Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. Prepared by: Debbie Musil Kwantlen University College Chapter 5 Accounting for Merchandising Operations

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. Income Measurement Process for a Merchandising Company SalesRevenue Cost of Goods Sold Cost of Goods Sold LessGrossProfitGrossProfit Equals OperatingExpenses NetIncome(Loss) EqualsLess

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. Perpetual Inventory System Maintains detailed records of inventory purchases and sales Maintains detailed records of inventory purchases and sales Continuously (perpetually) shows quantity and cost of inventory purchased, sold and on hand Continuously (perpetually) shows quantity and cost of inventory purchased, sold and on hand Cost of Goods Sold is calculated and recorded at the time of each sale Cost of Goods Sold is calculated and recorded at the time of each sale

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. Recording Merchandise Purchases When merchandise is purchased for resale: When merchandise is purchased for resale: Dr. Merchandise inventory (for cost of goods) Dr. Merchandise inventory (for cost of goods) Cr. Accounts payable (purchases on credit) or Cash (cash purchases) The purchase is normally recorded when the merchandise is received The purchase is normally recorded when the merchandise is received

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. Freight Costs Purchase agreement indicates when ownership of the goods is transferred from buyer to seller Purchase agreement indicates when ownership of the goods is transferred from buyer to seller FOB Shipping Point: FOB Shipping Point: Buyer accepts ownership at place of shipping and pays for shipping costsBuyer accepts ownership at place of shipping and pays for shipping costs Buyer debits Merchandise Inventory for cost of shippingBuyer debits Merchandise Inventory for cost of shipping FOB Destination: FOB Destination: Buyer accepts ownership when goods are delivered to buyer’s place of business and seller pays freight costsBuyer accepts ownership when goods are delivered to buyer’s place of business and seller pays freight costs Seller debits Freight Out for cost of shippingSeller debits Freight Out for cost of shipping

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. Purchase Returns & Allowances Goods purchased may be damaged, defective, of inferior quality, or they may not meet purchaser’s specifications Goods purchased may be damaged, defective, of inferior quality, or they may not meet purchaser’s specifications Goods may be returned or purchase price may be reduced (an allowance) Goods may be returned or purchase price may be reduced (an allowance) Entry to record: Entry to record: Dr. Cash or Accounts payable Dr. Cash or Accounts payable Cr. Merchandise Inventory (for amount of return or adjustment)

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. Quantity and Purchase Discounts Quantity discount: reduction in price due to the quantity being purchased Quantity discount: reduction in price due to the quantity being purchased Purchase discount: reduction in price due to early payment of amount due Purchase discount: reduction in price due to early payment of amount due Entry to record: Entry to record: Dr. Cash or Accounts payable Dr. Cash or Accounts payable Cr. Merchandise Inventory (for amount of discount)

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. Recording Sales of Merchandise Revenues are reported when earned Revenues are reported when earned Revenue recognition principleRevenue recognition principle Typically when goods are transferred from seller to buyerTypically when goods are transferred from seller to buyer Two entries needed to record the sale: Two entries needed to record the sale: To record sales revenue:To record sales revenue: Dr. Cash or Accounts payable Dr. Cash or Accounts payable Cr. Sales To record cost of goods sold:To record cost of goods sold: Dr. Cost of Goods Sold Dr. Cost of Goods Sold Cr. Merchandise Inventory

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. Sales Taxes Collected by merchandising companies on the goods that they sell Collected by merchandising companies on the goods that they sell Periodically remitted to government Periodically remitted to government Sales taxes collected are not revenue Sales taxes collected are not revenue Treated as a liability until paid (as they are due to the government)Treated as a liability until paid (as they are due to the government)

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. Sales Returns & Allowances Sales returns: when customers return merchandise to seller for credit or refund Sales returns: when customers return merchandise to seller for credit or refund Sales allowances: when seller grants customers a price reduction Sales allowances: when seller grants customers a price reduction Seller’s entry required: Seller’s entry required: Dr. Sales returns and allowances Cr. Accounts receivable or cash If merchandise returned, additional entry required: If merchandise returned, additional entry required: Dr. Merchandise inventory Cr. Cost of goods sold Dr. Merchandise inventory Cr. Cost of goods sold

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. Quantity and Sales Discounts Quantity discount: Quantity discount: Reduction in selling price due to the volume of goods purchasedReduction in selling price due to the volume of goods purchased Sale is recorded at reduced priceSale is recorded at reduced price Sales discount: Sales discount: Discount offered for early payment of billDiscount offered for early payment of bill Discount amount taken is credited to Sales Discounts (a contra revenue account)Discount amount taken is credited to Sales Discounts (a contra revenue account) Original amount in Sales is not changedOriginal amount in Sales is not changed

