Chapter 5 Accounting for Merchandise Operations Electronic Presentation

Chapter 5 Accounting for Merchandise Operations Electronic Presentation by Douglas Cloud Pepperdine University

Learning Goals 1. Distinguish the operating activities of a After studying this service business from those of a chapter, you should merchandising business. be able to: 2. Describe and illustrate the financial statements of a merchandising business. 3. Describe the accounting for the sale of merchandise. 4. Describe the accounting for the purchase of merchandise. Continued

Learning Goals 5. Describe the accounting for transportation costs and sales taxes. 6. Illustrate the dual nature of merchandising transactions. 7. Describe the accounting for merchandise shrinkage. 8. Describe and illustrate the effects of inventory misstatements on the financial statements. Continued

Learning Goals 9. Describe and illustrate the use of gross profit and operating income in analyzing a company’s operations.

Learning Goal 1 Distinguish the operating activities of a service business from those of a merchandising business.

In prior chapters, you were introduced to how to report the financial condition and changes in financial condition for a service business.

In this chapter, you will be exposed to the accounting for merchandise operations.

Home Depot Inc. Condensed Income Statement For the Year Ending December 28, 2001 (inrevenue millions) Net is the revenue Thesales received The cost of less from selling merchandise account for Net sales $45, 738 merchandise sold any returned 32, 057 or any merchandise Revenue minus Cost of merchandise soldmerchandise is matched against discounts reported. is Sales. Gross profit $13, 681 cost provides Operating expenses gross profit. net sales. 9, 490 Operating income Other income Income before taxes Income taxes Net income $ 4, 191 26 $ 4, 217 1, 636 $ 2, 581 What’s different on a merchandising income statement?

Learning Goal 2 Describe and illustrate the financial statements of a merchandising business.

Multiple-Step Income Statement Online Solutions Income Statement For the Year Ended December 31, 2007 Net sales Cost of merchandise sold Gross profit Operating expenses Operating income Other income and expense (net) Operating income before taxes Income taxes Net income $708, 255 525, 305 $182, 950 105, 710 $ 77, 240 (1, 840) $ 75, 400 15, 000 $ 60, 400

Multiple-Step Income Statement Sales Less sales returns and allowances Less sales discounts Net sales $720, 185 $6, 140 5, 790 11, 930 $708, 255 Sales is the total amount the customers are charged for merchandise sold, including cash sales and sales on account. Detailed Revenue Section

Multiple-Step Income Statement Sales Less sales returns and allowances Less sales discounts Net sales $720, 185 $6, 140 5, 790 11, 930 $708, 255 Sales returns and allowances are granted by the seller for damaged or defective merchandise.

Multiple-Step Income Statement Sales Less sales returns and allowances Less sales discounts Net sales $720, 185 $6, 140 5, 790 11, 930 $708, 255 Sales discounts are granted by the seller to customers for early payment of amounts owed.

Multiple-Step Income Statement Purchases $521, 980 Less: Purchases returns and allowances $9, 100 Purchases discounts 2, 525 11, 625 Net purchases $510, 355 Add transportation-in 17, 400 Cost of merchandise purchased $527, 755 Purchases is the full cost of buying merchandise for resale. Detailed Cost of Merchandise Purchased Section

Multiple-Step Income Statement Purchases $521, 980 Less: Purchases returns and allowances $9, 100 Purchases discounts 2, 525 11, 625 Net purchases $510, 355 Add transportation-in 17, 400 Cost of merchandise purchased $527, 755 AAPurchaseallowance return is the is acost reduction of the in purchase merchandise pricereturned becausetothe theitem seller. has a defect or was the wrong item ordered.

Multiple-Step Income Statement Purchases $521, 980 Less: Purchases returns and allowances $9, 100 Purchases discounts 2, 525 11, 625 Net purchases $510, 355 Add transportation-in 17, 400 Cost of merchandise purchased $527, 755 A Purchase discount is a reduction in the initial cost of the merchandise. Usually, it is due to early payment of the debt.

