Accounting for Merchandising Businesses Chapter 6 Accounting for Merchandising Businesses Accounting, 21st Edition Warren Reeve Fess © Copyright 2004 South-Western, a division of Thomson Learning. All rights reserved. Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc. PowerPoint Presentation by Douglas Cloud Professor Emeritus of Accounting Pepperdine University

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After studying this chapter, you should be able to: Objectives 1. Distinguish the activities of a service business from those of a merchandising business. 2. Describe and illustrate the financial statements of a merchandising business. 3. Describe the accounting for the sale of merchandise. 4. Describe the accounting for the purchase of merchandise. After studying this chapter, you should be able to:

Objectives 5. Describe the accounting for transportation costs, sales taxes, and trade discounts. 6. Illustrate the dual nature of merchandising transactions. 7. Prepare a chart of accounts for a merchandising business. 8. Describe the accounting cycle for a merchandising business. 9. Compute the ratio of net sales to assets as a measure of how effectively a business is using its assets.

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

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

Multiple-Step Income Statement

NetSolutions Income Statement For the Year Ended December 31, 2007 Revenue from sales: Sales $720,185 Less:Sales returns and allowances $ 6,140 Sales discounts 5,790 11,930 Net sales $708,255 Cost of merchandise sold 525,305 Gross profit $182,950 Continued

Continued Operating expenses: Selling expenses: Sales salaries expense $56,230 Advertising expense 10,860 Depr. Expense–store equipment 3,100 Miscellaneous selling expense 630 Total selling expenses $ 70,820 Administrative expenses: Office salaries expense $21,020 Rent expense 8,100 Depr. expense–office equipment 2,490 Insurance expense 1,910 Office supplies expense 610 Misc. administrative expense 760 Total admin. expenses 34,890 Total operating expenses 105,710 Income from operations $ 77,240 Continued

Other income and expenses: Rent revenue $ 600 Interest expense (2,440) (1,840) Net income $75,400 Concluded

Periodic vs. Perpetual Methods of Accounting Periodic Method A method of determining the cost of merchandise sold and the amount of merchandise on hand Under this method, the inventory records do not show the amount available for sale or the amount sold during the period

Periodic vs. Perpetual Methods of Accounting Under this method, each purchase and sale of merchandise is recorded in the inventory and the cost of merchandise sold accounts. The amount of merchandise available for sale and the amount sold are continuously disclosed in the inventory records.

Cost of Merchandise Purchased Purchases $521,980 Less: Purchase returns and allowances $9,100 Purchase discounts 2,525 11,625 Net purchases $510,355 Add transportation-in 17,400 Cost of merchandise purchased $527,755

Cost of Merchandise Sold Merchandise inventory, 1/1/07 $ 59,700 Purchases $521,980 Less: Purchase returns and allowances $9,100 Purchase discounts 2,525 11,625 Net purchases $510,355 Add transportation-in 17,400 Cost of merchandise purchased 527,755 Merchandise available for sale $587,455 Less merchandise inventory, 12/31/07 62,150 Cost of merchandise sold $525,305

Single-Step Income Statement for a Merchandising Business

NetSolutions Income Statement For the Year Ended December 31, 2007 Revenues: Net sales $708,255 Rent revenue 600 Total revenues $708,855 Expenses: Cost of merchandise sold $525,305 Selling expenses 70,820 Administrative expenses 34,890 Interest expense 2,440 Total expenses 633,455 Net income $ 75,400

Statement of Owner’s Equity for a Merchandising Business

Chris Clark, capital, 1/1/07 $153,800 Net income for year $75,400 NetSolutions Statement of Owner’s Equity For the Year Ended December 31, 2007 Chris Clark, capital, 1/1/07 $153,800 Net income for year $75,400 Less withdrawals 18,000 Increase in owner’s equity 57,400 Chris Clark, capital, 12/31/07 $211,200

Balance Sheet

NetSolutions Balance Sheet December 31, 2007 Assets Current assets: Cash $52,950 Accounts receivable 91,080 Merchandise inventory 62,150 Office supplies 480 Prepaid insurance 2,650 Total current assets $209,310 Continued

Property, plant, and equipment: Land $20,000 Store equipment $27,100 Less accumulated depreciation 5,700 21,400 Office equipment $15,570 depreciation 4,720 10,850 Total property, plant, and equipment 52,250 Total assets $261,560 Continued

