period. Prepare the journal entry Sauk Stereo makes to record its May 14 payment.

18 5-18 Accounts payable3,500June 3 Recording Purchases of Merchandise Cash 3,500 SO 2 Explain the recording of purchases under a perpetual inventory system. Illustration: If Sauk Stereo failed to take the discount, and instead made full payment of $3,500 on June 3, the journal entry would be:

19 5-19 Should discounts be taken when offered? Purchase Discounts Recording Purchases of Merchandise Example: 2% for 20 days = Annual rate of 36.5% (365/20 = twenty-day periods x 2% = 36.5%) SO 2 Explain the recording of purchases under a perpetual inventory system.

20 5-20 $3,5008 th - Return$300 Balance 4 th - Purchase $3, th - Discount Recording Purchases of Merchandise Summary of Purchasing Transactions 1506 th – Freight-in SO 2 Explain the recording of purchases under a perpetual inventory system.

21 5-21  Made using cash or credit (on account). Illustration 5-5  Normally recorded when earned, usually when goods transfer from seller to buyer.  Sales invoice should support each credit sale. Recording Sales of Merchandise SO 3 Explain the recording of sales revenues under a perpetual inventory system.

22 5-22 Journal Entries to Record a Sale Cash or Accounts receivableXXX Sales revenue XXX Recording Sales of Merchandise SO 3 Explain the recording of sales revenues under a perpetual inventory system. #1 Cost of goods soldYYY Inventory YYY #2 Selling Price Cost

23 5-23 Recording Sales of Merchandise SO 3 Explain the recording of sales revenues under a perpetual inventory system. Accounts receivable3,800May 4 Sales revenue 3,800 Illustration: Assume PW Audio Supply records its May 4 sale of $3,800 to Sauk Stereo on account (Illustration 5-5) as follows. Assume the merchandise cost PW Audio Supply $2,400. Cost of goods sold2,4004 Inventory 2,400

24 5-24  “Flipside” of purchase returns and allowances.  Contra-revenue account (debit).  Sales not reduced (debited) because: ► Would obscure importance of sales returns and allowances as a percentage of sales. ► Could distort comparisons. Sales Returns and Allowances Recording Sales of Merchandise SO 3 Explain the recording of sales revenues under a perpetual inventory system.

25 5-25 Illustration: Prepare the entry PW Audio Supply would make to record the credit for returned goods that had a $300 selling price (assume a $140 cost). Assume the goods were not defective. Recording Sales of Merchandise SO 3 Explain the recording of sales revenues under a perpetual inventory system. Sales returns and allowances 300May 8 Accounts receivable300 Inventory 1408 Cost of goods sold140

26 5-26 Recording Sales of Merchandise SO 3 Explain the recording of sales revenues under a perpetual inventory system. Sales returns and allowances 300May 8 Accounts receivable300 Inventory 508 Cost of goods sold50 Illustration: Assume the returned goods were defective and had a scrap value of $50, PW Audio would make the following entries:

27 5-27  Offered to customers to promote prompt payment.  “Flipside” of purchase discount.  Contra-revenue account (debit). Sales Discount Recording Sales of Merchandise SO 3 Explain the recording of sales revenues under a perpetual inventory system.

28 5-28 Recording Sales of Merchandise SO 3 Explain the recording of sales revenues under a perpetual inventory system. Cash3,430May 14 Accounts receivable3,500 Sales discounts70 * [($3,800 – $300) X 98%] * Illustration: Assume Sauk Stereo pays the balance due of $3,500 (gross invoice price of $3,800 less purchase returns and allowances of $300) on May 14, the last day of the discount period. Prepare the journal entry PW Audio Supply makes to record the receipt on May 14.

29 5-29  Subtract total expenses from total revenues  Two reasons for using the single-step format: 1) Conceptually the company does not realize any type of profit until total revenues exceed total expenses. 2) Format is simpler and easier to read. Single-Step Income Statement Income Statement Presentation SO 4 Distinguish between a single-step and a multiple-step income statement.

30 5-30 Illustration 5-7 SO 4 Income Statement Presentation Single- Step

31 5-31  Highlights the components of net income.  Three important line items: 1) gross profit, 2) income from operations, and 3) net income. SO 4 Distinguish between a single-step and a multiple-step income statement. Income Statement Presentation Multiple-Step Income Statement

32 5-32 Illustration 5-8 SO 4 Income Statement Presentation Multiple- Step Key Line Items

33 5-33 Sales Revenues Income Statement Presentation SO 4 Distinguish between a single-step and a multiple-step income statement. Illustration 5-9

34 5-34 Income Statement Presentation SO 4 Distinguish between a single-step and a multiple-step income statement. Illustration 5-11 Comparisons with past amounts and rates and with those in the industry indicate the effectiveness of a company’s purchasing and pricing policies. Gross Profit

35 5-35 Income Statement Presentation Illustration 5-11 Operating Expenses

36 5-36 Income Statement Presentation SO 4 Distinguish between a single-step and a multiple-step income statement. Nonoperating Activities Various revenues and expenses and gains and losses that are unrelated to the company’s main line of operations. Illustration 5-10

37 5-37 Illustration 5-11 Income Statement Presentation

38 5-38  No running account of changes in inventory.  Ending inventory determined by physical count.  Cost of goods sold not determined until the end of the period. SO 5 Determine cost of goods sold under a periodic system. Determining Cost of Goods Sold Under a Periodic System Income Statement Presentation

39 5-39 SO 5 Income Statement Presentation Determining Cost of Goods Sold Under a Periodic System Illustration 5-13 Cost of goods sold for a merchandiser using a periodic inventory system

40 5-40 Evaluating Profitability May be expressed as a percentage by dividing the amount of gross profit by net sales. SO 6 Explain the factors affecting profitability. Gross Profit Rate A decline in the gross profit rate might have several causes. ► Selling products with a lower “markup.” ► Increased competition may result in a lower selling price. ► Company forced to pay higher prices to its suppliers without being able to pass these costs on to its customers.

41 5-41 Evaluating Profitability SO 6 Explain the factors affecting profitability. Illustration 5-15 Why does Wal-Mart have a lower gross profit rate than Target and the industry average? Gross Profit Rate

42 5-42 Evaluating Profitability Measures the percentage of each dollar of sales that results in net income. SO 6 Explain the factors affecting profitability. Profit Margin Ratio How do the gross profit rate and profit margin ratio differ? ► Gross profit rate - measures the margin by which selling price exceeds cost of goods sold. ► Profit margin ratio - measures the extent by which selling price covers all expenses (including cost of goods sold).

43 5-43 Evaluating Profitability SO 6 Explain the factors affecting profitability. Illustration 5-17 How does Wal-Mart compare to its competitors? Keep in mind that an increasing percentage of Wal-Mart’s sales is from low-margin groceries. Profit Margin Ratio


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