Chapter Accounting for Merchandising Operations ACCT-103-5

Conceptual Learning Objectives SELF-STUDY C1: Describe merchandising activities and identify income components for a merchandising company. C2: Identify and explain the inventory asset of a merchandising company. C3: Describe both perpetual and periodic inventory systems. C4: Analyze and interpret cost flows and operating activities of a merchandising company. 4-2 ACCT-103-5

Analytical Learning Objectives SELF-STUDY A1: Compute the acid-test ratio and explain its use to assess liquidity. A2: Compute the gross margin ratio and explain its use to assess profitability. 4-3 ACCT-103-5

Procedural Learning Objectives P1: Analyze and record transactions for merchandise purchases using a perpetual system. P2: Analyze and record transactions for merchandise sales using a perpetual system. P3: Prepare adjustments and close accounts for a merchandising company. P4: Define and prepare multiple-step and single-step income statements. P5: Appendix 4A: Record and compare merchandising transactions using both periodic and perpetual inventory systems. NOT COVERED 4-4 ACCT-103-5

Merchandising Activities Service organizations sell time to earn revenue. Service organizations sell time to earn revenue. Examples: Accounting firms, law firms and plumbing services Service organizations sell time to earn revenue. Service organizations sell time to earn revenue. Examples: Accounting firms, law firms and plumbing services Revenues Expenses Minus Net income Equals 4-5 ACCT-103-5

Merchandising Activities Products that a company acquires to resell to customers are referred to as merchandise (also called goods). A merchandiser earns net income by buying and selling merchandise. A wholesaler is an intermediary that buys products from manufacturers or other wholesalers and sells them to retailers or other wholesalers. ACCT-103-5

ManufacturerWholesalerRetailerCustomer Merchandising Companies Merchandising Activities 4-7 ACCT-103-5

Merchandising Activities A. Reporting Income for a Merchandiser Revenues (net sales) from selling merchandise minus the cost of goods sold (the expense of buying and preparing the merchandise) to customers is called gross profit (also called gross margin). Gross profit minus expenses (generally called operating expenses) determines the net income or loss for the period. ACCT-103-5

Reporting Income of a Merchandiser products Merchandising companies sell products to earn revenue. Examples: sporting goods, clothing, and auto parts stores Cost of Goods Sold Gross Profit Expenses Net Income Net Sales Minus Equals Minus Equals 4-9 ACCT-103-5

Operating Cycle for a Merchandiser Begins with the purchase of merchandise and ends with the collection of cash from the sale of merchandise. Purchases Merchandise inventory Credit sales Accounts receivable Cash collection Purchases Merchandise inventory Cash sales Cash Sale Credit Sale 4-10 ACCT-103-5

Merchandising Activities B. Reporting Inventory for a Merchandiser 1. A merchandiser's balance sheet is the same as service business with the exception of one additional current asset, merchandise inventory, or simply inventory. 2. The cost of this asset includes the cost incurred to -Buy the goods, -Ship them to the store, and -Make them ready for sale. ACCT-103-5

Merchandising Activities C. Inventory Systems Merchandise available for sale consists of -what it begins with (beginning inventory) plus -what it purchases (net purchases). The merchandise available for sale is either -sold (cost of goods sold) or -kept for future sales (ending inventory). ACCT-103-5

Inventory Systems + + Beginning inventory Net purchases Merchandise available for sale Ending inventory Cost of goods sold = 4-13 ACCT-103-5

Merchandising Activities C. Inventory Systems Two alternative inventory systems are used to collect information about cost of goods sold and the inventory: a. Perpetual inventory system —continually updates accounting records for merchandise transactions (Specifically, for those records of inventory available for sale and inventory sold). b. Periodic inventory system —updates the accounting records for merchandise transactions only at the end of a period. ACCT-103-5

Merchandise Purchases (Perpetual System) The invoice serves as a source document for this event ACCT-103-5

 Seller  Invoice date  Purchaser  Order number  Credit terms  Freight terms  Goods  Invoice amount  Seller  Invoice date  Purchaser  Order number  Credit terms  Freight terms  Goods  Invoice amount         4-16 ACCT-103-5

Merchandise Purchases (Perpetual System) On June 20, Jason, Inc. purchased $14,000 of Merchandise Inventory paying cash ACCT-103-5

Trade Discounts Used by manufacturers and wholesalers to offer better prices for greater quantities purchased. Used by manufacturers and wholesalers to offer better prices for greater quantities purchased. Example Matrix, Inc. offers a 30% trade discount on orders of 1,000 units or more of their popular product Racer. Each Racer has a list price of $5.25. Example Matrix, Inc. offers a 30% trade discount on orders of 1,000 units or more of their popular product Racer. Each Racer has a list price of $ ACCT-103-5

Purchase Discounts A deduction from the invoice price granted to induce early payment of the amount due. Terms Time Due Discount Period Due: Invoice price minus discount Credit Period Due: Full Invoice Price Date of Invoice 4-19 ACCT-103-5

2/10,n/30 Purchase Discounts Discount Percent Number of Days Discount Is Available Otherwise, Net (or All) Is Due in 30 Days Credit Period 4-20 ACCT-103-5

