Chapter 9 Accounting for Merchandising Operations

In Chapters 1-6 You learned how to: o Prepare Adjusting Entries o Prepare Closing Entries o Use the Adjusted Balances to prepare Financial Statements o Complete the Accounting Cycle

Accrual Basis Accounting Revenue recorded only when earned not when cash is received Expense recorded only when incurred not when cash paid— in the period in which the company benefited from it

Accrual Basis adheres to... Generally Accepted Accounting Principles

Adjusting Entries Adjusting entries make the: revenue recognition & matching principles HAPPEN!

Still confused? Do we need another way to learn this concept?

Revenue Recognition – a rap If you wanna be accrual Here’s what you gotta do, When the service is performed You book the Revenue!

In Chapter 9 You will learn: o How Merchandise is Acquired and Sold o How Inventory Purchases and Sales are recorded in a firm’s accounting records –using Perpetual Inventory system o How to prepare Financial Statements that are meaningful for a merchandising operation o Appendix: Periodic inventory system

Merchandising Operations Buy Merchandise to Sell to their Customers Wholesalers sell their merchandise to Retailers Retailers Sell their merchandise directly to the final consumer 2 Categories

Target is a Retailer

The Operating Cycle for a Merchandiser…

In Chapter 2, we discussed the Historical Cost Principle Assets are recorded on the Balance Sheet at cost Cost includes all costs necessary to get the asset ready for its intended purpose $5,000

The Historical Cost Principle also applies to Inventory o Inventory is a Current Asset o It is recorded on the Balance Sheet at Historical Cost o Cost includes all costs necessary to get the inventory ready for its intended purpose o Let’s look at the cost components for Inventory…..

Let’s assume a Perpetual Inventory System o A Perpetual Inventory system records all changes in the value of Inventory directly in the Inventory Account.

This example begins on page 229 in your text. On June 1, 20X6, Quality Lawn Mowers purchases 100 lawn mowers for $150 each on account from Black & Decker.

Here’s the invoice….. This is the Invoice Date This is the Invoice Amount This information is needed to record the purchase of inventory

The journal entry to record the purchase of inventory….

The Purchase of Inventory is restricted to the Balance Sheet Assume the Initial Investment by shareholders was $100,000 cash.

Goods in Transit These are goods on board a truck, train, ship, or plane at the end of the period.

36 Goods in Transit Who includes these in inventory? zBuyer? zSeller? The Company with Legal Title

Shipping Terms FOB (free on board) shipping point- ownership of goods passes to buyer when public carrier accepts the goods FOB (free on board) destination- ownership of goods remains with the seller until the goods reach the buyer

Ownership passes to owner here Ownership passes to buyer here Public Carrier Co Public Carrier Co Seller Buyer FOB Shipping Point FOB Destination Point Illustration 6-4

Incoming Freight is added to Inventory As it Exits, It’s an Expense! Freight Costs – Memory Jog IN EX

Back to the invoice….. Goods were purchased FOB Shipping Point Title transferred to Quality Lawn Mowers at the time the units were shipped.

The journal entry to record the incoming freight charge Incoming Freight is Charged to Inventory

When Inventory is purchased FOB Shipping Point, the Freight Cost is added to Inventory Assume the Initial Investment by shareholders was $100,000 cash.

Purchase Returns and Allowances

Purchase Returns and Allowances reduce the cost of the Inventory and the amount owed to the vendor

Purchase Discounts 2/10 net 30 If paid within 10 days of invoice Take a 2% discount Are Discounts for Early Payment Otherwise, total is due within 30 days

Payment Terms Take a 1% discount if paid within 10 days, otherwise entire balance is due in 30 days. o Are included on the Invoice o To encourage prompt payment

Purchase Discounts Notice that the Payable Balance is now $0 Balance Owed = $14,700 $14,700 * 1% = $147 $14,700 minus $147 = $14,553

Notice that the Cost of the Inventory equals the sum of the cash payments. $14,896

Inventory T account $14,896 ÷ 98 units = $152 per mower

All transactions related to the Acquisition of inventory have been restricted to the Balance Sheet

As Assets are consumed, they are recorded as expenses on the Income Statement…. Balance Sheet Income Statement Supplies Supplies Expense Prepaid Insurance Insurance Expense Prepaid Rent Rent Expense

