Merchandising Operations and the Multistep Income Statement

Merchandising Operations and the Multistep Income Statement
Chapter 6 Merchandising Operations and the Multistep Income Statement PowerPoint Author: Brandy Mackintosh, CA Chapter 6: Merchandising Operations and the Multistep Income Statement

Distinguish between service and merchandising operations.
Learning Objective 6-1 Distinguish between service and merchandising operations. Learning objective 6-1 is to distinguish between service and merchandising operations.

Operating Cycles For any company to be successful, it must complete its operating cycle efficiently. The operating cycle is a series of activities that a company undertakes to generate revenues and, ultimately, cash. This slide contrasts the operating cycles of service and merchandising companies. Service companies such as Life Time Fitness follow a simple operating cycle: sell services to customers, collect cash from them, and use that money to pay for operating expenses. Merchandising companies differ in that their cycle begins with buying products. These products, which are called Inventory, are sold to customers, which leads to collecting cash that can be used to pay operating expenses and buy more inventory.

Operating Cycles (in thousands) (in millions) Part I
The operating cycle differences that were presented in the previous slide lead to important differences in how service and merchandising companies report their financial results. This slide shows three key differences in the balance sheet and income statement of a service company (Life Time Fitness) and a merchandising company (Walmart). Part II The first difference that we see is in the balance sheet excerpts. Merchandisers report Inventory as a current asset, but service companies do not. Service companies often report Supplies, but they differ from inventory because supplies are goods acquired for internal use. Inventory consists of goods acquired for resale to customers. Part III The income statement excerpts show the remaining two differences. First of all, service companies earn revenue from services whereas merchandisers earn revenue from sales. The final difference is that merchandisers report an expense called Cost of Goods Sold, which represents the total cost of all goods sold to customers during the period. Service companies do not incur this expense because they do not sell goods. (in thousands) (in millions)

Learning Objective 6-2 Explain the differences between periodic and perpetual inventory systems. Learning objective 6-2 is to explain the differences between periodic and perpetual inventory systems.

Inventory Systems Three accounts are particularly important to a merchandiser: Inventory The merchandiser’s total cost of acquiring goods that it has not yet sold - = Gross Profit Sales Revenue Total selling price of all goods that the merchandiser did sell to customers Part I Three accounts are particularly important to a merchandiser: Inventory, Sales Revenue, and Cost of Goods Sold. Part II Inventory reports the merchandiser’s total cost of acquiring goods that it has not yet sold. Whereas Sales Revenue and Cost of Goods Sold indicate the total selling price and cost of all goods that the merchandiser did sell to customers during the period. Part IV By subtracting Cost of Goods Sold from Sales Revenue, a merchandiser determines its gross profit, which represents the profit earned before taking into account other expenses such as salaries, wages, depreciation, and so on. Before we discuss the systems for tracking changes in Inventory, Sales Revenue, and Cost of Goods Sold, you should understand a key relationship between Inventory and Cost of Goods Sold which is shown on the next slide. Cost of Goods Sold Total cost of all goods that the merchandiser did sell to customers

BI + P – EI = CGS or BI + P – CGS = EI
Inventory Systems Part I A merchandiser starts each accounting period with a stock of inventory that we will call beginning inventory (BI). During the accounting period, the cost of new purchases (P) is added to the cost of beginning inventory. As in this slide, the sum of these two amounts (BI + P) represents the cost of goods available for sale. Goods available for sale either will be sold during the period (reported as Cost of Goods Sold (CGS) on the income statement) or will remain on hand (reported as ending inventory on the balance sheet). Ending inventory for one accounting period becomes beginning inventory for the next period. Part II A cost of goods sold equation can express the relationship among these items in two ways, as given here using the numbers in this slide. Companies track these costs using either a periodic or perpetual inventory system. The equation on the left of this slide is used for a periodic inventory system and the equation on the right of this slide depicts a perpetual inventory system. We will discuss these systems on the next slide. It is important to know however, that if one of the values in the cost of goods sold equation is unknown, you can use either version of the cost of goods sold equation or the inventory T-account to solve for the missing value. BI + P – EI = CGS or BI + P – CGS = EI $4, ,200 – 6,000 = $9, $4, ,200 – 9,000 = $6,000

Periodic Inventory System
A periodic inventory system updates the inventory records for merchandise purchases, sales, and returns only at the end of the accounting period. BI + P – EI = CGS To determine how much inventory is on hand and how much inventory has been sold, periodic systems require that inventory be physically counted by the employees at the end of the period. Part I A periodic inventory system updates the inventory records for merchandise purchases, sales, and returns only at the end of the accounting period. Although simple to maintain, a major drawback of a periodic system is that accurate records of the inventory on hand and the inventory that has been sold are unavailable during the accounting period. To determine these amounts, employees must physically count the inventory, which they do at the end of the period, when the store is “closed for inventory.” Part II Based on the inventory count, the cost of ending inventory (EI) is determined and subtracted to calculate the cost of goods sold (BI + P - EI = CGS). These amounts are then used to adjust the balances for Inventories and Cost of Goods Sold.

