Chapter 5 Accounting for Merchandising Businesses Financial and

Chapter 5 Accounting for Merchandising Businesses Financial and Managerial Accounting 8 th Edition Warren Reeve Fess 1

Objectives 1. 2. 3. 4. 5. 6. 7. 8. 9. Distinguish the activities of a service business from those of a merchandising business. Describe and illustrate the financial statements of a merchandising business. Describe the accounting for the sale of merchandise. Describe the accounting for the purchase of merchandise. Describe the accounting for transportation costs, sales taxes, and trade discounts. Illustrate the dual nature of merchandising transactions. Prepare a chart of accounts for a merchandising business. Describe the accounting cycle for a merchandising business. Compute the ratio of net sales to assets as a measure of how effectively a business is using its assets. 2

Nature of Businesses Service Business Fees earned $XXX Operating expenses –XXX Net income $XXX Merchandising Business Sales Cost of Merchandise Sold Gross Profit Operating Expenses Net Income $XXX –XXX $XXX 3

Collection Activity Purchasing Activity Cash Accounts Receivable Raw Materials Products Sales Activity Production Activity 4

Multiple-Step Income Statement Net. Solutions Income Statement For the Year Ended December 31, 2007 Revenue from sales: Sales $720, 185 Less: Sales returns and allowances $ 6, 140 Sales discounts 5, 790 11, 930 Net sales $708, 255 Cost of merchandise sold 525, 305 Gross profit $182, 950 Continued 5

Operating expenses: Selling expenses: Sales salaries expense $56, 230 Advertising expense 10, 860 Depr. Expense–store equipment 3, 100 Miscellaneous selling expense 630 Total selling expenses $ 70, 820 Administrative expenses: Office salaries expense $21, 020 Rent expense 8, 100 Depr. expense–office equipment 2, 490 Insurance expense 1, 910 Office supplies expense 610 Misc. administrative expense 760 Total admin. expenses 34, 890 Total operating expenses 105, 710 Income from operations $ 77, 240 Other income and expenses: Rent revenue $ 600 Interest expense (2, 440) (1, 840) Net income Continued 6 $75, 400

Periodic vs. Perpetual Methods of Accounting Periodic Method • A method of determining the cost of merchandise sold and the amount of merchandise on hand • Under this method, the inventory records do not show the amount available for sale or the amount sold during the period Perpetual Method • Under this method, each purchase and sale of merchandise is recorded in the inventory and the cost of merchandise sold accounts. • The amount of merchandise available for sale and the amount sold are continuously disclosed in the inventory records. 7

Cost of Merchandise Purchased Purchases Less: Purchase returns and allowances $9, 100 Purchase discounts 2, 525 Net purchases Add transportation-in Cost of merchandise purchased $521, 980 11, 625 $510, 355 17, 400 $527, 755 8

Cost of Merchandise Sold Merchandise inventory, 1/1/07 $ 59, 700 Purchases $521, 980 Less: Purchase returns and allowances $9, 100 Purchase discounts 2, 525 11, 625 Net purchases $510, 355 Add transportation-in 17, 400 Cost of merchandise purchased 527, 755 Merchandise available for sale $587, 455 Less merchandise inventory, 12/31/07 62, 150 Cost of merchandise sold $525, 305 9

Single-Step Income Statement for a Merchandising Business Net. Solutions Income Statement For the Year Ended December 31, 2007 Revenues: Net sales $708, 255 Rent revenue 600 Total revenues $708, 855 Expenses: Cost of merchandise sold $525, 305 Selling expenses 70, 820 Administrative expenses 34, 890 Interest expense 2, 440 Total expenses 633, 455 Net income $ 75, 400 10

Retained Earnings Statement Net. Solutions Retained Earnings Statement For the Year Ended December 31, 2007 Retained earnings, 1/1/07 Net income for year Less dividends Increase in owner’s equity Retained earnings, 12/31/07 $128800 $75, 400 18, 000 57, 400 $186, 200 11

Net. Solutions - Balance Sheet- December 31, 2007 Assets Current assets: Cash Accounts receivable Merchandise inventory Office supplies Prepaid insurance Total current assets$209, 310 Property, plant, and equipment: Land $20, 000 Store equipment $27, 100 Less accumulated depreciation 5, 700 Office equipment $15, 570 Less accumulated depreciation 4, 720 Total property, plant, and equipment Total assets $261, 560 $52, 950 91, 080 62, 150 480 2, 650 21, 400 10, 850 52, 250 12

Liabilities Current liabilities: Accounts payable $22, 420 Note payable (current portion) 5, 000 Salaries payable 1, 140 Unearned rent 1, 800 Total current liabilities $ 30, 360 Long-term liabilities: Note payable (due 2017) 20, 000 Total liabilities $ 50, 360 Stockholders’ Equity Capital stock $ 25, 000 Retained earnings 186, 200 211, 200 Total liab. and stockholders’ equity $261, 560 13

Sales Transactions 14

Cash Sales JOURNAL Description Date 2007 1 Jan. 3 Cash 2 3 4 PAGE 26 Post. Ref. Dr Cr. 1 800 00 Sales 1 800 00 To record cash sales. 5 On January 3, a firm sold $1, 800 of merchandise for cash. 15