As Inventory is consumed, it is expensed as Cost of Goods Sold. It will be recorded as Inventory Expense? So as Inventory is consumed… It is subtracted on the Multiple- Step Income Statement What’s a Multiple Step Income Statement?!! Yes, but the Expense is called “Cost of Goods Sold”

Why is it called a Multiple-Step Income Statement? Because rather than taking total revenues and subtracting total expenses in a single step: We “Step our way down” to Net Income Revenues Subtract Something and Calculate a subtotal Subtract something else, Calculate another subtotal, etc. Each subtotal will provide important information.

Multiple-Step Income Statement Net Sales - Cost of Goods Sold = Gross Profit - Operating Expenses = Income from Operations - Other Expenses + Other Revenues = Net Income ← Amount Customer pays for the goods ← Amount the Company paid for the goods ← This is our markup! ← Selling, General and Administrative Expenses ← Profitability of our Core Business ← Profitability of Peripheral Activities ← Transferred to Statement of Retained Earnings

No Chance….I’m a GONER! Yikes! That’s a lot to remember! Time for another JOG!

Multiple Step Income Statement – Memory Jog NC GONER! N Net Sales - Cost of Goods Sold = Gross Profit - Operating Expenses = Net Operating Income - Other Expenses + Other Revenues = Net Income C G O N E R

A Scanner System is a perpetual inventory system… Every time an item is scanned… 2) The inventory database is updated 1) The Sale is Recorded This allows for an instantaneous match of revenues and expenses

Journal Entries for Sales in a Perpetual Inventory System

Simultaneously, the cost of the units are removed from Inventory…. $14,896 ÷ 98 units = $152 per mower

Reporting Sales and Cost of Goods Sold Each mower sold for $400. Each unit cost $152. That’s a $248 markup per unit.

But our customer isn’t completely happy…. Sales Returns and Allowances is a contra-revenue account. Its purpose is to reduce sales, and provide more detailed information on the Income Statement.

Reporting Sales Returns and Allowances Sales Returns and Allowances is subtracted from Sales In the Calculation of Net Sales It allows the reader to know how content the customers are with the product. They reduced the price by $100 to make me happy!

We offered our customer payment terms of 2/10 net 30 to encourage prompt payment Notice that the Receivable Balance is now $0 $3,900 * 2% = $78 Receivable Balance = $3,900 $3,900 - $78 = $3,822

Reporting Sales Discounts Sales Discounts is subtracted from Sales In the Calculation of Net Sales It allows the reader to know how many customers took advantage of the early payment incentives Paying early saved me $78. I paid $3,822 for the mowers

Merchandisers generate revenue by delivering goods to their customers. The detail provided on a multiple-step income statement Allows the reader to assess how successful they are in achieving that goal.

Appendix – PERIODIC INV.

Perpetual Inventory System Continuous “perpetual” accounting records are kept to track the Sales transaction AND the Cost of the Goods Sold.  Better tracking of item availability, on hand, on order 2 journal entries for a sale

Periodic Inventory System No tracking Inventory just counted “periodically” to see what is on hand. 1 journal entry for sale

Sales Revenues - Under a Periodic System ONLY 1 entry is made for each sale one to record sale

Key difference between periodic and perpetual inventory… is the point at which the costs of goods sold is computed.

No attempt is made on date of sale to record the cost of merchandise sold... Periodic Inventory

Companies that use periodic inventory take a physical count to... zdetermine ending inventory zcompute cost of goods sold Companies that use perpetual inventory must take a physical inventory to check accuracy of “book inventory” to actual inventory.

Example: Perpetual vs. Periodic

End – Chapter 9

Shipping Terms – FOB Shipping Point Title transfers to BUYER at the time the goods are shipped Buyer Owns the goods in transit Freight Costs are paid by the BUYER This increases the cost of the goods purchased.

Shipping Terms – FOB Shipping Point

Shipping Terms – FOB Destination Title Changes at the time the goods reach their destination Seller owns the goods in transit Freight costs are paid by the SELLER The freight cost is recorded as an operating expense by the seller

Shipping Terms – FOB Destination