1. Introduction to Accounting for Merchandising Operations

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3. Objectives Review accrual accounting basics
Introduce terminology for merchandising operations

4. Accrual basics
revenue recognition
income determination
matching

5. Revenue Recognition
Revenue is recognized when the earning process is substantially complete and the measurability and the collectibility of the dollar amount is reasonably assured.

6. Revenue Recognition
Revenue is recognized when the earning process is substantially complete and the measurability and the collectibility of the dollar amount is reasonably assured.
For most businesses revenue is recognized when goods are shipped to customers or services are provided.

7. Question: If in January: What was the Revenue for January?
A photographer starts a new business on January 1st
The photographer takes, develops and delivers pictures worth $7,500 to customers
The photographer invoices $6,000 of these services in January but does not get around to invoicing a large corporate customer in February for the $1,500 owed for photos finished and delivered in January
Customers paid $5,000 for photos
The photographer expects all amounts owed will be collected eventually
What was the Revenue for January?

8. Question: Answer: $7,500 If in January:
A photographer starts a new business on January 1st
The photographer takes, develops and delivers pictures worth $7,500 to customers
The photographer invoices $6,000 of these services in January but does not get around to invoicing a large corporate customer in February for the $1,500 owed for photos finished and delivered in January
Customers paid $5,000 for photos
The photographer expects all amounts owed will be collected eventually
What was the Revenue for January?
Answer: $7,500

9. The earning process
The earning process can stretch over a considerable period of time and is fraught with uncertainties
Accountants recognize revenue at the earliest point when the work done to earn it is substantially complete

10. Revenue: an increase in net assets from operations

11. Income Determination
Under accrual accounting expenses incurred are matched with related revenue to determine net income for a particular time period

12. Income Determination Revenue $xxx Less: Expenses ($xx) Net Income $ xx
Under accrual accounting expenses incurred are matched with related revenue to determine net income for a particular time period

13. Question: If in January:
A photographer has Sales of $7,500
Photographic Supplies worth $700 are purchased on account
$500 is paid for the Photographic Supplies purchased
$400 of Photographic Supplies are used up
What was the Net Income for January if there were no other expenses?

14. Question: Answer: $7,100 If in January:
A photographer has Sales of $7,500
Photographic Supplies worth $700 are purchased on account
$500 is paid for the Photographic Supplies purchased
$400 of Photographic Supplies are used up
What was the Net Income for January if there were no other expenses?
Answer: $7,100

15. Net Income = Revenue - Expenses
= $7, – Supply Expense
Recognize expense:
Dr Supplies (balance sheet account)
Cr Cash or Accounts Payable
… not at time of purchase
Dr Supplies Expense (income statement)
Cr Supplies (balance sheet account)
… recognize expense at time assets expire/are used up

16. Expenses: a decrease in net assets (“used up” assets)

17. Matching
Mismatched shoes are silly .. Unmatched revenues and expenses are misleading

18. Matching Revenue $xxx Less: Expenses ($xx) Net Income $ xx
Mismatched shoes are silly .. Unmatched revenues and expenses are misleading

19. Cash vs Accrual Basis
In contrast to the accrual basis, cash basis accounting recognizes revenue when money is received and recognizes money when paid

20. Cash vs Accrual Basis
In contrast to the accrual basis, cash basis accounting recognizes revenue when money is received and recognizes money when paid
Cash basis may distort the portrayal of financial position and over or understate performance measurement

21. service operations Provide services rather than selling products
Have relatively small supply costs
Match expenses to revenue at end of period

22. Merchandising Operations
Buy and sell finished goods
Cost of Goods Sold – the cost of items shipped to customers - is usually a large expense
Inventory – is reported on the Balance Sheet: it is goods held for sale

23. Merchandising Operations
Cost of Goods Sold (COGS) is a significant expense for a merchandising operations
COGS is often reported as a separate line item on the Income Statement

