1. ACCT 201 FINANCIAL REPORTING Chapter 5
Dr. Lale Guler
Office: CAS 102

2. CHAPTER5 Accounting for Merchandising Operations Study Objectives
Service vs. merchandising companies
Perpetual vs. periodic inventory systems
Multi-step vs. single-step income statement
Comparison between the U.S. GAAP and IFRS

3. Merchandising Operations
Merchandising Companies
Buy and Sell Goods
Wholesaler
Retailer
Consumer
The primary source of revenues is referred to as sales revenue or sales.

4. Merchandising vs. Service Companies
Illustration 5-2
Operating Cycles
The operating cycle of a merchandising company ordinarily is longer than that of a service company.

5. Merchandising Operations
Flow of Costs
Illustration 5-3
Cost of goods sold is the total cost of merchandise sold during the period.
Companies use either a perpetual inventory system or a periodic inventory system to account for inventory.

6. Not used in a Service business.
Merchandising Operations
Income Measurement
Not used in a Service business.
Illustration 5-1

7. Perpetual vs. Periodic Systems
Perpetual system:
Inventory is adjusted for each change in inventory
COGS is adjusted for each sale/sale return
Directly determines how many goods are on hand on any date
Directly determines how many items are sold
Periodic system:
Inventory is NOT adjusted for each change in inventory
COGS is NOT adjusted for each sale/sale return; physical count determines cost of goods on hand and cost of goods sold
Based on physical count, inventory is adjusted periodically at the end of a reporting period.

8. Perpetual vs. Periodic Systems
Perpetual system:
Record purchases in Inventory account.
Not recorded in separate accounts:
Purchase returns and allowances,
Purchase discounts, and
Freight costs
Periodic system:
Record purchases in Purchases account.
Recorded in separate accounts:
Purchase returns and allowances,
Purchase discounts, and
Freight costs

9. Perpetual vs. Periodic Systems
Fesmire Co. reports the following data for 2000:
Beginning Inventory
January 1: 10 units at $10
Purchases and Sales (all credit) March 12: Purchased 30 units at $10.
April 8: Sold 18 units at $16.
July 6: Purchased 25 units at $10 .
August 9: Sold 24 units at $18.
Required: Provide journal entries.

10. Perpetual System Date Record Inventory Changes Record Sales Revenue
Mar 12
Purchase
Apr 8
Sale
Jul 6
Purchase
Aug 9
Sale

11. Periodic System Date Record Inventory Changes Record Sales Revenue
Mar 12
Apr 8
Jul 6
Aug 9
Dec 31

12. Periodic System Cost of Goods Sold Equation
In the periodic inventory system we use an equation to determine cost of goods sold. We take a beginning inventory and add net purchases to arrive at cost of goods available for sale. We subtract ending inventory from cost of goods available for sale to determine cost of goods sold.
Net purchases is equal to our gross purchases less purchase discounts and less purchase returns.

14. Perpetual Inventory System - Recording Purchases of Merchandise
Illustration: Sauk Stereo (the buyer) uses as a purchase invoice the sales invoice prepared by PW Audio Supply, Inc. (the seller). Please record the purchase of merchandise by Sauk.
Illustration 5-5

15. Perpetual Inventory System - Freight Costs (Terms of Sale)
Buyer pays freight costs.
Seller pays freight costs.

16. Freight costs incurred by the seller are an operating expense.
Perpetual Inventory System -
Freight Costs (Terms of Sale)
Illustration: Assume upon delivery of the goods on May 6, Sauk Stereo (the buyer) pays Acme Freight Company $150 for freight charges, the entry on Sauk Stereo’s books is:
Assume the freight terms on the invoice in Illustration 5-5 had required PW Audio Supply (the seller) to pay the freight charges, the entry by PW Audio Supply would have been:
Freight costs incurred by the seller are an operating expense.

17. Perpetual Inventory System - Purchase Returns and Allowances
Purchaser may be dissatisfied because goods are damaged or defective, of inferior quality, or do not meet specifications.
Purchase Return
Purchase Allowance
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.

18. Perpetual Inventory System - Purchase Returns and Allowances
Illustration: Assume that on May 8 Sauk Stereo (the buyer) returned to PW Audio Supply goods costing $300.
Illustration: Assume instead that on May 8 Sauk Stereo (the buyer) chose to keep the goods after being granted a $50 allowance (reduction in price).

19. Example: Credit terms may read 2/10, n/30.
Perpetual Inventory System -
Purchase Discounts
Credit terms may permit buyer to claim a cash discount for prompt payment.
Advantages:
Purchaser saves money.
Seller shortens the operating cycle.
Example: Credit terms may read 2/10, n/30.

20. Perpetual Inventory System - Purchase Discounts
1/10 EOM
n/10 EOM
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.
Net amount due within the first 10 days of the next month.

21. Perpetual Inventory System - Purchase Discounts
Illustration: 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.

22. Perpetual Inventory System - Purchase Discounts
Illustration: If Sauk Stereo failed to take the discount, and instead made full payment of $3,500 on June 3, the journal entry would be:

23. Perpetual Inventory System – Summary of Purchasing Transactions
4th - Purchase
$3,800
$300
8th - Return
6th – Freight-in
150 70
14th - Discount
Balance
$3,580

24. Perpetual Inventory System – Sales of Merchandise
Made using cash or credit (on account).
Illustration 5-5
Normally recorded when earned, usually when goods transfer from seller to buyer.
Sales invoice should support each credit sale.

