Principles of Financial Accounting, 11e 6 Accounting for Merchandising Businesses Principles of Financial Accounting, 11e Reeve • Warren • Duchac

1 Distinguish between the activities and financial statements of service and merchandising businesses. 6-4

Nature of Merchandising Businesses 1 Nature of Merchandising Businesses Service Business Fees earned $XXX Operating expenses –XXX Net income $XXX

Nature of Merchandising Businesses Merchandising Business 1 Nature of Merchandising Businesses Merchandising Business Sales $XXX Cost of Merchandise Sold –XXX Gross Profit $XXX Operating Expenses –XXX Net Income $XXX

1 When merchandise is sold, the revenue is reported as sales, and its cost is recognized as an expense called cost of merchandise sold.

1 Merchandise on hand (not sold) at the end of an accounting period is called merchandise inventory.

1 Example Exercise 6-1 Gross Profit During the current year, merchandise is sold for $250,000 cash and for $975,000 on account. The cost of the merchandise sold is $735,000. What is the amount of the gross profit? Follow My Example 6-1 The gross profit is $490,000 ($250,000 + $975,000 –$735,000). Follow My Example 6-1 For Practice: PE 6-1A, PE 6-1B 6-9

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2 Describe and illustrate the financial statements of a merchandising business. 6-11

Multiple-Step Income Statement 2 Multiple-Step Income Statement The multiple-step income statement contains several sections, subsections, and subtotals.

2 Exhibit 1 Multiple-Step Income Statement (continued on Slide 19)

2 The Sales account provides the total amount charged to customers for merchandise sold, including cash sales and sales on account.

2 Sales returns and allowances are granted by the seller to customers for damaged or defective merchandise.

2 Sales discounts are granted by the seller to customers for early payment of amounts owed.

2 Net sales is determined by subtracting sales returns and allowances and sales discounts from sales.

2 The cost of merchandise sold is the cost of the merchandise sold to customers.

2 Exhibit 1 Multiple-Step Income Statement (continued) (continued on Slide 28)

2 The buyer may return merchandise to the seller (a purchase return), or the buyer may receive a reduction in the initial price at which the merchandise was purchased (a purchase allowance).

2 You have seen how sellers may offer customers sales discounts for early payment of their bills. From the buyer’s perspective, such discounts are referred to as purchase discounts.

2 If merchandise inventory at the end of the period is determined by taking a physical count of inventory on hand, a periodic inventory system is being used.

2 Under the perpetual inventory system of accounting, the amounts of inventory available for sale and sold are continuously (perpetually) updated in the inventory records.

2 Exhibit 2 Cost of Merchandise Sold

Selling expenses are incurred directly in the selling of merchandise. 2 Selling expenses are incurred directly in the selling of merchandise. Sales salaries Store supplies used Depreciation of store equipment Delivery expense Advertising

Depreciation of office equipment Office supplies used 2 Administrative expenses sometimes called general expenses, are incurred in the administration or general operation of the business. Office salaries Depreciation of office equipment Office supplies used

2 Other income is revenue from sources other than the primary operating activity of a business. Other expense is an expense that cannot be traced directly to the normal operations of the business.

2 Exhibit 1 Multiple-Step Income Statement (concluded)

2 Example Exercise 6-2 Cost of Merchandise Sold Based upon the following data, determine the cost of merchandise sold for May. Use the format seen in Exhibit 2. Merchandise Inventory, May 1 $121,200 Merchandise Inventory, May 31 142,000 Purchases 985,000 Purchases Returns and Allowances 23,500 Purchases Discounts 21,000 Transportation In 11,300 6-29

2 Follow My Example 6-2 Merchandise Inventory, May 1 $ 121,200 Example Exercise 6-2 (continued) 2 Follow My Example 6-2 Merchandise Inventory, May 1 $ 121,200 Purchases $985,000 Less: Purchases ret. and allow. $23,500 Purchases discounts 21,000 44,500 Net purchases $940,500 Add transportation in 11,300 Cost of merchandise purchased 951,800 Merchandise available for sale $1,073,000 Less merchandise inventory, May 31 142,000 Cost of merchandise sold $ 931,000 For Practice: PE 6-2A, PE 6-2B 6-30

2 An alternative form of income statement is the single-step income statement. As shown in the next slide, the income statement for NetSolutions deducts the total of all expenses in one step from the total of all revenues.

