1. Financial Accounting: Tools for Business Decision Making Prepared by: Dr. Jessica J. Frazier and Philip Li Eastern Kentucky University Kimmel, Weygandt, Kieso

2. CHAPTER 5 Merchandising Operations After reading Chapter 5, you should be able to: zIdentify the differences between a service enterprise and a merchandising company. zExplain the recording of purchases under a perpetual inventory system. zExplain the recording of sales revenues under a perpetual inventory system. zIdentify the unique features of the financial statements for a merchandising company. zExplain the factors affecting the profitability.

3. THE DIFFERENCES BETWEEN A SERVICE ENTERPRISE AND A MERCHANDISING COMPANY zIn a merchandising company, the primary source of revenues is the sale of merchandise, referred to as sales revenue or sales. zUnlike expenses for a service company, expenses for a merchandising company are divided into two categories: yCost of goods sold - the total cost of merchandise sold during the period. yOperating expenses - selling and administrative expenses.

4. THE RECORDING OF PURCHASES UNDER A PERPETUAL INVENTORY SYSTEM zThe purchase of merchandise for resale is normally recorded by the merchandiser when the goods are received from the seller. zEvery purchase should be supported by business documents that provide written evidence of the transaction.

5. Purchase of Merchandise zCash purchase zCredit purchase

6. Cash Purchase zEvery cash purchase should be supported by a canceled check or a cash register receipt indicating the items purchased and the amounts paid. zCash purchases are recorded by an increase in Merchandise Inventory and a decrease in Cash.

7. Credit Purchase zEach credit purchase should be supported by a purchase invoice, which indicates the total purchase price and other relevant information. zCredit purchases are recorded by an increase in Merchandise Inventory and an increase in Accounts Payable.

8. Purchase Return zGoods which are damaged, defective, or of inferior quality may be returned to the seller for credit if the sale was made on credit, or for a cash refund if the purchase was for cash. zPurchase return is recorded by decreasing Accounts Payable and decreasing Merchandise Inventory.

9. Purchase Allowance zThe purchaser may choose to keep the goods which are damaged, defective, or of inferior quality provided the seller will grant a discount referred to as a purchase allowance.

10. Freight Costs zFreight costs are the cost of transporting the goods to the buyer's place of business. zIf the freight costs are to by paid by the buyer, the costs are considered part of the cost of purchasing inventory. zFreight costs is recorded by increasing Merchandise Inventory and decreasing Cash.

11. Freight-Out zFreight costs incurred by the seller on outgoing merchandise are an operating expense to the seller and labeled freight- out. Freight-out is recorded by increasing Freight-out and decreasing Cash.

12. Purchase Discount zThe credit terms of a purchase on account may allow the buyer to claim a discount if payment is made within a certain time. zCredit terms are normally written 2/10, n/30 which means a 2 percent purchase discount may be taken if the invoice is paid within 10 days of the invoice date. Net amount of the invoice is due within 30 days.

13. Purchase Discount zWhen payment is made within the discount period, the amount of Merchandise Inventory decreases. zThe entry to record a payment would require the purchases to decrease Accounts Payable, Decrease Cash, and decrease Merchandise Inventory.

14. RECORDING THE SALES REVENUE UNDER A PERPETUAL INVENTORY SYSTEM zSales revenues are recorded when goods are transferred from the seller to the buyer. This practice is in accordance with the revenue recognition principle. zSales may be made on credit or for cash. zEach sales transaction should be supported by a business document which provides written evidence of the sale. yCash register tapes provide evidence of cash sales. yA sales invoice provides written evidence of a credit sale.

15. Cash Sales zCash sales are recorded by increasing Cash and increasing Sales.

16. Credit Sales zCredit sales are recorded by increasing Accounts Receivable and increasing Sales.

17. Sales Returns and Allowances zA contra revenue account to Sales. It may be used to record credit for returned goods. zTwo entries are required to record the credit for Sales Returns and Allowances. yThe first entry is an increase in Sales Returns and Allowances and a decrease in Accounts Receivable. yThe second entry is an increase in Merchandise Inventory and a decrease in Cost of Goods Sold.

18. Sales Discount zThe seller may offer the customer a sales discount for the prompt payment of the balance due. zA sales discount, which is based on the invoice price less any returns and allowances, is recorded by increasing cash for the amount received from the customer, decreasing Accounts Receivable for the amount owed by the customer, and increasing Sales Discounts by the amount of the discount. zSales Discounts is a contra revenue account to sales.

19. THE UNIQUE FEATURES OF THE FINANCIAL STATEMENTS FOR A MERCHANDISING COMPANY zThe income statement for a merchandising company shows the following three amounts not shown in a service company income statement: zSales revenues xCost of goods sold xGross profit

20. Sales Revenues zThe income statement for a merchandising concern typically presents gross sales revenues for the period and deducts the contra revenue accounts (sales returns and allowances and sales discounts) to arrive at net sales.

21. Cost of Goods Sold zThe amount paid for the merchandise sold during the period.

22. Gross Profit zGross Profit is determined by deducting Cost of Goods Sold from Net Sales. zGross profit is the merchandising profit of the company.

23. FACTORS AFFECTING PROFITABILITY zProfit Margin Ratio, calculated by dividing net income by sales, is one measure of profitability. yProfit Margin Ratio may be altered by changing the the percentage of "markup" on the merchandise sold. zOperating Expenses to Sales Ratio, calculated by dividing operating expenses by sales revenue, is a measure of a company's ability to control operating expenses.

24. Chapter 5 Review zWhat are the differences between a service enterprise and a merchandising company? zGive a detailed explanation of the recording of purchases under a perpetual inventory system. Use hypothetical figures to illustrate the perpetual inventory system. zHow are sales revenues recorded under a perpetual inventory system?

25. Chapter 5 Review zWhat features are unique to the financial statements for a merchandising company? zWhat are the factors affecting profitability? Again, use hypothetical figures to illustrate your point.

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