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. Completing the Accounting Cycle Same types of adjusting entries as a service company Same types of adjusting entries as a service company One additional adjustment for inventory One additional adjustment for inventory To ensure the recorded inventory amount agrees with the actual quantity on handTo ensure the recorded inventory amount agrees with the actual quantity on hand A physical count is an important control feature A physical count is an important control feature A perpetual system indicates what should be thereA perpetual system indicates what should be there An inventory count will determine what existsAn inventory count will determine what exists Additional accounts to be closed: Sales, Sales Returns and Allowances, Sales Discounts, Cost of Goods Sold, Freight Out Additional accounts to be closed: Sales, Sales Returns and Allowances, Sales Discounts, Cost of Goods Sold, Freight Out

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. Multiple-Step Income Statement Calculation of Net sales and Gross profit Calculation of Income from operations Calculation of Non-operating activities and Net income

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. Single-Step Income Statement All data are classified as either (1) revenues or (2) expenses

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. Classified Balance Sheet Merchandise Inventory reported as a current asset following Accounts Receivable

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. Periodic Inventory System Purchases Calculation of Cost of Goods Sold is only performed at end of period Calculation of Cost of Goods Sold is only performed at end of period When physical inventory count is doneWhen physical inventory count is done Causes accounting entries to be different Causes accounting entries to be different Detailed records are not kept throughout the period Detailed records are not kept throughout the period Cost of Goods Sold is calculated at the end of the accounting period Cost of Goods Sold is calculated at the end of the accounting period

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. Recording Purchases of Merchandise Merchandise Inventory account is not used; separate accounts are used instead: Merchandise Inventory account is not used; separate accounts are used instead: Merchandise purchases are debited to Purchases accountMerchandise purchases are debited to Purchases account Freight costs are debited to Freight In accountFreight costs are debited to Freight In account Returns and allowances are credited to Purchase Returns and Allowances accountReturns and allowances are credited to Purchase Returns and Allowances account Discounts are credited to Purchase Discounts accountDiscounts are credited to Purchase Discounts account

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. Periodic Inventory System Sales At time of sale, only Sales Revenue is recorded At time of sale, only Sales Revenue is recorded Dr. Accounts receivable or Cash Cr. Sales No entry is made to recognize cost of salesNo entry is made to recognize cost of sales Freight costs, sales returns, allowances and discounts are treated the same as under a perpetual inventory system Freight costs, sales returns, allowances and discounts are treated the same as under a perpetual inventory system

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. Periodic Inventory System Calculating Cost of Goods Sold Cost of Goods Purchased Cost of Goods Purchased Add Purchases and Freight InAdd Purchases and Freight In Subtract Purchase Returns and Allowances and Purchase DiscountsSubtract Purchase Returns and Allowances and Purchase Discounts Cost of Goods on Hand Cost of Goods on Hand Based on physical count of inventoryBased on physical count of inventory = Number of units counted x unit cost Cost of Goods Sold Cost of Goods Sold = Cost of Goods on Hand at beginning of period + Cost of Goods Purchased – Cost of Goods on Hand at end of period

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. Periodic Inventory System Calculating Cost of Goods Sold = Inventory at start of period + Cost of Goods Purchased - Inventory at end of period

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. Periodic Inventory System Completing the Accounting Cycle Regular closing entries for all purchase and sales discounts, allowances, freight Regular closing entries for all purchase and sales discounts, allowances, freight Additional entry is required to close beginning merchandise inventory Additional entry is required to close beginning merchandise inventory Dr. Income summary Cr. Inventory Another entry is required to establish ending merchandise inventory Another entry is required to establish ending merchandise inventory Dr. Inventory Cr. Income summary

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. Using the Information in the Financial Statements Profitability ratios: measure income or operating success for a specific time period Profitability ratios: measure income or operating success for a specific time period Gross profit margin: Gross profit margin: Gross profit expressed as a percentageGross profit expressed as a percentage Measures the effectiveness of a company’s purchasing and pricing policiesMeasures the effectiveness of a company’s purchasing and pricing policies = Gross Profit ÷ Net Sales

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. Using the Information in the Financial Statements 2 Profit margin: Profit margin: The percentage of sales that results in net incomeThe percentage of sales that results in net income Measures the ability of a company to cover all expenses and provide a return to ownersMeasures the ability of a company to cover all expenses and provide a return to owners = Net Income ÷ Net Sales

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition © 2009 John Wiley & Sons Canada, Ltd. COPYRIGHT Copyright © 2009 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (The Canadian Copyright Licensing Agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information contained herein.