Perpetual Inventory System
In a perpetual inventory system, the inventory records are updated “perpetually,” that is, every time inventory is bought, sold, or returned. Perpetual systems often are combined with bar codes and optical scanners. A perpetual inventory system updates inventory records every time an item is bought, sold or returned. You may not realize it, but the bar-code readers at Walmart’s checkouts serve two purposes: (1) they calculate and record the sales revenue for each product you’re buying, and (2) they remove the product and its cost from Walmart’s inventory records. Similar scanners are used back in the “employees only” part of the store, where products are unloaded from the trucks or returned to suppliers. As a result of this continuous, or “perpetual,” updating, the balances in Walmart’s Inventory and Cost of Goods Sold accounts are always up to date.

Inventory Control Periodic Inventory System Perpetual Inventory System
No Up-to-Date Records Continuous Tracking A perpetual inventory system provides the best inventory control because it’s continuous tracking of transactions allows companies to instantly determine the quantity of products on the shelves and to evaluate the amount of time they have spent there. Using this information, companies can better manage their inventory and save a great deal of money in financing and storage charges. Another benefit of a perpetual inventory system is that it allows managers to estimate shrinkage, the politically correct term for loss of inventory from theft, fraud, and error. Because a perpetual inventory system records all goods purchased and sold, the ending inventory in the company’s perpetual records indicates how many units should be on hand. This ending inventory can be calculated by the cost of goods sold equation: BI + P – CGS = EI. Notice that you can’t do this kind of detective work with a periodic inventory system because it doesn’t provide an up-to-date record of the inventory that should be on hand when you count it. Notice that even if you’re using a perpetual inventory system, you still need to count the inventory occasionally (at least yearly) to ensure the accounting records are accurate and that any shrinkage is detected. Can’t Estimate Shrinkage Can Estimate Shrinkage

Analyze purchase transactions under a perpetual inventory system.
Learning Objective 6-3 Analyze purchase transactions under a perpetual inventory system. Learning objective 6-3 is to analyze purchase transactions under a perpetual inventory system.

Recording Inventory Purchases
We will now look at the accounting for inventory purchases, as well as transportation costs, purchase returns and allowances, and purchase discounts. We will record all inventory-related transactions in the Inventory account. We will now look at the accounting for inventory purchases, as well as transportation costs, purchase returns and allowances, and purchase discounts. We will record all inventory-related transactions in the Inventory account. This approach is generally associated with a perpetual inventory system because it maintains an up-to-date balance in the Inventory account at all times. An alternative approach, which maintains separate accounts for purchases, transportation costs, and so on, is generally used in a periodic inventory system and is demonstrated in the Supplement 6A slides later in this chapter.

Walmart receives $10,500 of bikes purchased on account.
Inventory Purchases Walmart receives $10,500 of bikes purchased on account. 1 Analyze Liabilities Assets = Stockholders’ Equity + Inventory +$10,500 Accounts Payable $10,500 Part I A transaction arises when Walmart receives the inventory that was previously ordered and they are invoiced for it. Let’s look at the example where Walmart receives $10,500 of bikes purchased on account. Part II The transaction would affect the accounting equation by increasing assets by $10,500 and increasing liabilities by $10,500. Part III We would record the transaction by debiting Inventory for $10,500 and crediting Accounts Payable for $10,500. 2 Record Inventory Accounts Payable 10,500

Transportation Cost Walmart pays $400 cash to a trucker who delivers the $10,500 of bikes to one of its stores. 1 Analyze Liabilities Assets = Stockholders’ Equity + Cash $400 Inventory $400 Part I The inventory that Walmart purchases does not magically appear in its stores. It must be shipped from the supplier to Walmart. Depending on the terms of sale, the transportation cost may be paid by either Walmart or the supplier. If the terms of sale are FOB shipping point, ownership of the goods transfers to Walmart at the shipping point, so Walmart would pay the transportation cost. If the terms are FOB destination, ownership transfers at the destination, so the supplier incurs the transportation cost. Assume that Walmart pays $400 cash to a trucker who delivers the $10,500 of bikes to one of its stores. Part II This transportation cost (also called freight-in) is recorded as an addition to Walmart’s Inventory account because it is a cost Walmart incurs to obtain the inventory. In general, a purchaser should include in the Inventory account any costs needed to get the inventory into a condition and location ready for sale. The transaction would affect the accounting equation by decreasing Cash by $400 and increasing Inventory by $400. Part III We would record the transaction by debiting Inventory for $400 and crediting Cash for $400. 2 Record Inventory Cash 400