Multiple-Step Income Statement Purchases $521, 980 Less: Purchases returns and allowances $9, 100 Purchases discounts 2, 525 11, 625 Net purchases $510, 355 Add transportation-in 17, 400 Cost of merchandise purchased $527, 755 Transportation-in is the shipping cost paid by the buyer for merchandise. Note that this freight payment increases the cost of the merchandise. It is not an expense.

Multiple-Step Income Statement “Cost of merchandise purchased” is a major portion of the cost of merchandise sold section, which follows the revenue section.

Multiple-Step Income Statement Note on the next slide that the only change is that the section begins by adding the beginning inventory and ends by subtracting the ending inventory.

Multiple-Step Income Statement Merchandise inventory, Jan. 1, 2007 Purchases $521, 980 Less: Pur. returns and allow. $9, 100 Purchases discounts 2, 525 11, 625 Net purchases $510, 355 Add transportation-in 17, 400 Cost of merchandise purchased Merchandise available for sale Less merchandise inventory, Dec. 31, 2007 Cost of merchandise sold $ 59, 700 527, 755 $587, 455 62, 150 $525, 305 Detailed Cost of Merchandise Sold Section

Multiple-Step Income Statement This income statement was prepared using the periodic inventory method. The number of units on hand was determined by a physical count.

Multiple-Step Income Statement In contrast, a perpetual inventory system keeps a running amount for each item as it is bought and sold. A physical count is still necessary for verification purposes.

Single-Step Income Statement Online Solutions Income Statement For the Year Ended December 31, 2007 Revenue: Net sales $708, 255 Expenses: Cost of merchandise sold Operating expenses Income taxes Other income and expense (net) Net income 60, 400 $525, 305 105, 710 15, 000 1, 840 647, 855 $

Retained Earnings Statement Online Solutions Retained Earnings Statement For the Year Ended December 31, 2007 Retained earnings, January 1, 2007 $128, 800 Net income for the year Less dividends Increase in retained earnings 42, 400 Retained earning, December 31, 2007 $171, 200 $60, 400 18, 000

Balance Sheet Online Solutions Balance Sheet December 31, 2007 Assets Current assets: Cash Accounts receivable 76, 080 Merchandise inventory 62, 150 Office supplies Prepaid insurance Continued 2, 650 $ 52, 950 480

Property, plant, and equipment: Land Store equipment $27, 100 less accumulated depr. 5, 700 Office equipment $15, 570 less accumulated depr. 4, 720 Total property, plant, and equip. 52, 250 Total assets $246, 560 $ 20, 000 21, 400 10, 850 Liabilities Current liabilities: Accounts payable 22, 420 Note payable Salaries payable $ Continued 5, 000

Long-term liabilities: Note payable (final payment due 2017) 20, 000 Total liabilities $ 50, 360 Stockholders’ Equity Capital stock Retained earnings 171, 200 196, 200 Total liabilities and stockholders’ equity $246, 560 $ 25, 000

Statement of Cash Flows Online Solutions Statement of Cash Flows For the Year Ended December 31, 2007 Cash flows from operating activities: Net income $ 60, 400 Add: Depreciation expense—store equipment Depreciation expense—office equipment Decrease in office supplies Decrease in prepaid insurance Increase in accounts payable Continued $ 3, 100 2, 490 120 350 8, 150 14, 210

Deduct: Increase in accounts receivable Increase in merchandise inventory Decrease in salaries payable Decrease in unearned rent Net cash flow form operating activities $47, 120 Cash flows from investing activities: Purchase of store equipment Purchase of office equipment Net cash flows used in investing activities (12, 670) Cash flows from financing activities: Payment of note payable Payment of dividends Net cash flows used in financing activities (23, 000) Net increase in cash $(24, 080) (2, 450) (360) (600) (27, 400) $ (7, 100) (5, 570) $ (5, 000) (18, 000)

Learning Goal 3 Describe the accounting for the sale of merchandise.

On January 3 Online Solutions sells merchandise costing $1, 200 for $1, 800. The customer charges the purchase on a Master. Card. Transactions involving Master. Card or Visa are treated as cash sales.