25. Perpetual Inventory System – Sales of Merchandise#1
Cash or Accounts receivable XXX
Selling Price
Sales revenue XXX #2
Cost of goods sold XXX
Cost
Inventory XXX

26. Perpetual Inventory System – Sales of Merchandise
Illustration: 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.

27. Perpetual Inventory System – Sales returns and allowances
Account : Sales returns and allowances
“Flipside” of purchase returns and allowances.
Contra-revenue account (debit).
Sales not reduced (debited) because:
Would obscure importance of sales returns and allowances as a percentage of sales.
Could distort comparisons.

28. Perpetual Inventory System – Sales returns and allowances
Illustration: 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.

29. Perpetual Inventory System – Sales returns and allowances
Illustration: Assume the returned goods were defective and had a scrap value of $50, PW Audio would make the following entries:

30. Perpetual Inventory System – Sales discounts
Offered to customers to promote prompt payment.
“Flipside” of purchase discount.
Contra-revenue account (debit).

31. Perpetual Inventory System – Sales discounts
Illustration: 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.

32. Completing the Accounting Cycle
Adjusting Entries
Generally the same as a service company.
One additional adjustment to make the records agree with the actual inventory on hand.
Involves adjusting Inventory and Cost of Goods Sold.

33. Completing the Accounting Cycle
Illustration: 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.

34. Periodic Inventory System
Recording Purchases of Merchandise
Illustration: On the basis of the sales invoice (Illustration 5-5) and receipt of the merchandise ordered from PW Audio Supply, Sauk Stereo records the $3,800 purchase as follows.

35. Periodic Inventory System
Freight Costs
Illustration: If Sauk pays Haul-It Freight Company $150
for freight charges on its purchase from PW Audio Supply on May 6, the entry on Sauk’s books is:

36. Periodic Inventory System
Purchase Returns and Allowances
Illustration: Sauk Stereo returns $300 of goods to PW Audio Supply and prepares the following entry to recognize the return.

37. Periodic Inventory System
Purchase Discounts
Illustration: On May 14 Sauk Stereo pays the balance due on account to PW Audio Supply, taking the 2% cash discount allowed by PW Audio for payment within 10 days. Sauk
Stereo records the payment and discount as follows.

38. Periodic Inventory System
Recording Sales of Merchandise
Illustration: PW Audio Supply, records the sale of $3,800 of merchandise to Sauk Stereo on May 4 (sales invoice No. 731, Illustration 5-5) as follows.

39. Periodic Inventory System
Sales Returns and Allowances
Illustration: To record the returned goods received from Sauk Stereo on May 8, PW Audio Supply records the $300 sales return as follows.

40. Periodic Inventory System
Sales Discounts
Illustration: On May 14, PW Audio Supply receives payment of $3,430 on account from Sauk Stereo. PW Audio honors the 2% cash discount and records the payment of Sauk’s account receivable in full as follows.

41. Summary
Comparison of Entries—Perpetual Vs. Periodic
Illustration 5A-3

42. Summary
Comparison of Entries—Perpetual Vs. Periodic
Illustration 5A-3

43. Forms of Financial Statements
Single-Step Income Statement
Subtract total expenses from total revenues
Format is simpler and easier to read.

44. Forms of Financial Statements
Single-Step Income Statement
Illustration 5-14

45. Forms of Financial Statements
Multiple-Step Income Statement
Shows several steps in determining net income.
Two steps relate to principal operating activities.
Distinguishes between operating and non-operating activities.

46. Forms of Financial Statements
Illustration 5-13
Income Statement Presentation of Sales

47. Forms of Financial Statements
Illustration 5-13
Gross Profit
Key Items:
Net sales
Gross profit
Gross profit rate
Illustration 5-10

48. Forms of Financial Statements
Illustration 5-13
Operating Expenses
Key Items:
Net sales
Gross profit
Operating expenses

49. Forms of Financial Statements
Key Items:
Net sales
Gross profit
Operating expenses
Non-operating activities
Net income
Illustration 5-13

50. Forms of Financial Statements
Key Items:
Net sales
Gross profit
Operating expenses
Non-operating activities
Net income
Illustration 5-12

51. Periodic Inventory System
Determining Cost of Goods Sold
Illustration 5A-2

52. Key Points
Under IFRS, revaluation of land, buildings, and intangible assets is permitted.
IFRS requires that two years of income statement information be presented, whereas GAAP requires three years.
The IASB and FASB are working on a project that will change the structure of financial statements. Specifically, this project will address the issue of how to classify various items in the income statement. A main goal of this new approach is to provide information that better represents how businesses are run. It will adopt major groupings similar to those currently used by the statement of cash flows (operating, investing, and financing), so that numbers can be more readily traced across statements.

53. Recording Purchases of Merchandise
Question
In a perpetual inventory system, a return of defective merchandise by a purchaser is recorded by crediting:
Purchases
Purchase Returns
Purchase Allowance
Inventory

54. Recording Sales of Merchandise
Question
The cost of goods sold is determined and recorded each time a sale occurs in:
periodic inventory system only.
a perpetual inventory system only.
both a periodic and perpetual inventory system.
neither a periodic nor perpetual inventory system.