Unit #14 – The Merchandising Company

Unit #14 – The Merchandising Company There are 3 types of Businesses A Service Company A Merchandise Company A Manufacturing Company We have covered the Accounting Cycle for a Service Company, now we will learn the differences of a Merchandise company

Unit #14 – The Merchandising Company Retailer Wholesaler Customer Manufacturing Company Retailer Service Company

Unit #14 – The Merchandising Company Business that sell Merchandise are known as Merchandising companies Since they sell products, we now must track the purchase, cost, and sale of these goods This is done through tracking the Merchandise Inventory Account This is the only essential difference between a Service & Merchandise Company

Unit #14 – Supplies Versus Inventory The first thing we have to clear up is the difference between supplies and merchandise. Supplies are purchased for use in running a business (i.e. office supplies, cleaning supplies).

Unit #14 – Supplies Versus Inventory Merchandise Inventory is purchased for RE-SALE. This idea is you buy goods, and re-sell them for a higher price in order to make money. Note: this doesn’t mean that pencils and paper can’t be inventory. If you are a stationary store, then these items ARE inventory. The key concept is “goods for re-sale”.

Unit #14 – Tracking Inventory The Periodic Inventory Method Adjustments are made at the end of the accounting period to track the inventory The Perpetual Inventory Method Adjustments are continually made and updated to keep track of the inventory

Unit #14 – The Periodic Inventory Method In the days before computerized accounting and inventory systems, larger companies would sell goods out of inventory with no intention of trying to keep inventory records up to date, especially with a high volume of sales. Instead, much like a supplies adjustment, an inventory count would be made at the end of the period (periodically). This will show how much inventory was missing, all of which is assumed to have been sold.

Unit #14 – The Perpetual Inventory Method Now thanks to technology, inventory systems can tell you exactly how much inventory (and what kind) is in the storeroom or on the floor (inventory is kept perpetually up to date). Every time a cashier scans a product, it records the sale, but also reduces the inventory level.   Now inventory counts are done much less frequently, and are usually just to catch discrepancies in the records and to account for theft.

Unit #14 – Why Inventory is Important! Inventory adds an entirely new dimension to running and evaluating a business. Inventory can become obsolete (summer clothing not sold by fall, too many of the hottest toys from last Christmas). Inventory also takes up space for which you pay rent, needs to be stored, stocked, and counted - which takes labour and inventory soaks up cash to sit there on the floor and do nothing, instead of paying the business’ bills. Not the least of which, inventory can be stolen.

Unit #14 – Why Inventory is Important! Inventory values can also be “played” with to alter a business’ reported Net Income. How? This is because the cost of inventory eventually makes it to the income statement as an expense called Cost of Goods Sold. The more you sell, the higher your cost of goods sold expense. The reason all this is significant, is because inventory is usually significant. The single largest expense for a merchandise business is usually the Cost of Goods Sold expense

Unit #14 – The Merchandising Company The concept of Cost of Goods Sold (COGS) Since now we are selling goods, part of the cost of generating revenue is the cost of the items we are selling. It is calculated like this:

Unit #14 – The Merchandising Company COGS is calculated like this: Value of what’s left in Inventory Cost of Goods Available for Sales during period Beginning Inventory - Purchase Returns & Purchase Discounts + Freight In - Ending Inventory + Purchases = COGS Expense This is the cost of having the merchandise shipped to us. It is deemed to be part of the cost of obtaining the goods, so it goes in Inventory. Value of goods sold during the period We will learn about these next Net Purchases

Unit #14 – The Merchandising Company How it fits into the Income Statement Revenue is now referred to as Sales Sales - COGS = Gross Profit This is also known as the ‘mark up’ on your goods - Operating Expenses These are the ‘expenses’ you are use to (Salaries, Rent, Amortization etc) = Net Income

Unit #14 – The Merchandising Company A Class Example A business with $20,000 worth of inventory on January 1st makes the following purchases Jan. 10 - $7,500, Jan. 17 - $1,500 Jan. 21 – Return for $900 When Inventory was counted on Jan. 31st the business had $14,000 worth of Inventory left Sales in January were $40,000, Operating Expenses were $17,000 Find the COGS Calculate the Net Income