Jan. 3 Cash Sales 1, 800 This entry is made whether the company uses the periodic or perpetual system. An additional entry is made if the firm uses a perpetual inventory system. Jan. 3 Cost of Merchandise Sold 1, 200 Merchandise Inventory 1, 200

During January Online Solutions sold merchandise costing $68, 000 to American Express customers for $100, 000. Online Solutions uses a perpetual inventory. Transactions involving American Express are recorded as sales on account.

Jan. 31 Accounts Receivable— American Express Sales 31 Cost of Merchandise Sold Merchandise Inventory 100, 000 68, 000 Online receives cash from American Express of $100, 000, less a 4% service fee on February 15. . Feb. 15 Cash Credit Card Expense Accounts Receivable– American Express 96, 000 4, 000 100, 000

Sales Discounts Credit Terms 2/10, n/30 Theisnet (full) …the is account The buyer amount paid within 10 is due by allowed a 2% th day. the 30 days. discount if…

Sales Discounts On January 12 Online Solutions sells merchandise costing $850 on account to Omega Tech for $1, 500. Credit terms are 2/10, n/30. Payment is received on January 22. Jan. 12 Accounts Receivable— Omega Tech Sales 12 Cost of Merchandise Sold Merchandise Inventory 1, 500 850

Sales Discounts On January 12 Online Solutions sells merchandise costing $850 on account to Omega Tech for $1, 500. Credit terms are 2/10, n/30. Payment is received on January 22. Contra Jan. 22 Cash 1, 470 (offsetting) Sales Discounts 30 account to Accounts Receivable— Sales 1, 500 Omega Tech.

Sales Returns and Allowances On January 13 Online Solutions issues a $2, 000 credit memorandum to Krier Company for merchandise that was returned. The merchandise (cost $1, 200) was sold on account. Contra (offsetting) Jan. 13 Sales Returns and Allowances 2, 000 account to Accounts Receivable— Sales Krier Company 2, 000 13 Merchandise Inventory Cost of Merchandise Sold 1, 200

Learning Goal 4 Describe the accounting for the purchase of merchandise.

On January 3 Online Solutions purchased $2, 500 of merchandise for cash. Recall that Online Solutions uses the perpetual system. Jan. 3 Merchandise Inventory Cash 2, 500 If this transaction had been on account from Max Corporation (terms: 1/15, n/30), the entry would have been: Jan. 3 Merchandise Inventory Accounts Payable—Max Corporation 2, 500

Purchase Discounts On January 17 Online Solutions pays Max Corporation the invoice amount less the discount. The asset Jan. 17 Accounts Payable—Max Corp. 2, 500 Merchandise Inventory 25 is account Cash 2475 reduced. Instead, assume the payment is made on Feb. 1 Accounts Payable—Max Corp. 2, 500 Cash 2, 500

Purchases Returns and Allowances On January 22 Online Solutions returns $5, 000 of merchandise purchased from Quantum Inc. Jan. 22 Accounts Payable—Quantum Inc. 5, 000 Merchandise Inventory 5, 000 If the above return represents only part of the total purchase and credit terms are 2/10, n/45, the discount, if taken on the balance of the order, only applies to the merchandise kept.

Learning Goal 5 Describe the accounting for transportation costs and sales taxes.

Transportation Costs Phil’s Trucking

Transportation Costs On January 19 Online Solutions buys merchandise from Data Max on Account, $2, 900, terms FOB shipping point, and prepays the transportation cost of $150. Jan. 19 Merchandise Inventory Accounts Payable—Data Max 19 Merchandise Inventory Cash 2, 900 150

Transportation Costs On January 24 Online Solutions sells merchandise to Miller Company on account, $4, 700, terms FOB destination. The cost of the merchandise sold is $2, 750, and Online Solutions pays the transportation cost of $350. Jan. 24 Accounts Receivable—Miller Co. Sales 24 Cost of Merchandise Sold Merchandise Inventory 4, 700 2, 750

Transportation Costs On January 24 Online Solutions sells merchandise to Miller Company on account, $4, 700, terms FOB destination. The cost of the merchandise sold is $2, 750, and Online Solutions pays the transportation cost of $350. Jan. 24 Transportation Out Cash An expense 350