2 Exhibit 3 Single-Step Income Statement

2 Statement of Owner’s Equity for Merchandising Business Exhibit 4

2 Exhibit 5 Report Form of Balance Sheet (Continued)

2 Exhibit 5 Report Form of Balance Sheet (continued)

3 Describe and illustrate the accounting for merchandise transactions including: 6-36

3 Sale of merchandise Purchase of merchandise Freight, sales taxes, and trade discounts Dual nature of merchandise transactions 6-37

3 Chart of Accounts for NetSolutions Merchandising Business Exhibit 6

3 Cash Sales On January 3, NetSolutions sold $1,800 of merchandise for cash.

3 Cash Sales Using the perpetual inventory system, the cost of merchandise sold and the decrease in merchandise inventory are recorded. The cost of merchandise sold on January 3 is $1,200.

3 Credit Card Sales Sales made to customers using credit cards are recorded as cash sales. Assume that NetSolutions paid credit card processing fees of $48 on January 1.

3 Sales on Account On January 12, NetSolutions sold merchandise on account for $510. The cost of merchandise sold was $280.

3 Sales Discounts The terms for when payments for merchandise are to be made, are called credit terms. If payment is required on delivery, the terms are cash or net cash. Otherwise, the buyer is allowed an amount of time, known as the credit period, in which to pay.

3 Receipts on Account On January 22, NetSolutions receives the amount due, less the 2 percent discount. $1,500 x .02

3 Credit Memorandum A credit memorandum, often called a credit memo, authorizes a credit to (decreases) the buyer’s account receivable.

3 Exhibit 9 Credit Memo

3 On January 13, issued Credit Memo 32 to Krier Company for merchandise returned to NetSolutions. Selling price, $225; cost to NetSolutions, $140.

3 Example Exercise 6-3 Sales Transactions Journalize the following merchandise transactions: Sold merchandise on account, $7,500 with terms of 2/10, n/30. The cost of the merchandise sold was $5,625. Received payment less the discount. 6-50

3 Follow My Example 6-3 Accounts Receivable……………. 7,500 Example Exercise 6-3 (continued) 3 Follow My Example 6-3 Accounts Receivable……………. 7,500 Sales…………………………….. 7,500 Cost of Merchandise Sold………. 5,625 Merchandise Inventory………. 5,625 Cash…………………………………. 7,350 Sales Discounts…………………… 150 Accounts Receivable…………. 7,500 For Practice: PE 6-3A, PE 6-3B 6-51

Purchase Merchandise for Cash 3 Purchase Merchandise for Cash * *Assumes a perpetual inventory system is used.

Purchase Merchandise on Account 3 Purchase Merchandise on Account * *Assumes a perpetual inventory system is used. We will assume a perpetual inventory system is used throughout the chapter. The periodic inventory system is discussed in Appendix 2.

3 Alpha Technologies issues an invoice for $3,000 to NetSolutions dated March 12, with terms 2/10, n/30. NetSolutions pays the amount due, less the discount, on March 22.

3 NetSolutions borrows cash at an annual interest rate of 6%. Should the firm borrow cash to pay the invoice within the discount period? Discount of 2% on $3,000 $60.00 Interest for 20 days at the rate of 6% on $2,940 – 9.80 Savings from borrowing $50.20 YES

3 3 Discount Taken

Assume that NetSolutions pays the invoice on April 11. 3 Discount Not Taken Assume that NetSolutions pays the invoice on April 11.

3 A purchases return involves actually returning merchandise that is damaged or does not meet the specifications of the order.

3 When the defective or incorrect merchandise is kept by the buyer and the vendor makes a price adjustment, that is a purchases allowance.

3 Exhibit 10 Debit Memo

3 NetSolutions receives the delivery from Maxim Systems and determines that $900 of the items are not the merchandise ordered. Debit memorandum #18 (also called a debit memo) is issued to Maxim Systems.

3 NetSolutions records the return of the merchandise indicated in the debit memo in Exhibit 10 as follows:

3 Price Allowance On May 2, NetSolutions purchased $5,000 of merchandise on account from Delta Data Link, terms 2/10, n/30.

3 NetSolutions returned $3,000 of the merchandise purchased from Delta Data Link on May 4.

3 On May 12, NetSolutions paid for the purchase of May 2 less the return and discount.

3 Example Exercise 6-4 Purchase Transactions Rofles Company purchased merchandise on account from a supplier for $11,500, terms 2/10, n/30. Rofles Company returned $3,000 of the merchandise and received full credit. If Rofles Company pays the invoice within the discount period, what is the amount of cash required for the payment? Under a perpetual inventory system, what account is credited by Rofles Company to record the return? 6-66

Example Exercise 6-4 (continued) 3 Follow My Example 6-4 $8,330. Purchase of $11,500 less the return of $3,000 less the discount of $170 [($11,500 – $3,000) × 2%]. Merchandise inventory For Practice: PE 6-4A, PE 6-4B 6-67

3 Freight If ownership of the merchandise passes to the buyer when the seller delivers the merchandise to the freight carrier, it is said to be FOB (free on board) shipping point.