Unit #14 – The Merchandising Company #1 - COGS Beginning Inventory $20,000 Add: Purchases 9,000 Less: Purchase Returns (900) Total Available 28,100 Less: Ending Inventory (14,000) Cost of Goods Sold 14,100  

Unit #14 – The Merchandising Company #2 – Net Income Sales $40,000 Less: Cost of Goods Sold (14,100) Gross Profit 25,900 Less: Operating Expenses (17,000) Net Income $8,900

Unit #14 – Discounts Discounts are offered to people who buy on account either from you – Sales Discounts Or from someone else – Purchase Discounts The purpose is to encourage people to pay sooner Think about it: an Accounts Receivable is your money in the hands of someone else – you want your money now!

Unit #14 – Discount Rules Rule Discounts only occur when cash changes hands Discounts always appear on the same side as cash Reason This is the only time you know for sure that someone has paid within the discount period This is because you are accepting less cash for the discount

Unit #14 – Discount Rules cont. 3. The Discount only affects Cash 4. Discounts are calculated on total amount owing Reason 3. Same as previous 4. Because Tarantino said so

Unit #14 – Discounts There are 2 new accounts we will be using for recording Discounts Purchase Discount (When you buy) This is a Contra–Expense Account Sales Discount (When you sell) This is a Contra–Revenue Account Therefore this has a Credit Balance Therefore this has a Debit Balance

Unit #14 – Discounts One last thing about Discounts What are “Terms”? How do we ‘read’ them? What does 2/10, n30 mean? With 30 Days to pay without penalty 2% Discount If paid within 10 Days

Unit #14 – Discounts An Example Jan. 10 – We bought a $1000 worth of supplies on account. Terms are 2/10, n30. Write this information down!   Date Particulars P.R. Debit Credit 1 2 3 Jan 10 Supplies 1000 Accounts Payable 1000 Bought supplies, Terms 2/10, n30.

Unit #14 – Purchase Discounts Let’s now say that we want to take advantage of the “Discount” and pay within the allotted time period (in this case it is 10 Days to receive a 2% Discount)   Date Particulars P.R. Debit Credit 1 2 3 Jan 18 Accounts Payable 1000 Cash 980 Purchase Discounts 20

Unit #14 – Sales Discounts Let’s take the same question, only now we sold instead or bought Jan. 10 – We sold $1000 worth of Supplies on account. Terms are 2/10, n30.   Date Particulars P.R. Debit Credit 1 2 3 Jan 10 Accounts Receivable 1000 Sales Revenue 1000 Sold $1000 to J. Doe

Unit #14 – Sales Discounts Again, it is now within the 10 Days and our customer has chosen to take advantage of the Discount   Date Particulars P.R. Debit Credit 1 2 3 Jan 18 Cash 980 Sales Discount 20 Accounts Receivable 1000

Unit #14 - Purchase Discounts If the transaction was for cash (when you bought supplies) and the discount was taken right away, it would look like this   Date Particulars P.R. Debit Credit 1 2 3 Jan 10 Supplies 1000 Cash 980 Purchase Discount 20

Unit #14 - Sales Discounts If the transaction was for cash (when you sold supplies) and the discount was taken right away, it would look like this   Date Particulars P.R. Debit Credit 1 2 3 Jan 10 Cash 980 Sales Discount 20 Sales Revenue 1000

Unit #14 – The Merchandising Company To track the purchase, cost, and shipment of merchandise new accounts are needed. They are as follows:

Unit #14 – The Merchandising Company New Account Type of Account 1. Merchandise Inventory Current Asset 2. Sales Revenue 3. Sales Discounts Contra-Revenue 4. Sales Returns & Allowances 5. Purchases COGS (expense) 6. Purchase Discounts COGS (Contra-Expense) 7. Purchase Returns & Allowances 8. Freight In 9. Freight Out (Delivery Expense) Operating Expense

Unit #14 – The Merchandising Company Updated Chart of Accounts Assets 100-199 Liabilities 200-299 Capital (including Drawings) 300-399 Revenues 400-499 COGS Expenses 500-599 Operating Expenses 600-699

