Financial Accounting, Seventh Edition Chapter 5 Accounting for Merchandising Operations

Service Activities Service organizations provide a service to earn revenue. Examples: Google, Verizon, Fox, Marriott, ESPN. Revenues Expenses Minus Net income Equals How has the NETFLIX business model changed over time?

Merchandising Operations Merchandising Companies Buy and Sell Goods Wholesaler Retailer Consumer The primary source of revenues is referred to as sales revenue or sales.

Merchandising Operations Income Measurement Sales Revenue Not used in a Service business. Less Cost of Goods Sold Gross Profit Equals Less Operating Income (Loss) Operating Expenses Equals Cost of goods sold (an Expense) is the total cost of merchandise sold during the period.

Reporting Income of Merchandising Company WAL-MART STORES, Inc. Consolidated Statement of Income For the year ended January 31, 2012 (all amounts in millions)

Reporting Income of Merchandising Company BEST BUY COMPANY, Inc. Consolidated Statement of Income For the year ended March 3, 2012 (all amounts in millions of dollars)

How Big is WAL-MART?

Knowledge Check Question: In its income statement, a company reported operating expenses of $157,000. Determine sales and gross profit given cost of goods sold was $544,000 and operating loss was $41,000. Sales: $660,000; Gross Profit: $503,000. Sales: $742,000; Gross Profit: $198,000. Sales: $742,000; Gross Profit: $585,000. Sales: $660,000; Gross Profit: $116,000.

Merchandising Operations Flow of Costs Perpetual System Purchases increase Merchandise Inventory. Freight costs, Purchase Returns and Allowances and Purchase Discounts are included in Merchandise Inventory. Cost of Goods Sold is increased and Merchandise Inventory is decreased for each sale. Physical count done to verify Merchandise Inventory balance. The perpetual inventory system provides a continuous record of Merchandise Inventory and Cost of Goods Sold.

Merchandising Operations Cost of Beginning inventory Net cost of purchases + = Cost of goods available for sale Cost of Ending inventory Cost of goods sold +

Knowledge Check: A company’s cost of goods sold was $345,000 Knowledge Check: A company’s cost of goods sold was $345,000. Determine net cost of purchases and cost of ending inventory, given cost of goods available for sale were $595,000 and cost of beginning inventory was $120,000. Net Cost of Purchases Cost of Ending Inventory $475,000 $250,000 $250,000 $475,000 $475,000 $225,000 $250,000 $225,000

Merchandising Operations Flow of Costs Periodic System Purchases of merchandise increase Purchases. Ending Inventory determined by physical count. Calculation of Cost of Goods Sold: Beginning inventory $ 100,000 Add: Purchases, net 800,000 Goods available for sale 900,000 Less: Ending inventory 125,000 Cost of goods sold $ 775,000

Invoice date Purchaser Order number Credit terms   Seller Invoice date Purchaser Order number Credit terms Freight terms Goods Invoice amount      This is an example of an invoice that would support the purchase of merchandise inventory. Notice all the different information on the invoice such as the seller, purchaser, credit terms, items purchased, and amount of the purchase. The invoice helps provide much of the information needed when recording the entry to purchase inventory.  4-13

Recording Purchases of Merchandise On February 1, Wally Mart purchased $10,000 of Merchandise inventory, on account (terms: 2/10, n 30).

Recording Transportation Costs Seller Buyer Merchandise FOB shipping point (buyer pays freight costs) FOB destination (seller pays freight costs)

Recording Purchase of Merchandise along with Transportation Costs On February 1, Wally Mart purchased merchandise inventory (fob shipping point), and paid $600 transportation costs in cash.

Recording Purchase Returns of Merchandise Purchase Returns and Allowances Purchaser may be dissatisfied because goods are damaged or defective, of inferior quality, or do not meet specifications. Purchase Return Purchase Allowance 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.

Recording Purchase Returns of Merchandise On February 4, Wally Mart returned $1,000 of defective merchandise to the supplier.

Recording Purchase Discounts A deduction from the invoice price granted to induce early payment of the amount due. Advantages: Purchaser saves money. Seller shortens the operating cycle. 2/10,n/30 Discount Percent Number of Days Discount Is Available Otherwise, Net (or All) Is Due Credit Period

Recording Purchases of Merchandise Purchase Discount Terms 2/10, n/30 1/10 EOM n/10 EOM 2% discount if paid within 10 days, otherwise net amount due within 30 days. 1% discount if paid within first 10 days of next month. Net amount due within the first 10 days of the next month.