Purchase Returns and Allowances
Walmart returned some of the bikes to the supplier and received a $500 reduction in the balance owed. 1 Analyze Liabilities Assets = Stockholders’ Equity + Inventory $500 Accounts Payable $500 Part I When goods purchased from a supplier arrive in damaged condition or fail to meet specifications, the buyer can (1) return them for a full refund or (2) keep them and ask for a cost reduction, called an allowance. Either way, these purchase returns and allowances are accounted for by reducing the cost of the inventory and either recording a cash refund or by reducing the liability owed to the supplier. Assume, for example, that Walmart returned some of the bikes to the supplier and received a $500 reduction in the balance owed. Part II The transaction would affect the accounting equation by decreasing Inventory by $500 and decreasing Accounts Payable by $500. Part III We would record the transaction by debiting Accounts Payable for $500 and crediting Inventory for $500. 2 Record Accounts Payable Inventory 500

Purchase Discounts Walmart’s bike purchase for $10,500 had terms of 2/10, n/30. Recall that Walmart returned inventory costing $500 and received a $500 reduction in its Accounts Payable. Walmart paid within the discount period. 1 Analyze Liabilities Assets = Stockholders’ Equity + Cash $9,800 Inventory $200 Accounts Payable -$10,000 Part I When inventory is bought on credit, terms such as “2/10, n/30” may be specified. The “2/10” part means that if the purchaser pays by the 10th day of taking ownership of the goods, a 2 percent purchase discount can be deducted from the amount owed. The “n/30” part means that if payment is not made within the 10-day discount period, the full amount will be due 30 days after ownership transferred. Assume, for example, that Walmart’s purchase of bikes for $10,500 occurred with terms 2/10, n/30. The initial purchase would be accounted for as shown earlier, by recording a $10,500 increase in Inventory (with a debit) and a $10,500 increase in Accounts Payable (with a credit). Walmart returned inventory costing $500 and received a $500 reduction in its Accounts Payable. Consequently, Walmart owed the supplier $10,000 for the purchase. Part II Multiplying this balance by the 2 percent discount, we find that Walmart’s purchase discount is $200 (2% × $10,000 = $200), which means that Walmart has to make a payment of only $9,800 ($10,000 - $200 = $9,800) to fully satisfy its $10,000 of Accounts Payable. The transaction would affect the accounting equation by decreasing Cash by $9,800, decreasing Inventory by $200, and decreasing Accounts Payable by $10,000. Part III We would record the transaction by debiting Accounts Payable for $10,000, crediting Cash for $9,800, and crediting Inventory for $200. 2 Record Accounts Payable Cash Inventory 9,800 200 10,000

Summary of Inventory Transactions
Here you can see a summary, in table and T-account format, of how inventory transactions affect the Inventory account on the balance sheet, assuming beginning inventory was $4,800.

Analyze sales transactions under a perpetual inventory system.
Learning Objective 6-4 Analyze sales transactions under a perpetual inventory system. Learning objective 6-4 is to analyze sales transactions under a perpetual inventory system.

Recording Inventory Sales
Merchandisers earn revenues by transferring control of merchandise to a customer, either for cash or on credit. For a merchandiser who is shipping goods to a customer, the transfer of control occurs at one of two possible times: FOB shipping point —the sale is recorded when the goods leave the seller’s shipping department. FOB destination —the sale is recorded when the goods reach their destination (the customer). Part I As required by the revenue recognition principle, merchandisers record revenue when they fulfill their performance obligations by transferring control of the goods to customers. Part II For a retail merchandiser like Walmart, this transfer occurs when a customer buys and takes possession of the goods at checkout. For a wholesale merchandiser who is shipping goods to a customer, the transfer of control occurs at a time stated in the written sales agreement. The sales agreement will specify one of two possible times: FOB shipping point —the sale is recorded when the goods leave the seller’s shipping department. FOB destination —the sale is recorded when the goods reach their destination (the customer). Unless otherwise indicated, the examples in this book assume that transfer of control occurs when goods are shipped (FOB shipping point), which usually means the buyer pays for all transportation costs.

Every merchandise sale has two components, each of which requires an entry in a perpetual inventory system. Selling Price Part I Every merchandise sale has two components, and in a perpetual inventory system, each of these two components require an entry. Part II Selling price. Walmart’s sales price is recorded as an increase in Sales Revenue and a corresponding increase in either Cash (for a cash sale) or Accounts Receivable (for a sale on account). Part III Cost. The cost that Walmart incurred to initially buy the merchandise is removed from Inventory and reported as an expense called Cost of Goods Sold (CGS). Cost

Walmart sells two Schwinn mountain bikes at a selling price of $200 per bike, for a total of $400 cash. The bikes had previously been recorded in Walmart’s Inventory at a cost of $175 per bike, for a total cost of $350. 1 Analyze Liabilities Assets = Stockholders’ Equity + Cash $400 Inventory $350 Sales Revenue $400 Cost of Goods Sold -$350 2 Record Cash Sales Revenue Cost of Goods Sold Inventory 400 350 Part I Assume Walmart sells two Schwinn mountain bikes at a selling price of $200 per bike, for a total of $400 cash. The bikes had previously been recorded in Walmart’s Inventory at a cost of $175 per bike, for a total cost of $350. Part II In this transaction, Cash, an asset, increased by $400, and Sales Revenue, a subcategory of Stockholders’ Equity, increased by the same amount. Also, Inventory, an asset, decreased by $350 and Cost of Goods Sold, a subcategory of Stockholders’ Equity, increased by $350, which ultimately reduces Stockholders’ Equity. Part III The general journal entries are a debit to Cash and a credit to Sales Revenue for $400, and a debit to Cost of Goods Sold and a credit to Inventory for $350. Notice in this slide that the first part of Walmart’s journal entry involving Cash and Sales Revenue is recorded at the total selling price ($400). The second part involving Cost of Goods Sold and Inventory uses Walmart’s total cost ($350). The $50 difference between selling price and cost ($400 2 $350) is called the gross profit. Gross profit is not directly recorded in an account by itself but instead is a subtotal produced by subtracting Cost of Goods Sold from Sales Revenue on the income statement.