Unit #14 – The Merchandising Company: The Periodic Inventory Method Merchandising Inventory is our new Current Asset, under the Periodic method of Accounting, it is only touched during the Closing Entries If you have bought inventory, instead of going to the Merchandise Inventory account it goes to the Purchases account

Unit #14 – The Merchandising Company: The Periodic Inventory Method New Account Type of Account Merchandise Inventory Current Asset (Beginning Accounting Period Value) 2. Sales Revenue 3. Sales Discounts Contra-Revenue 4. Sales Returns & Allowances Contra-Revenue 5. Purchases COGS (expense) 6. Purchase Discounts COGS (Contra-Expense) 7. Purchase Returns & Allowances COGS (Contra-Expense) 8. Freight In COGS (expense) 9. Freight Out (Delivery Expense) Operating Expense

Unit #14 – The Merchandising Company: The Periodic Inventory Method Cash Purchase of Merchandise (Page 300) Jun. 8 – Purchases sports equipment from Schwinn, $500, Cheque 86   Date Particulars P.R. Debit Credit 1 2 3 Jun 8 Purchases 500 Cash 500 Purchase Sports Equipment, Cheque 86

Unit #14 – The Merchandising Company: The Periodic Inventory Method Credit Purchase of Merchandise Jun. 9 – Purchases sports equipment from Spalding, invoice 2974, $200 on account   Date Particulars P.R. Debit Credit 1 2 3 Jun 9 Purchases 200 A/P Spalding 200 Purchased Equipment, invoice 2974

Unit #14 – The Merchandising Company: The Periodic Inventory Method Goods Returned for Cash Refund (Purchase Return & Allowances) Jun. 10 – Received refund Cheque for $100 from Schwinn for goods returned.   Date Particulars P.R. Debit Credit 1 2 3 Jun 10 Cash 100 Purchases Ret. & Allow. 100 Cash Refund from Schwinn

Unit #14 – The Merchandising Company: The Periodic Inventory Method Goods returned for Credit (Purchase Returns & Allowances) Jun. 11 – Received Credit Invoice 981 for $200 from Spalding Ltd. for returned tennis equipment.   Date Particulars P.R. Debit Credit 1 2 3 Jun 11 A/P Spalding Ltd 200 Purchases Ret. & Allow 200 Returned Defective Equipment, invoice 981

Unit #14 – The Merchandising Company: The Periodic Inventory Method Sales Returns & Allowances Jun 14 - J. Doe returned $100 worth of hockey sticks   Date Particulars P.R. Debit Credit 1 2 3 Jun 14 Sales Returns & Allowances 100 Cash 100 Refund for J. Doe

Unit #14 – The Merchandising Company: The Periodic Inventory Method Freight In Freight In is part of the Cost Of Goods Sold Account (Freight Out is not)   Date Particulars P.R. Debit Credit 1 2 3 Jun 16 Freight In 200 Cash 200

Unit #14 – The Merchandising Company: The Periodic Inventory Method Freight out (An Operating Expense) It would be recorded like this   Date Particulars P.R. Debit Credit 1 2 3 Jun 18 Freight Out 150 Cash 150

Unit #14 – The Merchandising Company: The Periodic Inventory Method The previous examples along with the Purchase & Sales Discount examples are the new entries you may have to make into the General Journal for a Merchandising Company using the Periodic Inventory Method.

Unit #14 – The Merchandising Company: The Periodic Inventory Method Each of these new accounts also have to shown on the Trial Balance and either the Income Statement or Balance Sheet! Also note that all of these transactions can include taxes! (HST Recoverable (When Buying) or HST Payable (When Selling)) with them, but we have already covered that!

Unit #14 – The Merchandising Company: The Perpetual Inventory Method The name perpetual is a reference to the fact that the merchandise inventory account always shows us the value of inventory that should be on hand (i.e. it is perpetually kept up to date). As technology becomes more and more widespread and affordable, most businesses have acquired computerized inventory and accounting systems. In fact, some computerized accounting software programs do not even support the periodic method of accounting anymore – only the perpetual!