When Discount is Not Taken If we fail to take a 2/10, n/30 discount, is it really expensive? 365 days ÷ 20 days × 2% = 36.5% annual rate Days in a year Days in a year Number of additional days before payment Number of additional days before payment Percent paid to keep money Percent paid to keep money 4-21 ACCT-103-5

Purchase Discounts On May 7, Jason, Inc. purchased $27,000 of merchandise inventory on account, credit terms are 2/10, n/ ACCT-103-5

Purchase Discounts On May 15, Jason, Inc. paid the amount due on the purchase of May 7. *$27,000 × 2% = $540 discount 4-23 ACCT-103-5

Purchase Discounts After we post these entries, the accounts involved look like this: Merchandise Inventory Accounts Payable 5/7 27,000 5/ /15 27,000 Bal. 26,460 Bal ACCT-103-5

Purchase Returns and Allowances Purchase Return... Merchandise returned by the purchaser to the supplier. Purchase Allowance... A reduction in the cost of defective merchandise received by a purchaser from a supplier. Purchase Return... Merchandise returned by the purchaser to the supplier. Purchase Allowance... A reduction in the cost of defective merchandise received by a purchaser from a supplier ACCT-103-5

Purchase Returns and Allowances On May 9, Matrix, Inc. purchased $20,000 of merchandise inventory on account, credit terms are 2/10, n/ ACCT-103-5

Purchase Returns and Allowances On May 10, Matrix, Inc. returned $500 of defective merchandise to the supplier ACCT-103-5

Purchase Returns and Allowances On May 18, Matrix, Inc. paid the amount owed for the purchase of May ACCT-103-5

Transportation Costs FOB shipping point (buyer pays) FOB destination (seller pays) Merchandise Seller Buyer 4-29 ACCT-103-5

Transportation Costs On May 12, Jason, Inc. purchased $8,000 of merchandise inventory for cash and also paid $100 transportation costs ACCT-103-5

Quick Check  On July 6, 2009, Seller Co. sold $7,500 of merchandise to Buyer, Co. on account; terms of 2/10,n/30. The shipping terms were FOB shipping point. The shipping cost was $100. Which of the following will be part of Buyer’s July 6 journal entry? a. Credit Sales $7,500 b. Credit Purchase Discounts $150 c. Debit Merchandise Inventory $7,600 d. Debit Accounts Payable $7,450 On July 6, 2009, Seller Co. sold $7,500 of merchandise to Buyer, Co. on account; terms of 2/10,n/30. The shipping terms were FOB shipping point. The shipping cost was $100. Which of the following will be part of Buyer’s July 6 journal entry? a. Credit Sales $7,500 b. Credit Purchase Discounts $150 c. Debit Merchandise Inventory $7,600 d. Debit Accounts Payable $7,450 FOB shipping point indicates the buyer ultimately pays the freight. This is recorded with a debit to Merchandise Inventory ACCT-103-5

Cost of Merchandise Purchased 4-32 ACCT-103-5

Accounting for Merchandise Sales Sales discounts and returns and allowances are Contra Revenue accounts ACCT-103-5

Sales of Merchandise On March 18, Diamond Store sold $25,000 of merchandise on account. The merchandise was carried in inventory at a cost of $18, ACCT-103-5

Sales Discounts On June 8, Barton Co. sold merchandise costing $3,500 for $6,000 on account. Credit terms were 2/10, n/30. Let’s prepare the journal entries. On June 8, Barton Co. sold merchandise costing $3,500 for $6,000 on account. Credit terms were 2/10, n/30. Let’s prepare the journal entries ACCT-103-5

Sales Discounts On June 17, Barton Co. received a check for $5,880 in full payment of the June 8 sale ACCT-103-5

Sales Returns and Allowances On June 12, Barton Co. sold merchandise costing $4,000 for $7,500 on account. The credit terms were 2/10, n/ ACCT-103-5

Sales Returns and Allowances On June 14, merchandise with a sales price of $800 and a cost of $470 was returned to Barton. The return is related to the June 12 sale ACCT-103-5

Sales Returns and Allowances On June 20, Barton received the amount owed to it from the sale of June ACCT-103-5

Let’s complete the accounting cycle by preparing the closing entries closing entries for Barton 4-40 ACCT-103-5

Step 1: Step 1: Close Credit Balances in Temporary Accounts to Income Summary 4-41 ACCT-103-5

Step 2: Step 2: Close Debit Balances in Temporary Accounts to Income Summary 4-42 ACCT-103-5

Step 3: Step 3: Close Income Summary to Retained Earnings 4-43 ACCT-103-5

Step 4: Step 4: Close Dividends to Retained Earnings 4-44 ACCT-103-5

Multiple-Step Income Statement 4-45 ACCT-103-5

Single-Step Income Statement 4-46 ACCT-103-5

Balance Sheet 4-47 ACCT-103-5

Acid-Test Ratio A common rule of thumb is the acid-test ratio should have a value of at least 1.0 to conclude a company is unlikely to face liquidity problems in the near future. = Quick Assets Quick Assets Current Liabilities Acid-TestRatio Acid-TestRatio = Cash + S/T Investments + Receivables Cash + S/T Investments + Receivables Current Liabilities 4-48 ACCT-103-5

Gross Margin Ratio Percentage of dollar sales available to cover expenses and provide a profit. Gross Margin Ratio Net Sales - Cost of Goods Sold Net Sales = 4-49 ACCT-103-5