Sales Returns and Allowances
When goods sold to a customer arrive in damaged condition or are otherwise unsatisfactory, the customer can (1) return them for a full refund or (2) keep them and ask for a reduction in the selling price, called an allowance. When goods sold to a customer arrive in damaged condition or are otherwise unsatisfactory, the customer can (1) return them for a full refund or (2) keep them and ask for a reduction in the selling price, called an allowance. These sales returns and allowances require Walmart to revise the previously recorded sale and, in the case of returns, to revise the previously recorded inventory reduction and cost of goods sold.

Sales Returns and Allowances
Suppose that after Walmart sold the two Schwinn mountain bikes, the customer returned one to Walmart. Assuming that the bike is still like new, Walmart would refund the $200 selling price to the customer and take the bike back into inventory. 1 Analyze Liabilities Assets = Stockholders’ Equity + Cash $200 Inventory $175 Sales Returns and Allowances (+xR) -$200 Cost of Goods Sold $175 Part I Suppose that after Walmart sold the two Schwinn mountain bikes, the customer returned one to Walmart. Assuming that the bike is still like new, Walmart would refund the $200 selling price to the customer and take the bike back into inventory at its cost of $175. Part II In this transaction, Cash, an asset, decreased by $200, and Sales Returns and Allowances, a contra-revenue account, increased by the same amount which ultimately reduces stockholders’ equity. Also, Inventory, an asset, increased by $175 and Cost of Goods Sold, a subcategory of Stockholders’ Equity, decreased by $175, which ultimately increases Stockholders’ Equity. Part III The general journal entries are a debit to Sales Returns and Allowances and credit to Cash for $200, and a debit to Inventory and a credit to Cost of Goods Sold for $175. Using a contra-revenue account instead of directly reducing the Sales account allows Walmart to track the value of goods returned, providing clues about whether customers are happy with the quality and price of Walmart ’s products. 2 Record Sales Returns & Allowances (+xR) Cash Inventory Cost of Goods Sold 200 175

Sales on Account and Sales Discounts
Suppose Walmart’s warehouse store (Sam’s Club) sells printer paper on account to a local business for $1,000 with payment terms of 2/10, n/30. The paper had cost Sam’s Club $700. 1 Analyze Liabilities Assets = Stockholders’ Equity + Accounts Receivable+$1,000 Inventory $700 Sales Revenue $1,000 Cost of Goods Sold -$700 Part I Just as you saw earlier in this chapter for purchase discounts, a merchandiser can specify terms such as “2/10, n/30” to encourage customers to pay promptly for sales on account. The “2/10” means that if the customer pays by the 10th day after the sale date, a 2 percent sales discount will be deducted from the selling price. The “n/30” part implies that if payment is not made within the 10-day discount period, the full amount will be due 30 days after the date of sale. Suppose Walmart’s warehouse store (Sam’s Club) sells printer paper on account to a local business for $1,000 with payment terms of 2/10, n/30. The paper had cost Sam’s Club $700. Part II To account for this initial sale, Accounts Receivable, an asset, increases by $1,000, and Sales Revenue, a subcategory of Stockholders’ Equity, increases by the same amount. Also, Inventory, an asset, decreases by $700 and Cost of Goods Sold, a subcategory of Stockholders’ Equity, increases by $700, which ultimately reduces Stockholders’ Equity. Part III The general journal entries are a debit to Accounts Receivable and credit to Sales Revenue for $1,000, and a debit to Cost of Goods Sold and a credit to Inventory for $700. 2 Record Accounts Receivable Sales Revenue Cost of Goods Sold Inventory 1,000 700

Sales on Account and Sales Discounts
To take advantage of this 2% discount, the customer must pay Walmart within 10 days. If the customer does so, it will deduct the $20 discount (2% $1,000) from the total owed ($1,000), and then pay $980 to Walmart. 1 Analyze Liabilities Assets = Stockholders’ Equity + Cash $980 Accounts Receivable -$1,000 Sales Discounts (+xR) -$20 Part I To take advantage of the 2% discount, the customer must pay Walmart within 10 days. If the customer does so, it will deduct the $20 discount (2% times $1,000) from the total owed ($1,000), and then remit $980 cash to Walmart. Part II In this transaction, Cash, an asset, increased by $980, Accounts Receivable, an asset, decreased by $1,000, and Sales Discounts, a contra-revenue account, increased by $20, which ultimately reduces Stockholders’ Equity. Part III The general journal entry is a debit to Cash for $980, a debit to Sales Discounts for $20, and a credit to Accounts Receivable for $1,000. If the customer doesn’t pay by the end of the discount period, Walmart would not allow the customer to take a discount for early payment. Instead, the customer would have to pay the full $1,000, which Walmart would record as an increase in Cash (debit) and a decrease in Accounts Receivable (credit). 2 Record Cash Sales Discounts (+xR) Accounts Receivable 1,000 980 20 (2% × $1,000)