Transportation Costs On January 14 Online Solutions sells merchandise to Golden Company on account, $8, 000, terms 2/10, n/30, FOB shipping point. The cost of the merchandise sold is $4, 800, and Online pays the transportation cost of $500. Jan. 14 Accounts Receivable—Golden Co. Sales 14 Cost of Merchandise Sold Merchandise Inventory 8, 000 4, 800

Transportation Costs On January 14 Online Solutions sells merchandise to Golden Company on account, $8, 000, terms 2/10, n/30, FOB shipping point. The cost of the merchandise sold is $4, 800, and Online pays the transportation cost of $500. Jan. 14 Accounts Receivable—Golden Co. Cash 500 Online prepaid the transportation cost although it is Golden’s responsibility. This debit sets up the reimbursement.

Sales Taxes On March 19 Tom’s Meat Market had cash sales totaling $1, 700. The local sales tax is 7%, which is collected on each sale. The entry to record the day’s sales is as follows: Mar. 19 Cash Sales Taxes Payable 1, 819 1, 700 119

Learning Goal 6 Illustrate the dual nature of merchandising transactions.

July 1. Scully Company sold merchandise on account to Burton Co. , $7, 500, terms FOB shipping point, n/45. The cost of the merchandise sold was $4, 500 Scully Co. (Seller) Accounts Receivable—Burton Co. Sales 7, 500 Cost of Merchandise Sold Merchandise Inventory 4, 500 7, 500 4, 500

July 1. Scully Company sold merchandise on account to Burton Co. , $7, 500, terms FOB shipping point, n/45. The cost of the merchandise sold was $4, 500 Burton Co. (Buyer) Merchandise Inventory Accounts Payable—Scully Co. 7, 500

July 2. Burton Co. paid transportation charges of $150 on July 1 purchase of Scully Company. Scully Co. (Seller) No entry. Burton Co. (Buyer) Merchandise Inventory Cash 150

July 5. Scully Company sold merchandise on account to Burton Co. , $5, 000, terms FOB destination, n/45. The cost of the merchandise sold was $3, 500 Scully Co. (Seller) Accounts Receivable—Burton Co. Sales 5, 000 Cost of Merchandise Sold Merchandise Inventory 3, 500 5, 000 3, 500

July 5. Scully Company sold merchandise on account to Burton Co. , $5, 000, terms FOB destination, n/45. The cost of the merchandise sold was $3, 500 Burton Co. (Buyer) Merchandise Inventory Accounts Payable—Scully Co. 5, 000

July 7. Scully Co. paid transportation charges of $250 for delivery of merchandise sold to Burton Co. on July 5. Scully Co. (Seller) Transportation Out Cash 250 Burton Co. (Buyer) No entry

July 13. Scully Company issued Burton Co. a credit memorandum for merchandise returned, $1, 000. The merchandise had been purchased by Burton Co. on account on July 5. The cost of the merchandise returned was $700. Scully Co. (Seller) Sales Return and Allowances Accounts Receivable—Burton Co. Merchandise Inventory Cost of Merchandise Sold 1, 000 700

July 13. Scully Company issued Burton Co. a credit memorandum for merchandise returned, $1, 000. The merchandise had been purchased by Burton Co. on account on July 5. The cost of the merchandise returned was $700. Burton Co. (Buyer) Accounts Payable—Scully Co. Merchandise Inventory 1, 000

July 15. Scully Company received payment from Burton Co. for purchase of July 5. Scully Co. (Seller) Cash Accounts Receivable—Burton Co. 4, 000 Burton Co. (Buyer) Accounts Payable—Scully Co. Cash 4, 000

July 18. Scully Co. sold merchandise on account to Burton Co. , $12, 000, terms FOB shipping point, 2/10, n/eom. Scully Co. prepaid transportation costs of $500, which were added to the invoice. The cost of the merchandise The full amount is sold was due $7, 200. by the end of the month. Scully Co. (Seller) Accounts Receivable—Burton Co. Sales Accounts Receivable—Burton Co. Cash 12, 000 500