Note payable (current portion) 5,000 Salaries payable 1,140 Liabilities Current liabilities: Accounts payable $22,420 Note payable (current portion) 5,000 Salaries payable 1,140 Unearned rent 1,800 Total current liabilities $ 30,360 Long-term liabilities: Note payable (due 2017) 20,000 Total liabilities $ 50,360 Owner’s Equity Chris Clark, capital 211,200 Total liabilities and owner’s equity $261,560 Concluded

Sales Transactions

On January 3, a firm sold $1,800 of merchandise for cash. Cash Sales JOURNAL PAGE 26 Post. Ref. Description Dr Cr. Date 2007 1 Jan. 3 Cash 1 800 00 2 Sales 1 800 00 To record cash sales. 3 4 5 On January 3, a firm sold $1,800 of merchandise for cash.

Cash Sales 6 3 Cost of Merchandise Sold 1 280 00 7 Merchandise Inventory 1 280 00 8 To record the cost of merchandise sold. 9 10 Using a perpetual inventory, the inventory cost of $1,200 must be recorded.

Cash Sales JOURNAL PAGE 28 Post. Ref. Description Dr Cr. Date 2007 1 Jan. 31 Credit Card Expense 48 00 2 Cash 48 00 3 To record service charges on credit card sales for the month. 4 5 Credit card sales (MasterCard or Visa) are recorded as cash sales. At the end of the month, $48 was sent to cover this service charge.

Sales on Account Jan. 12 Accounts Receivable—Sims Co. 510 00 Sales 510 00 Invoice No. 7172. 12 Cost of Merchandise Sold 280 00 Merchandise Inventory 280 00 Cost of merchandise sold on Invoice No. 7172. On January 12, a firm sold Sims Company merchandise on account, $510. The cost of the merchandise to the seller was $280.

Sales Discounts The terms for when payments for merchandise are to be made are called credit terms. If buyer is allowed an amount of time to pay, it is known as the credit period.

Sales Discounts Credit Terms Invoice for $1,500 Terms: 2/10, n/30 If invoice is paid within 10 days of invoice date $1,470 paid (less 2% as a cash discount)

If invoice is NOT paid within 10 days of invoice date Sales Discounts Credit Terms If invoice is NOT paid within 10 days of invoice date Invoice for $1,500 Terms: 2/10, n/30 $1,500 PAID

Sales Discounts Jan. 21 Cash 499 80 Sales Discounts 10 20 Accounts Receivable—Sims Co. 510 00 Collection of Invoice No. 7172, less discount. On January 21, the firm receives the amount due from Sims (refer to Slide 25), less the 2 percent discount.

Sales Returns and Allowances Merchandise that is returned to the vendor is referred to as a sales return. If there is a defect in the product or the wrong item was shipped, the seller may reduce the initial price at which the goods were sold. This is known as a sales allowance.

Sales Returns and Allowances Jan. 13 Sales Returns and Allowances 225 00 Accounts Receivable—Krier Co. 225 00 Credit Memo No. 32. 13 Merchandise Inventory 140 00 Cost of Merchandise Sold 140 00 Cost of merchandise returned—Credit Memo 32. On January 13, issued Credit Memo 32 to Krier Company for merchandise returned to NetSolutions. Selling price, $225; cost to NetSolutions, $140.

Purchase Transactions

Purchase Transactions Post. Ref. Description Dr Cr. Date 2007 1 Jan. 3 Merchandise Inventory 2 510 00 2 Cash 2 510 00 Purchased inventory from Bowen Co. 3 4 5 On January 3, Purchased merchandise for cash from Bowen Company, $2,510.

What’s the last day the invoice can be paid? Purchase Discounts What’s the last day the invoice can be paid? Alpha Technologies issues an invoice for $3,000 to NetSolutions dated March 12, with terms 2/10, n/30.

Purchase Discounts The full amount is due on April 11. Let’s do a simple calculation. Invoice period 30 Days in March 31 Date of invoice 12 Remaining days 19 April 11

Purchase Discounts We can borrow at an annual interest rate of 6%. Should we borrow to pay the invoice within the discount period? $60 discount (2% x $3,000)?