Summary of Sales-Related Transactions
The sales returns and allowances and sales discounts introduced in this section were recorded using contra-revenue accounts. The sales returns and allowances and sales discounts introduced in this section were recorded using contra-revenue accounts. This slide summarizes how these items are reported on an income statement prepared for internal management use. By using contra-revenue accounts, accountants and managers are able to monitor and control how sales returns, and allowances, and discounts affect the company’s business operations. For example, frequent customer returns of defective products would cause an increase in the Sales Returns and Allowances account. In response to an increase in this account, Walmart’s managers might discontinue selling the product or find a new supplier for it. Accountants rarely report sales returns, allowances, and discounts in an income statement prepared for external users because that could reveal crucial information to competitors. Instead, when preparing an income statement for external reporting purposes, accountants begin with Net Sales, as shown in a later slide.

Prepare and analyze a merchandiser’s multistep income statement.
Learning Objective 6-5 Prepare and analyze a merchandiser’s multistep income statement. Learning objective 6-5 is to prepare and analyze a merchandiser’s multistep income statement.

Multistep Income Statement
Part I To show how much profit is earned from product sales, without being clouded by other operating costs, merchandise companies often present their income statement using a multistep format. A multistep income statement is similar to what you saw in the first few chapters, with expenses being subtracted from revenues to arrive at net income. The difference is that a multistep format separates the revenues and expenses that relate to core operations from all the other (peripheral) items that affect net income. Part II For merchandisers, a key measure is the amount of profit earned over the cost of goods sold, so their multistep income statements separate Cost of Goods Sold from other expenses. As shown in this slide, this extra step produces a subtotal called gross profit, which is the profit the company earned from selling goods, over and above the cost of the goods. Part III Notice in this slide that after the gross profit line, the multistep income statement presents other items in a format similar to what you saw for a service company in Chapter 3. The category called Selling, General, and Administrative Expenses includes a variety of operating expenses such as salaries and wages, utilities, advertising, rent, and the costs of delivering merchandise to customers. These expenses are subtracted from gross profit to yield Income from Operations, which is a measure of the company’s income from regular operating activities, before considering the effects of interest, income taxes, and any nonrecurring items.

Gross Profit Analysis = × Gross Profit % Gross Profit Net Sales 100
Part I Gross profit is Net Sales minus Cost of Goods Sold. It is a subtotal, not an account. In this slide, we see that Walmart’s gross profit increased throughout the three years. The difficulty in interpreting the increasing dollars of gross profit is that Walmart also increased its net sales over these three years, so we don’t know whether the increase in gross profit dollars arises solely because Walmart increased its sales volume or whether it also is generating more profit per sale. To determine the amount of gross profit included in each dollar of sales, analysts typically evaluate the gross profit percentage. Part II The gross profit percentage is gross profit (which is Net Sales minus Cost of Goods Sold) divided by Net Sales, which is then multiplied by 100. The gross profit percentage measures the percentage of gross profit earned on each dollar of sales. A higher gross profit percentage means that the company is selling products for a greater markup over its cost. This ratio can be used to (1) analyze changes in the company’s operations over time, (2) compare one company to another, and (3) determine whether a company is earning enough on each sale to cover its operating expenses. Gross Profit % = Gross Profit Net Sales × 100

Comparing Gross Profit Percentages
Part I Be aware that gross profit percentages can vary greatly between industries and between companies in the same industry. Walmart’s gross profit percentage of 24.3 percent is characteristic of its slogan of “Saving people money so they can live better.” Walmart’s strategy is to earn a relatively small amount of profit on each dollar of sales, but to compensate by generating a huge volume of sales. In contrast, high-end department stores carry brand-name fashions with high-end prices, resulting in fewer sales, but more profit on each sale. In 2013, Macy’s reported a 40.1 percent gross profit percentage. Part II Gross profit percentages can vary across industries too. As seen in this slide, gas stations compared to florists have a much lower gross profit percentage.

Recording Inventory Transactions in a Periodic System
Supplement 6A Recording Inventory Transactions in a Periodic System Supplement 6A: Recording Inventory Transactions in a Periodic System

Record inventory transactions in a periodic system.
Learning Objective 6-S1 Record inventory transactions in a periodic system. Learning objective 6-S1 is to record inventory transactions in a periodic system.