July 18. Scully Co. sold merchandise on account to Burton Co. , $12, 000, terms FOB shipping point, 2/10, n/eom. Scully Co. prepaid transportation costs of $500, which were added to the invoice. The cost of the merchandise sold was $7, 200. Scully Co. (Seller) Cost of Merchandise Sold Merchandise Inventory 7, 200

July 18. Scully Co. sold merchandise on account to Burton Co. , $12, 000, terms FOB shipping point, 2/10, n/eom. Scully Co. prepaid transportation costs of $500, which were added to the invoice. The cost of the merchandise sold was $7, 200. Burton Co. (Buyer) Merchandise Inventory Accounts Payable—Scully Co. 12, 500

July 28. Scully Company received payment from Burton Company for purchase of July 18, less discount (2% x $12, 000). Scully Co. (Seller) Cash Sales Discount Accounts Receivable—Burton Co. 12, 260 240 12, 500 Burton Co. (Buyer) Accounts Payable—Scully Co. Merchandise Inventory Cash 12, 500 240 12, 260

Learning Goal 7 Describe the accounting for merchandise shrinkage.

When a company uses a perpetual inventory, a physical count is taken at the end of the accounting period to determine the accuracy of the perpetual records and to record any inventory shrinkage.

Online Solutions’ inventory records indicate that $63, 950 of merchandise should be available for sale on December 31, 2007. The physical inventory taken on that date indicates that only $62, 150 of merchandise is available for sale. Inventory shrinkage is $1, 800 Cost of Merchandise Sold Merchandise Inventory 1, 800

Learning Goal 8 Describe and illustrate the effects of inventory misstatements on the financial statements.

Effects of Inventory Misstatements Income Statement Effects Physical Inventory Misstatement Inventory Shrinkage Misstated Cost of Gross Merchandise Profit Sold Misstated Net Income Misstated Balance Sheet Effects Net Total Retained Physical Adjusted Mer. Current Assets Earnings Income Inventory Inv. Misstated Assets Misstated Misstatement

On December 31, 2007, Sapra Company incorrectly counted its physical inventory as $115, 000 instead of $125, 000. Amount of Misstatement Overstated (Understated) 2007 Financial Statements Balance Sheet as of December 31, 2007: Merchandise inventory Current assets Total stockholders’ equity (retained earnings) Income Statement for Year Ended December 31, 2007: Cost of merchandise sold Gross profit Net income $(10, 000) $10, 000 (10, 000)

On December 31, 2007, Sapra Company incorrectly counted its physical inventory as $115, 000 instead of $125, 000. Amount of Misstatement Overstated (Understated) 2008 Financial Statements Balance Sheet as of December 31, 2008: Merchandise inventory Current assets Total stockholders’ equity (retained earnings) Income Statement for Year Ended December 31, 2008: Cost of merchandise sold Gross profit Net income Correct $(10, 000) 10, 000

Learning Goal 9 Describe and illustrate the use of gross profit and operating income in analyzing a company’s operations.

Gross profit and operating …the efficiency and income are two important effectiveness of a profitability measures analyst merchandiser’s operations. use in assessing…

Gross Profit Percent Net sales Cost of merchandise sold Gross profit Operating expenses Operating income $32, 004 22, 789 $ 9, 215 8, 459 $ 756 $9, 2 l 5 = 28. 8% $32, 004

Gross Profit Percent J. C. Penny’s gross profit percentage went from 28. 8% to 27. 7%, then recovered back to 29. 8%.

Gross Profit Percent The recovery in the third year was attributed to better merchandise assortment, improved inventory productivity, and centralized buying.

Operating Income Percent Net sales Cost of merchandise sold Gross profit Operating expenses Operating income $756 = 2. 4% $32, 004 22, 789 $ 9, 215 8, 459 $ 756

Operating Income Percent The company’s operating income percentage dropped from 2. 4% to 0. 6%, then recovered back to 2. 7%.

Operating Income Percent This recovery was attributed to lower catalog and marketing costs, lower telemarketing costs, and a shift from development to maintenance of JCPenny. com.

Chapter 5 The End