1. Chapter-5: Accounting for Merchandising Operations Merchandising OperationsRecording Purchases of MerchandiseRecording Sales of MerchandiseCompleting the Accounting CycleForms of Financial Statement 1

2. Merchandising Operations Merchandising Companies Buy and Sell Goods WholesalerRetailerConsumer The primary source of revenues is referred to as sales revenue or sales. 2

3. Merchandising Operations Income Measurement Cost of goods sold is the total cost of merchandise sold during the period. Not used in a Service business. 3

4. Merchandising Operations The operating cycle of a merchandising company ordinarily is longer than that of a service company. Operating Cycles 4

5. Merchandising Operations Companies use either a perpetual inventory system or a periodic inventory system to account for inventory. Flow of Costs 5

6. Merchandising Operations Perpetual System  Maintain detailed records of the cost of each inventory purchase and sale.  Records continuously show inventory that should be on hand.  Company determines cost of goods sold each time a sale occurs. Flow of Costs Periodic System  Do not keep detailed records of the goods on hand.  Cost of goods sold determined by count at the end of the accounting period. 6

7. Merchandising Operations Calculation of COGS Beginning inventory$ 100,000 Add: Purchases, net800,000 Goods available for sale900,000 Less: Ending inventory125,000 Cost of goods sold$ 775,000 7

8. Merchandising Operations Additional Consideration Perpetual System:  Traditionally used for merchandise with high unit values.  Provides better control over inventories.  Requires additional clerical work and additional cost to maintain inventory records.  Nowadays fully computerized system makes it easier to record 8

9. Recording Purchases of Merchandise (Perpetual system)  Companies purchase inventory using cash or credit (on account).  Normally recorded when goods are received.  Purchase invoice should support each credit purchase. 9

10. Recording Purchases of Merchandise Example: Sauk Stereo (the buyer) uses as a purchase invoice, the sales invoice prepared by PW Audio Supply, Inc. (the seller). Prepare the journal entry for Sauk Stereo for the invoice from PW Audio Supply. Inventory (or, Merchandise Inventory) 3,800May 4 Accounts payable 3,800 (to record goods purchased on account from PW Audio Supply) 10

11. Recording Purchases of Merchandise Seller places goods Free On Board the carrier, and buyer pays freight costs. Freight Costs – FOB Shipping Point Example: Assume upon delivery of the goods on May 6, Sauk Stereo pays Acme Freight Company $150 for freight charges, the entry on Sauk Stereo’s books is: Inventory150May 6 Cash 150 11

12. Recording Purchases of Merchandise Freight Costs – FOB Destination Seller places goods Free On Board to the buyer’s place of business, and seller pays freight costs. Freight costs incurred by the seller are an operating expense. Example: Assume the freight terms on the invoice in Illustration 5-5 had required PW Audio Supply to pay the freight charges, the entry by PW Audio Supply would have been: Freight-out (or, Delivery Expense) 150May 4 Cash 150 12

13. Recording Purchases of Merchandise Purchaser may be dissatisfied because goods are damaged or defective, of inferior quality, or do not meet specifications. Purchase Returns and Allowances 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. Purchase Return Purchase Allowance Example: Assume that on May 8 Sauk Stereo returned to PW Audio Supply goods costing $300. Accounts payable300May 8 Inventory 300 13

14. Recording Purchases of Merchandise Sellers may permit buyer to claim a cash discount for prompt payment through Credit Terms. Credit terms specify the amount of cash discount and time period in which discount is offered. Advantages:  Purchaser saves money.  Seller shortens the operating cycle. Purchase Discounts 14

15. Recording Purchases of Merchandise 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. 2/10, n/301/10 EOM Net amount due within the first 10 days of the next month. n/10 EOM Purchase Discounts: Examples of Credit Terms 15

16. Recording Purchases of Merchandise Accounts payable3,500May 14 Cash 3,430 Inventory 70 (Discount = $3,500 x 2% = $70) Example: Assume Sauk Stereo pays the balance due of $3,500 (gross invoice price of $3,800 less purchase returns and allowances of $300) on May 14, the last day of the discount period. Prepare the journal entry Sauk Stereo makes to record its May 14 payment. (terms: 2/10, n/30) Purchase Discounts 16

17. Recording Purchases of Merchandise Should discounts be taken when offered? ◦ If cash is sitting idle and not generating any return then discount should be taken ◦ If cash is generating a return then compare the income with the discount amount and take the one with higher advantage.  Examples of returns: Bank interests, Stock profits, Bond interests etc. Purchase Discounts 17

18. Recording Purchases of Merchandise Example: 18

19. Recording Purchases of Merchandise $3,800 8 th - Return $300 Balance 4 th - Purchase $3,580 70 14 th - Discount Summary of Purchasing Transactions 150 6 th – Freight-in 19