An electronics retailer stocks and sells just one item and the following events occurred: Businesses using a periodic inventory system update inventory records only at the end of the accounting period. Unlike a perpetual inventory system, a periodic system does not track the cost of goods sold during the accounting period. This supplement illustrates typical journal entries made when using a periodic inventory system. We will record purchase and sale transactions using a periodic system and then compare the periodic systems with a perpetual system. We will record these events assuming the company uses a periodic inventory system and then compare the periodic inventory system to a perpetual inventory system.

Periodic Inventory System Perpetual Inventory System Part I In a periodic inventory system, we record purchases with a debit to Purchases, while in a perpetual inventory system, the debit is to Inventory. Otherwise the purchase entry is the same. Part II When goods are sold, we debit Accounts Receivable and credit Sales Revenue both in a periodic system and in a perpetual system. To keep the inventory balance up to date in a perpetual system, we record an additional entry to reduce the inventory when goods are sold. We debit Cost of Goods Sold and credit Inventory.

Periodic Inventory System Part I Since the Inventory account is not up to date in a periodic system, and Cost of Goods Sold has not been recorded, we need to count the Ending Inventory and use the Cost of Goods Sold equation to determine Cost of Goods Sold. Using the equations to solve for Cost of Goods Sold, we find that Cost of goods sold equals Beginning Inventory plus Purchases less Ending Inventory. ($4,800 + $10,200 - $6,000 = $9,000) Part II In the first end-of-year adjustment entry, we close the balance in the Purchases account with a credit, close the Beginning Inventory balance with a credit, and debit Cost of Goods Sold. This entry transfers Beginning Inventory and Net Purchases to Cost of Goods Sold, effectively treating all goods as if they were sold. In the second end-of-year adjustment entry, we debit Inventory for the ending balance that we determined from the physical count and credit Cost of Goods Sold. This entry adjusts the Cost of Goods Sold by subtracting the amount of Ending Inventory still on hand, recognizing that not all goods were sold. As a result of the two entries, the Inventory balance is $6,000 and cost of Goods Sold is $9,000. Part III Since Inventory and Cost of Goods Sold balances are kept up to date with each purchase and sale transaction during the period using a perpetual inventory system, no end-of-period adjustment entries are required. A physical inventory count is still necessary using a perpetual inventory system to assess the accuracy of the perpetual records and identify theft and other forms of shrinkage. Any shrinkage would be recorded by reducing the Inventory account and increasing an expense account (such as Inventory Shrinkage or Cost of Goods Sold) BI + P – EI = CGS End-of-year adjustment entries are not required using a perpetual inventory system.

Summary of the Effects on the Accounting Equation A summary of the effects of the journal entries on the accounting equation shows that total effects and the resulting financial statements are identical. Only the timing and nature of the entries differ.

Chapter 6 Solved Exercises
M6-2, M6-16, E6-3, E6-5, E6-13, E6-20 Chapter 6 Solved Exercises: M6-2, M6-16, E6-3, E6-5, E6-13, E6-20

Beginning inventory Purchases Cost of Goods Sold Ending balance
M6-2 Calculating Shrinkage in a Perpetual Inventory System Corey’s Campus Store has $4,000 of inventory on hand at the beginning of the month. During the month, the company buys $41,000 of merchandise and sells merchandise that had cost $30,000. At the end of the month, $13,000 of inventory is on hand. How much shrinkage occurred during the month? Beginning inventory Purchases Cost of Goods Sold Ending balance Inventory count Shrinkage $ 4,000 +41,000 -30,000 15,000 -13,000 $ 2,000 Part I M6-2 Calculating Shrinkage in a Perpetual Inventory System Corey’s Campus Store has $4,000 of inventory on hand at the beginning of the month. During the month, the company buys $41,000 of merchandise and sells merchandise that had cost $30,000. At the end of the month, $13,000 of inventory is on hand. How much shrinkage occurred during the month? Part II The shrinkage for the month is $2,000 and is calculated as shown on this slide.

M6-16 Interpreting Changes in Gross Profit Percentage
Luxottica Group, the Italian company that sells Ray Ban and Oakley sunglasses, reported net sales of €7.1 billion in 2012 and €6.2 billion in Gross profit increased from €4.1 billion in 2011 to €4.7 billion in Was the increase in gross profit caused by (a) an increase in gross profit per sale, (b) an increase in sales volume, or (c) a combination of (a) and (b)? Net Sales Cost of Goods Sold Gross Profit Gross Profit Percentage 2011 6.2 2.1 4.1 66.1% 2012 7.1 2.4 4.7 66.2% (in billions of euro) Part I M6-16 Interpreting Changes in Gross Profit Percentage Luxottica Group, the Italian company that sells Ray Ban and Oakley sunglasses, reported net sales of €7.1 billion in 2012 and €6.2 billion in Gross profit increased from €4.1 billion in 2011 to €4.7 billion in Was the increase in gross profit caused by (a) an increase in gross profit per sale, (b) an increase in sales volume, or (c) a combination of (a) and (b)? Part II First, we need to determine Luxxotica’s gross profit percentage for each year. In 2011 the gross profit percentage was 66.1%, and in 2012 the gross profit percentage was 66.2%. Therefore Luxottica’s increase in gross profit was caused by a combination of both (a) an increase in gross profit per sale (from 66.1% to 66.2%) and (b) an increase in sales volume (€6.2B to €7.1B).