Recording Payments, net of Returns and Discounts On February 10, the last day of the discount period, Wally Mart paid the balance due for the Feb 1 purchase. Prepare the journal entry for payment.

Recording Payments without discount If Wally Mart failed to take the discount, and instead made full payment on February 15, the journal entry would be:

A credit to merchandise inventory for $700. Knowledge Check: Tony Company purchased $8,500 of merchandise on September 25 on terms of 1/10, n30. On September 27, Tony returned defective merchandise worth $700, and received full credit. The invoice was paid in full on September 30. Tony’s journal entry on September 30 will include: A credit to merchandise inventory for $700. A debit to accounts payable for $7,800. A credit to cash for $8,415 A credit to Merchandise Inventory for $85.

Recording Sales of Merchandise Made for cash or credit (on account). Normally recorded when earned, usually when goods transfer from seller to buyer. Sales invoice should support each credit sale. Two Journal Entries to Record a Sale: Cash or Accounts receivable XXX Selling Price #1 Sales XXX Cost of goods sold XXX Cost #2 Merchandise inventory XXX

Recording Sales of Merchandise On February 11, Wally Mart sold $1,000 of merchandise on account. The merchandise was carried in inventory at a cost of $700. Credit Terms were 3/10, n 30.

Recording Returns of Merchandise Sold On February 13, a customer returned merchandise with a sales price of $300 and a cost of $210 to Wally Mart . The return is related to the Feb 11 sale. Assume the goods were NOT defective. Sales Returns and Allowances is a contra revenue account.

Recording returns of Merchandise Sold Sales 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 between total sales in different accounting periods.

Recording Returns of Merchandise Sold On February 13, a customer returned merchandise with a sales price of $300 and a cost of $210 to Wally Mart . The return is related to the Feb 11 sale. Assume the returned goods were defective, and had a scrap value of $50. The journal entry would be:

Cash Receipts, net of Returns and Discounts On February 17, Wally Mart received the net amount owed from the sale of Feb 11. Sales Discounts is a contra revenue account.

Knowledge Check: On July 26, Tyler Company makes a sale for $500 to Pauli Company. The cost of the merchandise sold was $300. On August 1, Pauli Company returned the merchandise, which is not defective, and is restored back to the inventory. What is the effect of the August 1 transaction on Total assets and Equity for Tyler Company? Total assets increase $300;Equity increases $300. Total assets decrease $500; Equity decreases $500. Total assets decrease $200; Equity decreases $200. Total assets increase $200; Equity increases $200.

Completing the Accounting Cycle Adjusting Entries Generally the same as a service company. One additional adjustment to make the records agree with the actual inventory on hand. Involves adjusting Merchandise Inventory and Cost of Goods Sold.

Adjusting Entry for Shrinkage At the end of accounting period, Wally Mart’s Inventory Account shows an unadjusted balance of $15,000, but a physical count shows that only $14,300 of inventory on hand. Determine the adjusting entry for Shrinkage.

Forms of Financial Statements Multiple-Step Income Statement Shows several steps in determining net income. Two steps relate to principal operating activities. Distinguishes between operating and non-operating activities.

Multiple-Step Income Statement Income Statement Presentation of Sales

Multiple-Step Income Statement Gross Profit Illustration 5-13 Key Items: Net sales Gross profit Gross profit rate Illustration 5-10

Forms of Financial Statements Illustration 5-13 Forms of Financial Statements Multiple-Step Key Items: Net sales Gross profit Operating expenses

Forms of Financial Statements Illustration 5-13 Forms of Financial Statements Key Items: Net sales Gross profit Operating expenses Nonoperating activities Net income

Forms of Financial Statements Single-Step Income Statement Subtract total expenses from total revenues Two reasons for using the single-step format: Company does not realize any type of profit until total revenues exceed total expenses. Format is simpler and easier to read.

Forms of Financial Statements Illustration 5-14 Single-Step

Forms of Financial Statements Classified Balance Sheet Illustration 5-15

End of Chapter 5 “If You Always Do What You Always Did, You Always Get What You Always Got.” W. Edward Deming