24. Merchandising Operations
Cost of Goods Sold (COGS) is a significant expense for a merchandising operations
COGS is often reported as a separate line item on the Income Statement
Often the change in inventory is computed at the time of each sale (the perpetual method)

25. income statement Revenue $xxx Cost of Goods Sold xxx Gross Profit xxx
Operating Expenses
Selling Expenses xxx
Administrative Expenses xxx xxx
Net Income $xxx

26. Balance Sheet ASSETS Current Assets Cash $xxx Accounts receivable xxx
Inventory, at cost xxx
Prepaid expenses xxx
Total Current Assets xxxx
Capital Assets
Land $ xxx
Buildings and Equipment xxx
less: Accumulated depreciation xxx xxxx
Total Assets $xxxx

27. Recognizing Cost of Goods Sold
…not expensed when goods are purchased
Dr Inventory (balance sheet account)
Cr Cash or Accounts Payable
… COGS is recognized when goods are sold
Dr Cost of Goods Sold (income statement)
Cr Inventory (balance sheet account)

28. Recognizing Cost of Goods Sold
…not expensed when goods are purchased
Dr Inventory (balance sheet account)
Cr Cash or Accounts Payable
… COGS is recognized when goods are sold
Dr Cost of Goods Sold (income statement)
Cr Inventory (balance sheet account)
Well controlled merchandise operations use a separate inventory account for each item

29. Perpetual inventory system
separate account for each inventory item
accounting entry for every inventory receipt and shipment
Dr Inventory
Cr Accounts Payable or Cash
When received

30. Perpetual inventory system
separate account for each inventory item
accounting entry for every inventory receipt and shipment
Dr Inventory
Cr Accounts Payable or Cash
Dr Cost of Goods Sold
Cr Inventory
When received
When sold and shipped

31. Merchandising Operations
Cost of Goods Sold (COGS) is a significant expense for a merchandising operations
COGS is often reported as a separate line item on the Income Statement
Often the change in inventory is computed at the time of each sale (the perpetual method)
Sometimes the change in inventory is computed at the end of the accounting period (the periodic method)

32. Periodic inventory system
used by small, non-computerized operations
debit all receipts to ‘Purchases’ account
count and value inventory at period-end
adjusting entry at period-end:
Dr or Cr Inventory
(adjust to count:
dr if inventory has increased during the period
cr if inventory has decreased during the period)
Dr Cost of Goods Sold (to balance entry)
Cr Purchases (to make balance $0)

33. Merchandising Operations
Cost of Goods Sold (COGS) is a significant expense for a merchandising operations
COGS is often reported as a separate line item on the Income Statement
Often the change in inventory is computed at the time of each sale (the perpetual method)
Sometimes the change in inventory is computed at the end of the accounting period (the periodic method)
Even if the perpetual method is used, inventory must be counted and valued and the accounting records adjusted to the computed value

34. Mug promotions
Prepare financial statements for the world’s simplest merchandising business

35. Mug promotions Buys ceramic mugs for $2 each
Customizes the mugs with a logo (in this example magically at no labour cost to focus attention on the inventory transactions)
Sells the customized mugs on account for $3 each

36. Mug Promotions Begins June: Cash $ 5,000 Accounts Receivable $ 2,000
Inventory $ 4,000
Accounts Payable $ 1,000
During June:
receives 1,000 mugs and ships 2,500 mugs
invoices customers for 2,000 mugs
collects $5,000 from customers
Pays suppliers $2,000

37. Question: What was revenue in June?
Begins June:
Cash $ 5,000
Accounts Receivable $ 2,000
Inventory $ 4,000
Accounts Payable $ 1,000
During June:
receives 1,000 mugs and ships 2,500 mugs
invoices customers for 2,000 mugs
collects $5,000 from customers
Pays suppliers $2,000
Mugs sell for $3 each on account; mugs cost $2 each

38. Answer: Mug Promotions Income Statement for June Revenue $7,500
Mugs sell for $3 each and 2,500 were shipped in June.
Revenue is recognized when goods are delivered.