Let’s see… Interest on the amount due of $3,000 less the 2 percent… Purchase Discounts Let’s see… Interest on the amount due of $3,000 less the 2 percent… Discount $60.00 Interest for 20 days at the rate of 6% on $2,940 –9.80 Savings from borrowing $50.20

Purchase Discounts Looks like we should take advantage of the discount even if we have to borrow the money. Discount $60.00 Interest for 20 days at the rate of 6% on $2,940 –9.80 Savings from borrowing $50.20

Purchase Discounts JOURNAL PAGE 27 Post. Ref. Description Dr Cr. Date 2007 1 Mar. 12 Merchandise Inventory 3 000 00 2 Accounts Payable—Alpha Technologies 3 000 00 3 4 5 On March 12, NetSolutions purchased merchandise on account from Alpha Technologies, $3,000.

Purchase Discounts JOURNAL PAGE 27 Post. Ref. Description Dr Cr. Date 2007 1 Mar. 22 Accounts Payable—Alpha Technol. 3 000 00 Cash 2 940 00 Merchandise Inventory 60 00 2 3 4 5 If payment is made by March 22 NetSolutions records the discount as a reduction in cost.

Purchase Discounts JOURNAL PAGE 27 Post. Ref. Description Dr Cr. Date 2007 1 Apr. 11 Accounts Payable—Alpha Technol. 3 000 00 Cash 3 000 00 2 3 4 5 If NetSolutions does not pay the invoice until April 11, it would pay the full amount.

Purchases Returns and Allowances A purchases return involves actually returning merchandise that is damaged or does not meet the specifications of the order. When the defective or incorrect merchandise is kept by the buyer and the vendor makes a price adjustment, this is a purchases allowance.

Purchases Returns and Allowances You sent me the wrong interface cards. We’ll send a debit memorandum with the returned items. NetSolutions received the delivery from Maxim Systems and determined that $900 of the items were not the merchandise ordered. Debit memorandum #18 is issued to Maxim Systems.

Purchases Returns and Allowances Mar. 7 Accounts Payable—Maxim Systems 900 00 Merchandise Inventory 900 00 Debit Memo No. 18

Purchases Returns and Allowances On May 2, NetSolutions purchased $5,000 of merchandise from Delta Data Link, subject to terms 2/10, n/30. May 2 Merchandise Inventory 5 000 00 Purchased merchandise. Accounts Payable—Delta Data 5 000 00

Purchases Returns and Allowances On May 4, NetSolutions returns $3,000 of the merchandise. May 4 Accounts Payable—Delta Data Links 3 000 00 Returned portion of merchandise purchased. Merchandise Inventory 3 000 00

Purchases Returns and Allowances On May 12, NetSolutions pays the amount due. May 12 Accounts Payable—Delta Data Links 2 000 00 Paid invoice. Cash 1 960 00 Merchandise Inventory 40 00 ($5,000 – $3,000) x 2%

Transportation Costs

FOB Shipping Point Buyer pays freight costs and debits Merchandise Inventory Fruit Express Title passes to buyer as shipment leaves shipping point.

FOB Shipping Point June 10 Merchandise Inventory 900 00 Accounts Payable—Magna Data 900 00 Purchased merchandise, terms FOB shipping point. 10 Merchandise Inventory 50 00 Cash 50 00 Paid shipping cost . On June 10, NetSolutions buys merchandise from Magna Data on account, $900, terms FOB shipping point and pays the transportation cost of $50.

FOB Destination Seller pays freight costs and debits Transportation Out Fruit Express Title passes to buyer upon arrival at destination.

FOB Destination June 15 Accounts Receivable—Kranz Co. 700 00 Sales 700 00 Sold merchandise, terms FOB destination. 15 Cost of Merchandise Sold 480 00 Merchandise Inventory 480 00 Cost of sale of Kranz Co . 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 the transportation cost of $40.

FOB Destination June 15 Transportation Out 40 00 Cash 40 00 Paid shipping cost on merchandise sold. 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 the transportation cost of $40.

Sales Taxes Aug. 12 Accounts Receivable—Lemon Co. 106 00 Sales 100 00 Sales Taxes Payable 6 00 Invoice No. 339 On August 12, merchandise is sold on account to Lemon Company, $100. The state has a 6% sales tax.

