Needles Powers Principles of Financial Accounting 12e Accounting for Merchandising Operations 6 C H A P T E R ©human/iStockphoto

Concepts Underlying Merchandising Accounting  A merchandising company earns income by buying and selling goods, which are called merchandise inventory. –The buying and selling of goods adds to the complexity of the accounting process. –Merchandise inventory is an important component on the operating cycle, which is the cycle of buying and holding merchandise until it is sold and then collecting payment for the sales. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Concepts Underlying Merchandising Accounting - Perpetual inventory system—Under this system, continuous records are kept of the quantity and, usually, the cost of individual items as they are bought and sold.  At all times, the balance of the Merchandise Inventory account equals the cost of goods on hand. - Periodic inventory system—Under this system, the inventory not yet sold is counted periodically.  The physical count is called physical inventory, which is usually taken at the end of the accounting period.  The figure for inventory is accurate only on the balance sheet date. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Two basic systems of accounting for merchandise inventory are used:

Multistep Income Statement  A multistep income statement goes through a series of steps or subtotals to arrive at net income. –In the income statement of a service company (which provides services as opposed to products), the operating expenses are deducted from revenues in a single step to arrive at income from operations. –The income statements of manufacturing companies (which make and sell products) and merchandising companies (which buy and sell products) include an additional step of calculating gross margin by subtracting the cost of goods from net sales. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Net Sales and Cost of Goods Sold  Net sales (or net revenue) is computed as follows: Net Sales = Gross Sales − Sales Returns and Allowances –Gross sales consist of the total revenue from cash and credit sales during a period. –Sales returns and allowances include cash refunds and credits on account. They also include any discounts from selling prices made to customers who have returned defective or unsatisfactory products.  Cost of goods sold (or cost of sales or cost of revenue) is the amount a merchandiser paid for the merchandise it sold during a period. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Gross Margin and Income from Operations  Gross margin (or gross profit) is computed as follows: Gross Margin = Net Sales − Cost of Goods Sold –Managers and owners are also interested in percentage of gross margin, which is computed as follows: Percentage of Gross Margin = Gross Margin ÷ Net Sales  Income from operations (or operating income) is the income from a company’s main business and is computed as follows: Income from Operations = Gross Margin − Operating Expenses ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Operating Expenses  Operating expenses are the expenses, other than cost of goods sold, that are incurred in running a business. They are computed as follows: Operating Expenses = Selling Expenses + General and Administrative Expenses –Selling expenses include the costs of storing goods and preparing them for sale; preparing displays, advertising, and otherwise promoting sales; and delivering goods to the buyer. –General and administrative expenses include accounting, personnel, credit checking, collections, and any other expenses that apply to overall operations. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Other Revenues and Expenses and Net Income  Other revenues and expenses (or nonoperating revenues and expenses) are not related to a company’s operating activities. Included in this section are: –Revenues from investments (such as dividends on stock) –Interest expenses and other expenses that result from borrowing money  Net income (or net earnings) is the final figure, or “bottom line,” of an income statement and is computed as follows: Net Income = Gross Margin − Operating Expenses +/ − Other Revenues and Expenses ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Single-Step Income Statement  In a single-step income statement, net income is derived in a single step by putting the major categories of revenues in the first part of the statement and the major categories of costs and expenses in the second part.  Both the multistep form and the single-step form have advantages. –The multistep form shows the components used in deriving net income. –The single-step form has the advantage of simplicity. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Terms of Sale  Manufacturers and wholesalers often quote prices as a percentage off their list or catalogue prices. Such a reduction is called a trade discount. –If an article is listed at $1,000 with a trade discount of 40 percent, or $400, the seller records the sale at $600, and the buyer records the purchase at $600.  If an invoice is marked “n/30” (“net 30”), the invoice is due 30 days after the invoice date. If the invoice is marked “n/10 eom,” it is due 10 days after the end of the month (“eom”). ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Sales and Purchases Discounts  In some industries, it is customary to give a sales discount for early payment. –An invoice that offers a sales discount of “2/10, n/30” means that the buyer either can pay within 10 days of the invoice date and receive a 2 percent discount or wait 30 days and pay the full amount.  Purchase discounts are discounts that the buyer takes for the early payment of merchandise. –Both the seller and the buyer record the purchase at the full amount. If the buyer pays in time to get the discount, it is recorded as “Sales Discount” for the seller and “Purchases Discount” for the buyer. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Transportation Costs (slide 1 of 2)  Special terms designate whether the seller or purchaser pays the freight charges: –FOB shipping point means that the seller places the merchandise “free on board” at the point of origin and the buyer bears the shipping costs. The title to the merchandise passes to the buyer at that point. –FOB destination means that the seller bears the transportation costs to the delivery point. The seller retains title until the merchandise reaches its destination and usually prepays the shipping costs, in which case the buyer makes no accounting entry for freight. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Transportation Costs (slide 2 of 2)  When the buyer pays the transportation charge, it is called freight-in, and it is added to the cost of merchandise purchased.  When the seller pays the transportation charge, it is called delivery expense (or freight-out), and it is included in selling expenses on the income statement. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Perpetual Inventory System  Under the perpetual inventory system, Merchandise Inventory and Cost of Goods Sold are continually updated during the accounting period as purchases, sales, and other inventory transactions occur. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Periodic Inventory System (slide 1 of 2)  Under the periodic inventory system, cost of goods sold must be computed on the income statement because it is not updated for purchases, sales, and other transactions during the accounting period.  It is important to distinguish between the cost of goods sold and the cost of goods available for sale. –The cost of goods sold is the cost of merchandise actually sold in the accounting period. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Periodic Inventory System (slide 2 of 2) –The cost of goods available for sale is the total cost of merchandise that could be sold in the accounting period. It is the sum of the following two factors:  The amount of merchandise on hand at the beginning of the period.  The net purchases during the period. (Net purchases consist of total purchases plus freight-in less any deductions, such as purchases returns and allowances and discounts from suppliers for early payment.) –The difference between cost of goods available for sale and cost of goods sold is the amount not sold, or the ending merchandise inventory. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Cash Flows in the Operating Cycle ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

The Financing Period  The financing period (or cash gap) is the amount of time from the purchase of inventory until it is sold and payment is collected, less the amount of time creditors give the company to pay for the inventory. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Foreign Business Transactions  An international business transaction is measured in two different currencies, and one currency has to be translated into another by using an exchange rate.  If a U.S. company bills a foreign company in the foreign company’s currency and accepts payment in the foreign currency, it will incur an exchange gain or loss if the exchange rate changes between the date of the sale and the date of payment. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.