3 On June 10, NetSolutions buys merchandise from Magna Data on account, $900, terms FOB shipping point and pays the transportation cost of $50.

3 If ownership of the merchandise passes to the buyer when the buyer receives the merchandise, the terms are said to be FOB (free on board) destination.

3 On June 15, NetSolutions sells merchandise to Kranz Company on account, $700, terms FOB destination. The cost of the merchandise sold is $480. NetSolutions pays freight of $40.

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3 On June 20, NetSolutions sells merchandise to Planter Company on account, $800, terms FOB shipping point. NetSolutions paid freight of $45, which was added to the invoice. The cost of the merchandise sold is $360.

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3 Exhibit 11 Freight Terms

Returns and Allowances 3 Example Exercise 6-5 Freight Terms Determine the amount to be paid in full settlement of each of invoices (a) and (b), assuming that credit for returns and allowances was received prior to payment and that all invoices were paid within the discount period. Freight Paid by Seller Returns and Allowances Merchandise Freight Terms a. $4,500 $200 FOB shipping point, $ 800 1/10, n/30 $5,000 60 FOB destination, 2,500 2/10, n/30 6-76

Example Exercise 6-5 (continued) 3 Follow My Example 6-5 $3,863. Purchase of $4,500 less return of $800 less the discount of $37 [($4,500 – $800) × 1%] plus $200 of shipping. $2,450. Purchase of $5,000 less return of $2,500 less the discount of $50 [($5,000 – $2,500) × 2%]. For Practice: PE 6-5A, PE 6-5B 6-77

3 Sales Taxes On August 12, merchandise is sold on account to Lemon Company, $100. The state has a 6% sales tax.

3 Sales Taxes On a regular basis, the seller pays to the taxing authority (state) the amount of the sales taxes collected.

3 Trade Discounts When wholesalers offer special discounts to certain classes of buyers who order large quantities, these discounts are called trade discounts.

Dual Nature of Merchandise Transactions 3 Dual Nature of Merchandise Transactions Each merchandising transaction affects a buyer and a seller. In the following illustrations, we show how the same transactions would be recorded by both the seller and the buyer. July 1. Scully Company sold merchandise on account to Burton Co., $7,500, terms FOB shipping point, n/45. The cost of the merchandise sold was $4,500.

Scully Company (Seller) Burton Company (Buyer) 3 Scully Company (Seller) Accounts Receivable—Burton Co. 7,500 Sales 7,500 Cost of Merchandise Sold 4,500 Merchandise Inventory 4,500 Burton Company (Buyer) Merchandise Inventory. 7,500 Accounts Payable—Scully Co. 7,500

3 July 2. Burton Company paid transportation charges of $150 on the July 1 purchase from Scully Company.

Scully Company (Seller) Burton Company (Buyer) 3 Scully Company (Seller) No entry. Burton Company (Buyer) Merchandise Inventory 150 Cash 150

3 July 5. Scully Company sold merchandise on account to Burton Co., $5,000, terms FOB destination, n/30. The cost of the merchandise sold was $3,500.

Scully Company (Seller) Burton Company (Buyer) 3 Scully Company (Seller) Accounts Receivable—Burton Co. 5,000 Sales 5,000 Cost of Merchandise Sold 3,500 Merchandise Inventory 3,500 Burton Company (Buyer) Merchandise Inventory. 5,000 Accounts Payable—Scully Co. 5,000

3 July 7. Scully Company paid transportation costs of $250 for delivery of merchandise sold to Burton Company on July 5.

Scully Company (Seller) Burton Company (Buyer) 3 Scully Company (Seller) Delivery Expense 250 Cash 250 Burton Company (Buyer) No entry.

3 July 13. Scully Company issued Burton Company a credit memorandum for merchandise returned, $1,000. The cost of the merchandise returned was $700.

Scully Company (Seller) Burton Company (Buyer) 3 Scully Company (Seller) Sales Returns and Allowances 1,000 Accounts Receivable—Burton Co. 1,000 Merchandise Inventory 700 Cost of Merchandise Sold 700 Burton Company (Buyer) Accounts Payable—Scully Co. 1,000 Merchandise Inventory 1,000

3 July 15. Scully Company received payment from Burton Company for purchase of July 5.

Scully Company (Seller) Burton Company (Buyer) 3 Scully Company (Seller) Cash 4,000 Accounts Receivable—Burton Co. 4,000 Burton Company (Buyer) Accounts Payable—Scully Co. 4,000 Cash 4,000

3 July 18. Scully Company sold merchandise on account to Burton Company, $12,000, terms FOB shipping point, 2/10, n/eom. Scully prepaid transportation costs of $500, which were added to the invoice. The cost of the merchandise sold was $7,200.