39. Question: What was COGS in June?
Begins June:
Cash $ 5,000
Accounts Receivable $ 2,000
Inventory $ 4,000
Accounts Payable $ 1,000
During June:
receives 1,000 mugs and ships 2,500 mugs
invoices customers for 2,000 mugs
collects $5,000 from customers
Pays suppliers $2,000
Mugs sell for $3 each on account; mugs cost $2 each

40. Answer: Mug Promotions Income Statement for June Revenue $7,500
Cost of goods sold ,000
Gross Profit $2,500
Mugs cost $2 each. Cost of goods sold is matched to revenue - - 2,500 mugs were sold in June so the cost of 2,500 mugs, 2,500 x $2, is recognized as Cost of Goods Sold
There are no other expenses – Net Income is also $2,500

41. Question: What was Cash Balance at June 30th?
Begins June:
Cash $ 5,000
Accounts Receivable $ 2,000
Inventory $ 4,000
Accounts Payable $ 1,000
During June:
receives 1,000 mugs and ships 2,500 mugs
invoices customers for 2,000 mugs
collects $5,000 from customers
Pays suppliers $2,000
Mugs sell for $3 each on account; mugs cost $2 each

42. Answer:
ASSETS June June 1
Cash $8, $ 5,000
Accounts Receivable ?? $ 2,000
Inventory ?? $ 4,000
?? $11,000
LIABILITIES and OWNER’s EQUITY
Accounts Payable ?? $ 1,000
Owner’s Equity ?? ??
Cash Balance June 1 ($5,000) + Customer Receipts ($5,000) – payments to suppliers ($2,000)

43. Question: What was Accounts Receivable Balance at June 30th?
Begins June:
Cash $ 5,000
Accounts Receivable $ 2,000
Inventory $ 4,000
Accounts Payable $ 1,000
During June:
receives 1,000 mugs and ships 2,500 mugs
invoices customers for 2,000 mugs
collects $5,000 from customers
Pays suppliers $2,000
Mugs sell for $3 each on account; mugs cost $2 each

44. Answer
ASSETS June June 1
Cash $8, $ 5,000
Accounts Receivable , $ 2,000
Inventory ?? $ 4,000
?? $11,000
LIABILITIES and OWNER’s EQUITY
Accounts Payable ?? $ 1,000
Owner’s Equity ?? ??
A/R Balance June 1 ($2,000) + Credit Sales ($7,500) - Customer Receipts ($5,000)

45. Question: What was Inventory Balance at June 30th?
Begins June:
Cash $ 5,000
Accounts Receivable $ 2,000
Inventory $ 4,000
Accounts Payable $ 1,000
During June:
receives 1,000 mugs and ships 2,500 mugs
invoices customers for 2,000 mugs
collects $5,000 from customers
Pays suppliers $2,000
Mugs sell for $3 each on account; mugs cost $2 each

46. Answer
ASSETS June June 1
Cash $8, $ 5,000
Accounts Receivable , $ 2,000
Inventory , $ 4,000
$13, $11,000
LIABILITIES and OWNER’s EQUITY
Accounts Payable ?? $ 1,000
Owner’s Equity ?? ??
Inventory Balance June 1 ($4,000) + mugs purchased (1,000 x $2 = $2,000) – cost of mugs shipped ($5,000)

47. Question: What was Accounts Payable Balance at June 30th?
Begins June:
Cash $ 5,000
Accounts Receivable $ 2,000
Inventory $ 4,000
Accounts Payable $ 1,000
During June:
receives 1,000 mugs and ships 2,500 mugs
invoices customers for 2,000 mugs
collects $5,000 from customers
Pays suppliers $2,000
Mugs sell for $3 each on account; mugs cost $2 each

48. Answer
ASSETS June June 1
Cash $8, $ 5,000
Accounts Receivable , $ 2,000
Inventory , $ 4,000
$13, $11,000
LIABILITIES and OWNER’s EQUITY
Accounts Payable $1, $ 1,000
Owner’s Equity ?? ??
Accounts Payable Balance June 1 ($1,000) + mugs purchased (1,000 x $2 = $2,000) – payments ($2,000)