Ending Inventory (perpetual)
E6-3 Identifying Shrinkage and Other Missing Inventory Information Calculate the missing information for each of the following independent cases: Case A B C D Beg. Inventory $100 200 150 260 Purchases $700 800 500 600 Cost of Goods Sold $300 850 650 Ending Inventory (perpetual) Ending Inventory (As Counted) Shrinkage $500 450 210 $420 440 $80 10 ? ? ? ? Part I E6-3 Identifying Shrinkage and Other Missing Inventory Information Calculate the missing information for each of the following independent cases: A: Beginning Inventory, $100; Purchases, $700; Cost of Goods Sold, $300, and Ending Inventory as counted, $420. Part II The Ending Inventory per the perpetual records is $500, which leaves a shrinkage of $80. B: Beginning Inventory, $200; Purchases, $800; Ending Inventory per the perpetual records, $150; and Ending Inventory as counted, $150. Part III The Cost of Goods Sold is $850 and the shrinkage is $0. C: Beginning Inventory, $150; Purchases, $500; Cost of Goods Sold, $200; Ending Inventory per the perpetual records, $450; and Shrinkage, $10. Part IV The Ending Inventory as counted is $440. D: Beginning Inventory, $260; Cost of Goods Sold, $650; Ending Inventory per the perpetual records, $210; and Ending Inventory as counted, $200. Part V Inventory purchased is $600 and shrinkage is $10.

E6-5 Inferring Missing Amounts Based on Income Statement Relationships
Supply the missing dollar amounts for each of the following independent cases. E6-5 Inferring Missing Amounts Based on Income Statement Relationships Supply the missing dollar amounts for each of the independent cases.

Supply the missing dollar amounts for each of the following independent cases. $300 ? 200 650 Case A B C D E Sales Revenue $700 900 800 1,000 Beginning Inventory $100 100 50 Purchases $800 600 Cost of Goods Available Cost of Goods Sold Cost of Ending Inventory $? 150 300 250 Gross Profit 900 600 $? ? 400 500 400 1,000 850 50 600 400 500 300 900 150 Part I Case A. (Missing amounts are shown in red) Total Available equals Beginning Inventory plus Purchases. ($100 + $800 = $900) Cost of Ending Inventory equals Total Available less Cost of Goods Sold. ($900 - $300 = $600) Gross Profit equals Sales less Cost of Goods Sold. ($700 - $300 = $400) Part II Case B. (Missing amounts are shown in blue) Total Available equals Beginning Inventory plus Purchases. ($200 + $800 = $1,000) Cost of goods sold equals cost of goods available – cost of ending inventory ($1,000 – $150) = $850 Gross Profit equals Sales less Cost of Goods Sold ($900 - $850) = $50 Part III Case C. (Missing amounts are shown in green) Sales equals cost of goods sold plus Gross Profit. ($200 + $400 = $600) Total Available equals Cost of goods sold plus Ending Inventory. ($200 + $300 = $500) Purchases equals Total Available less Beginning Inventory. ($500 - $100 = $400) Part IV Case D. (Missing amounts are shown in orange) Gross Profit equals Sales minus Cost of Goods Sold ($800 - $650) = $150 Total available equals Cost of Goods sold plus Ending Inventory. ($650 + $250 = $900) Beginning Inventory equals total Available less Purchases. ($900 - $600 = $300) Part V Case E. (Missing amounts are shown in purple) Cost of goods available for sale equals beginning inventory plus purchases ($50 + $900 = $950) Cost of goods sold equals sales revenue minus gross profit ($1,000 - $500 = $500) Cost of ending inventory equals goods available for sale minus cost of goods sold ($950 - $500 = $450) 950 500 450

Jan. 6 Sold goods for $100 to Wizard Inc. with terms 2/10, n/30. The
E6-13 Recording Journal Entries for Net Sales with Credit Sales and Sales Discounts Using the information in E6-12, prepare journal entries to record the transactions, assuming Solitare uses a perpetual inventory system. Jan. 6 Sold goods for $100 to Wizard Inc. with terms 2/10, n/30. The goods cost Solitare $70. 6 Sold goods to SpyderCorp for $80 with terms 2/10, n/30. The goods cost Solitare $60. 14 Collected cash due from Wizard Inc. Feb. 2 Collected cash due from SpyderCorp. 28 Sold goods for $50 to Bridges with terms 2/10, n/45. The goods cost Solitare $30. Part I E6-13 Recording Journal Entries for Net Sales with Credit Sales and Sales Discounts Using the information in E6-12, prepare journal entries to record the transactions, assuming Solitare uses a perpetual inventory system. Jan. 6: Sold goods for $100 to Wizard Inc. with terms 2/10, n/30. The goods cost Solitare $70. Part II The first entry is to debit Accounts Receivable and credit Sales Revenue for $100. The second entry is to debit Cost of Goods Sold and credit Inventory for $70. Jan. 6 Accounts Receivable Sales Revenue Cost of Goods Sold Inventory 100 70