Sales Taxes Sept.15 Sales Tax Payable 2 900 00 Cash 2 900 00 Payment for sales taxes collected during August. On September 15, the seller sends in a payment of $2,900 to the taxing unit for the August taxes collected.

Illustration of Accounting for Merchandise Transactions 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 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.

Illustration of Accounting for Merchandise Transactions Scully Company (Seller) No entry. Burton Company (Buyer) Merchandise Inventory 150 Cash 150 July 2. Burton Company paid transportation charges of $150 on July 1 purchase from Scully Company.

Illustration of Accounting for Merchandise Transactions 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 July 5. Scully Company sold merchandise on account to Burton Co., $5,000, terms FOB shipping point, n/30. The cost of the merchandise sold was $3,500.

Illustration of Accounting for Merchandise Transactions Scully Company (Seller) Transportation Out 250 Cash 250 Burton Company (Buyer) No entry. July 7. Scully Company paid transportation costs of $250 for delivery of merchandise sold to Burton Company on July 5.

Illustration of Accounting for Merchandise Transactions 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 July 13. Scully Company issued Burton Company a credit memorandum for $1,000 of merchandise returned from a July 5 purchase on account. The cost of the merchandise was $700.

Illustration of Accounting for Merchandise Transactions Scully Company (Seller) Cash 4,000 Accounts Receivable—Burton Co. 4,000 Burton Company (Buyer) Accounts Payable—Scully Co. 4,000 Cash 4,000 July 15. Scully Company received payment from Burton Company for purchase of July 5.

Illustration of Accounting for Merchandise Transactions Scully Company (Seller) Accounts Receivable—Burton Co. 12,000 Sales 12,000 Accounts Receivable—Burton Co. 500 Cash 500 Burton Company (Buyer) Merchandise Inventory 12,500 Accounts Payable—Scully Co. 12,500 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.

Illustration of Accounting for Merchandise Transactions Continued (Seller) Cost of Merchandise Sold 7,200 Merchandise Inventory 7,200 Burton Company (Buyer) 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.

Illustration of Accounting for Merchandise Transactions 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 July 28. Scully Company received payment from Burton Company for purchase of July 18, less discount (2% x $12,000).

Balance Sheet Accounts NetSolutions Chart of Accounts Balance Sheet Accounts 200 Liabilities 210 Accounts Payable 211 Salaries Payable 212 Unearned Rent 215 Notes Payable 300 Owner’s Equity 310 Chris Clark, Capital 311 Chris Clark, Drawing 312 Income Summary 100 Assets 110 Cash 112 Accounts Receivable 115 Merchandise Inventory 116 Office Supplies 117 Prepaid Insurance 120 Land 123 Store Equipment 124 Accumulated Depreciation— Store Equipment 125 Office Equipment 126 Accumulated Depreciation— Office Equipment

Income Statement Accounts NetSolutions Chart of Accounts Income Statement Accounts 500 Costs and Expenses 510 Cost of Merchandise Sold 520 Sales Salaries Expense 521 Advertising Expense 522 Depreciation Expense— Store Equipment 523 Transportation Out 529 Miscellaneous Selling Expense 530 Office Salaries Expense 531 Rent Expense 532 Depreciation Expense— Office Equipment 533 Insurance Expense 534 Office Supplies Expense 539 Miscellaneous Admin. Expense 400 Revenues 410 Sales 411 Sales Returns and Allowances 412 Sales Discounts 600 Other Income 610 Rent Revenue 700 Other Expense 710 Interest Expense

Merchandise Inventory Shrinkage NetSolutions inventory records indicate that $63,950 of merchandise should be available for sale on December 31, 2007. The physical count reveals that only $62,150 is actually available.

Merchandise Inventory Shrinkage Adjusting Entry Dec. 31 Cost of Merchandise Sold 1 800 00 Merchandise Inventory 1 800 00 Inventory records $63,950 Inventory count 62,150 Inventory shortage $ 1,800

Profitability Measures -- Effective Use of Assets Ratio of Net Sales to Assets Sears Penney Net sales $41,366,000 $31,846,000 Total assets: Beginning of year $50,409,000 $19,742,000 End of year $44,317,000 $20,908,000 Average $47,363,000 $20,325,000 Ratio of net sales to assets .87 to 1 1.57 to 1 Ratio Use: To assess the effectiveness in the use of assets to generate sales.

Chapter 6 The End