Unit #14 – The Merchandising Company: The Perpetual Inventory Method Recall!!! New Account Type of Account 1. Merchandise Inventory Current Asset 2. Sales Revenue 3. Sales Discounts Contra-Revenue 4. Sales Returns & Allowances Contra-Revenue 5. Purchases COGS (expense) 6. Purchase Discounts COGS (Contra-Expense) 7. Purchase Returns & Allowances COGS (Contra-Expense) 8. Freight In COGS (expense) 9. Freight Out (Delivery Expense) Operating Expense 10. Inventory Shortage Operating Expense We use the Cost of Goods Sold Account to track the items we’re selling - as we sell them.

Unit #14 – The Merchandising Company: The Perpetual Inventory Method Notice, we now use the Merch. Inventory Account instead of the Purchases Account Cash Purchase of Inventory Jun. 8 – Purchases sports equipment from Schwinn, $500, Cheque 86   Date Particulars P.R. Debit Credit 1 2 3 Jun 8 Merchandise Inventory 500 Cash 500 Purchased Sports Equipment, Cheque 86

Unit #14 – The Merchandising Company: The Perpetual Inventory Method Credit Purchase of Merchandise Jun. 9 – Purchases sports equipment from Spalding, invoice 2974, $200 on account   Date Particulars P.R. Debit Credit 1 2 3 Jun 9 Merchandise Inventory 200 A/P Spalding Ltd. 200 Purchases Equipment, Invoice 2974

Unit #14 – The Merchandising Company: The Perpetual Inventory Method Goods Returned for Cash Refund (Purchase Return & Allowances) Jun. 10 – Received refund Cheque for $100 from Schwinn for goods returned.   Date Particulars P.R. Debit Credit 1 2 3 Jun 10 Cash 100 Merchandise Inventory 100 Cash Refund received from Schwinn

Unit #14 – The Merchandising Company: The Perpetual Inventory Method Goods returned for Credit (Purchase Returns & Allowances) Jun. 11 – Received Credit Invoice 981 for $200 from Spalding Ltd. for returned tennis equipment.   Date Particulars P.R. Debit Credit 1 2 3 Jun 11 A/P Spalding Ltd 200 Merchandise Inventory 200 Merchandise return, credit invoice 981

Unit #14 – The Merchandising Company: The Perpetual Inventory Method Recording a Purchase Discount Jun 12 - Sent Cheque for $490 to Spalding Ltd. In payment of invoice 4918, terms 2/10, n30 Notice that instead of using the Purchase Discount Account, we used the Merchandise Inventory Account   Date Particulars P.R. Debit Credit 1 2 3 4 Jun 27 A/P Spalding 500 Cash 490 Merchandise Inventory 10 Paid invoice 4918, less 2% discount

Unit #14 – The Merchandising Company: The Perpetual Inventory Method Freight In Freight In is part of the Cost Of Goods Sold Account, so we now use Merchandise Inventory instead   Date Particulars P.R. Debit Credit 1 2 3 Jun 16 Merchandise Inventory 200 Cash 200

Unit #14 – The Merchandising Company: The Perpetual Inventory Method To Recap the differences in Journal Entries from the Periodic Method! Anytime you would use the following accounts in the Periodic Inventory Method, you use Merchandise Inventory in the Perpetual Inventory Method – Merch Inventory is a Current Asset! 5. Purchases COGS (expense) 6. Purchase Discounts COGS (Contra-Expense) 7. Purchase Returns & Allowances COGS (Contra-Expense) 8. Freight In COGS (expense)

Unit #14 – The Merchandising Company: The Perpetual Inventory Method Every time we make a Sale and/or give a Sales Discount, or make a Sales Return the original entry is the same, but we have to “update” our Merchandise Inventory Account So let’s assume we made of sale of $1000 plus HST. How would we record this?

Unit #14 – The Merchandising Company: The Perpetual Inventory Method   Date Particulars P.R. Debit Credit 1 2 3 4 5 6 7 8 Jan 10 Cash 1130 HST Payable 130 Sales Revenue 1000 Cost of Goods Sold 700 Merchandise Inventory 700 This is to keep our inventory “up-to-date” with every sale, sales discount, or sales return