E6-13 Recording Journal Entries for Net Sales with Credit Sales and Sales Discounts Using the information in E6-12, prepare journal entries to record the transactions, assuming Solitare uses a perpetual inventory system. Jan. 6 Sold goods for $100 to Wizard Inc. with terms 2/10, n/30. The goods cost Solitare $70. 6 Sold goods to SpyderCorp for $80 with terms 2/10, n/30. The goods cost Solitare $60. 14 Collected cash due from Wizard Inc. Feb. 2 Collected cash due from SpyderCorp. 28 Sold goods for $50 to Bridges with terms 2/10, n/45. The goods cost Solitare $30. Part I Jan. 6: Sold goods to SpyderCorp for $80 with terms 2/10, n/30. The goods cost Solitare $60. Part II The first entry is to debit Accounts Receivable and credit Sales Revenue for $80. The second entry is to debit Cost of Goods Sold and credit Inventory for $60. Jan. 6 Accounts Receivable Sales Revenue Cost of Goods Sold Inventory 80 60

E6-13 Recording Journal Entries for Net Sales with Credit Sales and Sales Discounts Using the information in E6-12, prepare journal entries to record the transactions, assuming Solitare uses a perpetual inventory system. Jan. 6 Sold goods for $100 to Wizard Inc. with terms 2/10, n/30. The goods cost Solitare $70. 6 Sold goods to SpyderCorp for $80 with terms 2/10, n/30. The goods cost Solitare $60. 14 Collected cash due from Wizard Inc. Feb. 2 Collected cash due from SpyderCorp. 28 Sold goods for $50 to Bridges with terms 2/10, n/45. The goods cost Solitare $30. Part I Jan. 14: Collected cash due from Wizard Inc. Part II Because Wizard Inc. paid within the discount period, the entry is to debit Cash $98, debit Sales Discounts $2, and credit Accounts Receivable $100. Jan. 14 Cash ($100 x 98%) Sales Discounts ($100 x 2%) Accounts Receivable 100 98 2

E6-13 Recording Journal Entries for Net Sales with Credit Sales and Sales Discounts Using the information in E6-12, prepare journal entries to record the transactions, assuming Solitare uses a perpetual inventory system. Jan. 6 Sold goods for $100 to Wizard Inc. with terms 2/10, n/30. The goods cost Solitare $70. 6 Sold goods to SpyderCorp for $80 with terms 2/10, n/30. The goods cost Solitare $60. 14 Collected cash due from Wizard Inc. Feb. 2 Collected cash due from SpyderCorp. 28 Sold goods for $50 to Bridges with terms 2/10, n/45. The goods cost Solitare $30. Part I Feb. 2: Collected cash due from SpyderCorp. Part II Because SpyderCorp paid outside of the discount period, the entry is to debit Cash and credit Accounts Receivable $80. Feb. 2 Cash Accounts Receivable 80

E6-13 Recording Journal Entries for Net Sales with Credit Sales and Sales Discounts Using the information in E6-12, prepare journal entries to record the transactions, assuming Solitare uses a perpetual inventory system. Jan. 6 Sold goods for $100 to Wizard Inc. with terms 2/10, n/30. The goods cost Solitare $70. 6 Sold goods to SpyderCorp for $80 with terms 2/10, n/30. The goods cost Solitare $60. 14 Collected cash due from Wizard Inc. Feb. 2 Collected cash due from SpyderCorp. 28 Sold goods for $50 to Bridges with terms 2/10, n/45. The goods cost Solitare $30. Part I Feb. 28: Sold goods for $50 to Bridges with terms 2/10, n/45. The goods cost Solitare $30. Part II The first entry is to debit Accounts Receivable and credit Sales Revenue for $50. The second entry is to debit Cost of Goods Sold and credit Inventory for $30. Feb. 28 Accounts Receivable Sales Revenue Cost of Goods Sold Inventory 50 30

Supply the missing dollar amounts for the income statement of Williamson Company for each of the following independent cases: Sales Revenue Sales Returns and Allowances Net Sales Cost of Goods Sold Gross Profit Case B $ 6,000 500 5,500 4,050 $ 1,450 Case A $ 8,000 150 7,850 5,750 $ 2,100 Case C $ 6,195 275 5,920 5,400 $ Part I E6-20 Inferring Missing Amounts Based on Income Statement Relationships Supply the missing dollar amounts for the income statement of Williamson Company for each of the following independent cases. We will start with Case A. Part II For Case A, Net Sales is $7,850 and Gross Profit is $2,100. Part III For Case B, Sales Returns and Allowances is $500 and Net Sales is $5,500. Part IV For Case C, Sales Revenue is $6,195 and Gross Profit is $520.

End of Chapter 6 End of chapter 6.

Merchandising Operations and the Multistep Income Statement

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Merchandising Operations and the Multistep Income Statement

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