Scully Company (Seller) Burton Company (Buyer) 3 Scully Company (Seller) Accounts Receivable—Burton Co. 12,000 Sales 12,000 Accounts Receivable—Burton Co. 500 Cash 500 Cost of Merchandise Sold 7,200 Merchandise Inventory 7,200 Burton Company (Buyer) Merchandise Inventory 12,500 Accounts Payable—Scully Co. 12,500

3 July 28. Scully Company received payment from Burton Company for purchase of July 18, less discount (2% × $12,000).

Scully Company (Seller) Burton Company (Buyer) 3 Scully Company (Seller) Cash 12,260 Sales Discounts 240 Accounts Receivable—Burton Co. 12,500 Burton Company (Buyer) Accounts Payable—Scully Co. 12,500 Merchandise Inventory 240 Cash 12,260

3 Example Exercise 6-6 Transactions for Buyer and Seller Sievert Co. sold merchandise to Bray Co. on account, $11,500, terms 2/15, n/30. The cost of the merchandise sold is $6,900. Sievert Co. issued a credit memorandum for $900 for merchandise returned and later received the amount due within the discount period. The cost of the merchandise returned was $540. Journalize Sievert Co.’s and Bray Co.’s entries for the payment of the amount due. 6-97

Example Exercise 6-6 (continued) 3 Follow My Example 6-6 Cash ($11,500 – $900 – $212)…………………………….. 10,388 Sales Discounts [($11,500 – $900) × 2%]…..................... 212 Accounts Receivable—Bray Co ($11,500 – $900)… 10,600 Bray Company Journal Entries: Accounts Payable—Sievert Co. ($11,500 – $900)……... 10,600 Merchandise Inventory [($11,500 – $900) × 2%]…… 212 Cash ($11,500 – $900 – $212)…………….................... 10,388 For Practice: PE 6-6A, PE 6-6B 6-98

4 Describe the adjusting and closing process for a merchandising business. 6-99

4 Merchandising businesses may experience some loss of inventory due to shoplifting, employee theft, or errors in recording or counting inventory. If the balance of the Merchandise Inventory account is larger than the total amount of the merchandise count, the difference is often called inventory shrinkage or inventory shortage.

4 NetSolutions’ inventory records indicate the following on December 31, 2011: Dec. 31, 2011 Account balance of Merchandise Inventory $63,950 Physical merchandise inventory on hand 62,150 Inventory shrinkage $ 1,800

4 At the end of the accounting period, inventory shrinkage is recorded by the following adjusting entry:

4 Step 1: Closing Entries Debit each temporary account with a credit balance, such as Sales, for its balance and credit Income Summary.

4 Step 2: Closing Entries Credit each temporary account with a debit balance, such as an expense, for the balance and credit Income Summary.

4 Step 3: Closing Entries Debit Income Summary for the amount of its balance (net income) and credit the owner’s equity account.

4 Step 4: Closing Entries Debit the owner’s capital account for the balance of the drawing account and credit the drawing account.

4 NetSolutions’ Income Summary account after the closing entries have been posted is as follows:

4 Example Exercise 6-7 Inventory Shrinkage Pulmonary Company’s perpetual inventory records indicate that $382,800 of merchandise should be on hand on March 31, 2010. The physical inventory indicates that $371,250 of merchandise is actually on hand. Journalize the adjusting entry for the inventory shrinkage for Pulmonary Company for the year ended March 31, 2010. 6-108

4 Follow My Example 6-7 Mar. 31 Cost of Merchandise Sold………. 11,550 Example Exercise 6-7 (continued) 4 Follow My Example 6-7 Mar. 31 Cost of Merchandise Sold………. 11,550 Merchandise Inventory………. 11,550 Inventory shrinkage ($382,800 – $371,250). For Practice: PE 6-7A, PE 6-7B 6-109

The Periodic Inventory System Appendix 2: The Periodic Inventory System 6-118

Determining Cost of Merchandise Sold Using the Periodic System Exhibit 18

Chart of Accounts Under the Periodic Inventory System Exhibit 19

Transactions Using the Periodic and Perpetual Inventory Systems Exhibit 20

Transactions Using the Periodic and Perpetual Inventory Systems (continued) Exhibit 20

Closing Entries for NetSolutions