20. Recording Sales of Merchandise (Perpetual system)  Made using cash or credit (on account).  Normally recorded when earned, usually when goods transfer from seller to buyer.  Sales invoice should support each credit sale. 20

21. Recording Sales of Merchandise Journal Entries to Record a Sale Cash or Accounts receivableXXX Sales revenue XXX #1 Cost of goods soldXXX Inventory XXX #2 Selling Price Cost 21

22. Recording Sales of Merchandise Accounts receivable3,800May 4 Sales revenue 3,800 Example: Assume PW Audio Supply records its May 4 sale of $3,800 to Sauk Stereo on account (Illustration 5-5) as follows. Assume the merchandise cost PW Audio Supply $2,400. Cost of goods sold2,4004 Inventory 2,400 22

23.  “Flipside” of purchase returns and allowances.  Customer/Client may be dissatisfied because goods are damaged or defective, of inferior quality, or do not meet specifications.  Contra-revenue account (Sales returns and allowances ) (debit).  Sales not reduced (debited) because: ► Would obscure importance of sales returns and allowances as a percentage of sales. ► Could distort comparisons. Recording Sales of Merchandise Sales Returns and Allowances 23

24. Recording Sales of Merchandise Example: Prepare the entry PW Audio Supply would make to record the credit for returned goods that had a $300 selling price (assume a $140 cost). Assume the goods were not defective. Sales returns and allowances 300May 8 Accounts receivable300 Inventory 1408 Cost of goods sold140 24

25. Recording Sales of Merchandise Sales returns and allowances 300May 8 Accounts receivable300 Inventory 508 Cost of goods sold50 Example: Assume the returned goods were defective and had a scrap value of $50, PW Audio would make the following entries: 25

26. Recording Sales of Merchandise  Offered to customers to promote prompt payment.  “Flipside” of purchase discount.  Contra-revenue account (Sales discounts) (debit).  *(3800-300-70=3430) Sales Discount 26

27. Recording Sales of Merchandise Cash3,430May 14 Accounts receivable3,500 Sales discounts70 * [($3,800 – $300) X 2%] * Example: Assume Sauk Stereo pays the balance due of $3,500 (gross invoice price of $3,800 less purchase returns and allowances of $300) on May 14, the last day of the discount period. Prepare the journal entry PW Audio Supply makes to record the receipt on May 14. 27

28. Completing the Accounting Cycle  Generally the same as a service company.  One additional adjustment to make the records agree with the actual inventory on hand.  In perpetual inventory system adjustment is required only when records are incorrect due to recording errors, theft or waste.  Involves adjusting Inventory and Cost of Goods Sold. Adjusting Entries 28

29. Completing the Accounting Cycle Example: Suppose that PW Audio Supply has an unadjusted balance of $40,500 in Merchandise Inventory. Through a physical count, PW Audio determines that its actual merchandise inventory at year-end is $40,000. The company would make an adjusting entry as follows. Cost of goods sold 500 Inventory500 29

30. Completing the Accounting Cycle Closing Entries 30

31. Completing the Accounting Cycle Closing Entries 31

32. Forms of Financial Statements  Shows several steps in determining net income.  Two steps relate to principal operating activities.  Distinguishes between operating and non-operating activities.  The multi-step income statement involves the use of multiple sub-totals within the income statement, which makes it easier for readers to aggregate selected types of information within the report.  The usual subtotals are for the gross margin, operating expenses, and other income, which allow readers to determine how much the company earns just from its manufacturing activities (the gross margin), what it spends on supporting operations (the operating expense total) and what component of its results do not relate to its core activities (the other income total). Multiple-Step Income Statement 32

33. Forms of Financial Statement Multiple Step Income Statement Key Items:  Net sales  Gross profit  Gross profit rate 33

34. Forms of Financial Statement Key Items:  Net sales  Gross profit  Operating expenses: Operating expenses are those expenditures that a business incurs to engage in any activities not directly associated with the production of goods or services. (Selling, general & administrative exp) Multiple Step Income Statement 34

35. Forms of Financial Statement Key Items:  Net sales  Gross profit  Operating expenses  Non- operating activities  Net income Multiple-Step Income Statement 35

36. Forms of Financial Statement Multiple- Step Income Statement 36

37. Forms of Financial Statement  Subtract total expenses from total revenues  Two reasons for using the single-step format: 1.Company does not realize any profit until total revenues exceed total expenses. 2.Format is simpler and easier to read. Single-Step Income Statement 37

38. Forms of Financial Statement Single-Step Income Statement 38

39. Forms of Financial Statement Classified Balance Sheet 39