49. Question: What was Owner’s Equity Balance at June 30th?
Begins June:
Cash $ 5,000
Accounts Receivable $ 2,000
Inventory $ 4,000
Accounts Payable $ 1,000
During June:
receives 1,000 mugs and ships 2,500 mugs
invoices customers for 2,000 mugs
collects $5,000 from customers
Pays suppliers $2,000
Mugs sell for $3 each on account; mugs cost $2 each

50. Answer ASSETS June 30 June 1 Cash $8,000 $ 5,000
Accounts Receivable , $ 2,000
Inventory , $ 4,000
$13, $11,000
LIABILITIES and OWNER’s EQUITY
Accounts Payable $1, $ 1,000
Owner’s Equity ?? $10,000
?? $11,000
Balance Sheet Equation – Assets = Liabilities + OE

51. Question: Do June 30th Statements Balance?
Does the computed Net Income change Owner’s Equity to balance the Balance Sheet?
Begins June:
Cash $ 5,000
Accounts Receivable $ 2,000
Inventory $ 4,000
Accounts Payable $ 1,000
During June:
receives 1,000 mugs and ships 2,500 mugs
invoices customers for 2,000 mugs
collects $5,000 from customers
Pays suppliers $2,000
Mugs sell for $3 each on account; mugs cost $2 each

52. Answer ASSETS June 30 June 1 Cash $8,000 $ 5,000
Accounts Receivable , $ 2,000
Inventory , $ 4,000
$13, $11,000
LIABILITIES and OWNER’s EQUITY
Accounts Payable $1, $ 1,000
Owner’s Equity $12, $10,000
$13, $11,000
Yes! Owner’s Equity at June 1 + Net Income ($2,500) is $12,500 which balances

53. Retained Earnings (RE) Net Income = Revenue - Expenses
Financial Statements
Balance Sheet
Assets = Liabilities + Shareholders' Equity
Share Capital + Retained Earnings
Cash Flow Statement
Changes in cash result from:
investing activities
financing activities
operating activities
Statement of
Retained Earnings (RE)
Dividends decrease RE
Net Income increases RE
Income Statement
Net Income = Revenue - Expenses
Businesses differ on B/S: is there inventory
existence of inventories
raw as well as finished for a manufacturer
merchandisers buy and sell finished products and include both wholesalers and retailers
Review articulation:
Articulate at the micro level - T-Accounts too
Adjusting entries affect one B/S account one I/S account
Cash flow is not equal to Net Income

54. Computing COGS Opening Inventory $xxxx Plus net cost of purchases
Purchases $xxxx
Less: Purchases returns
and allowances (xxx)
Less: Purchase discounts (xx)
Add: Transporation in xx xxx
Cost of Goods Available xxxx
Less ending inventory (xxx)
COGS $xxxx

55. manufacturing operations
also use Inventory and Cost of Goods Sold accounts
costs included in inventory not only product costs, but also certain manufacturing costs and period costs (e.g., rent and utilities)
Separate inventories amounts are reported: raw materials inventories, work-in-process inventories and finished goods inventories.

56. inventory errors
Errors which incorrectly includes or excludes items from ending inventory will result in both income statement and balance sheet errors
Errors in inventory valuation will result in both income statement and balance sheet errors.
Inventory errors can be HUGE

57. merchandising example
world's largest home improvement
retailer
For year ended February 3, 2002:
over 1,500 stores and 280,000 employees

58. merchandising example
world's largest home improvement retailer
over 1,500 stores and over 250,000 employees
Net Sales over $50 billion US
Cost of Goods Sold over $30 billion US

59. Accounting’s contribution
Home Depot:
has over 40,000 different inventory items
has over 6 Billion US$ in inventory
Good inventory accounting is a part of its success story