Cash Sales 6 3 Cost of Merchandise Sold 7 Merchandise Inventory 8 9 1 200 00 To record the cost of merchandise sold. 10 Using a perpetual inventory, the inventory cost of $1, 200 must be recorded. 16

Cash Sales JOURNAL Description Date 2007 1 Jan. 31 Credit Card Expense 2 3 4 5 PAGE 28 Post. Ref. Dr Cr. 48 00 Cash 48 00 To record service charges on credit card sales for the month. At Credit the end cardofsales the month, (Master. Card $48 was or sent Visa)toare cover recorded this service as cashcharge. sales. 17

Sales on Account Jan. 12 Accounts Receivable—Sims Co. 510 00 Sales 510 00 Invoice No. 7172. 12 Cost of Merchandise Sold Merchandise Inventory 280 00 Cost of merchandise sold on Invoice No. 7172. On January 12, a firm sold Sims Company merchandise on account, $510. The cost of the merchandise to the seller was $280. 18

Sales Discounts The terms for when payments for merchandise are to be made are called credit terms. If buyer is allowed an amount of time to pay, it is known as the credit period. 19

Sales Discounts Credit Terms If invoice is paid within 10 days of invoice date $1, 470 paid (less 2% as a cash discount) Invoice for $1, 500 Terms: 2/10, n/30 If invoice is NOT paid within 10 days of invoice date $1, 500 PAID 20

Sales Discounts Jan. 22 Cash 1 470 00 Sales Discounts Accounts Receivable—Sims Co. 30 00 1 500 00 Collection of Invoice No. 7172, less discount. On January 22, the firm receives $1, 470 from Sims Co. which is the amount due of $1, 500 less a 2 percent discount. 21

Sales Returns and Allowances Merchandise that is returned to the vendor is referred to as a sales return. If there is a defect in the product or the wrong item was shipped, the seller may reduce the initial price at which the goods were sold. This is known as a sales allowance. 22

Sales Returns and Allowances Jan. 13 Sales Returns and Allowances 225 00 Accounts Receivable—Krier Co. 225 00 Credit Memo No. 32. 13 Merchandise Inventory Cost of Merchandise Sold Cost of merchandise returned—Credit Memo 32. 140 00 On January 13, issued Credit Memo 32 to Krier Company for merchandise returned to Net. Solutions. Selling price, $225; cost to Net. Solutions, $140. 23

Purchase Transactions 24

Purchase Transactions Description Date 2007 1 Jan. 3 Merchandise Inventory 2 3 4 Post. Ref. Dr Cr. 2 510 00 Cash 2 510 00 Purchased inventory from Bowen Co. 5 On January 13, Purchased merchandise for cash from Alden Company, $2, 510. 25

Purchase Discounts What’s the last day the invoice can be paid? Alpha Technologies issues an invoice for $3, 000 to Net. Solutions dated March 12, with terms 2/10, n/30. 26

Purchase Discounts The full amount is due on April 11. Let’s do a simple calculation. Invoice period Days in March 31 Date of invoice 12 Remaining days April 30 19 11 27

Purchase Discounts We can borrow at an annual interest rate of 6%. Should we borrow the to pay the invoice within the discount period? $60 discount (2% x $3, 000)? 28

Purchase Discounts Let’s see… Interest on the amount due of $3, 000 less the 2 percent… Discount $60. 00 Interest for 20 days at the rate of 6% on $2, 940 – 9. 80 Savings from borrowing $50. 20 29

Purchase Discounts Looks like we should take advantage of the discount even if we have to borrow the money. Discount $60. 00 Interest for 20 days at the rate of 6% on $2, 940 – 9. 80 Savings from borrowing $50. 20 30

Purchase Discounts JOURNAL Date Description 2007 1 Mar. 12 Merchandise Inventory 2 3 4 PAGE 27 Post. Ref. Dr Cr. 3 000 00 Accounts Payable—Alpha Technologies 3 000 00 5 On March 12, Net. Solutions purchased merchandise on account from Alpha Technologies, $3, 000. 31

Purchase Discounts JOURNAL Description Date 2007 1 Mar. 22 Accounts Payable—Alpha Technol. 2 Cash 3 4 Merchandise Inventory PAGE 27 Post. Ref. Dr Cr. 3 000 00 2 940 00 60 00 5 If payment is made by March 22 Net. Solutions records the discount as a reduction in cost. 32

Purchase Discounts JOURNAL Description Date 2007 1 Apr. 11 Accounts Payable—Alpha Technol. 2 Cash PAGE 27 Post. Ref. Dr Cr. 3 000 00 3 4 5 If Net. Solutions does not pay the invoice until April 11, it would pay the full amount. 33

Purchases Returns and Allowances A purchases return involves actually returning merchandise that is damaged or does not meet the specifications of the order. When the defective or incorrect merchandise is kept by the buyer and the vendor makes a price adjustment, this is a purchases allowance. 34

Purchases Returns and Allowances You sent me the wrong interface cards. We’ll send a debit memorandum with the returned items. Net. Solutions received the delivery from Maxim Systems and determined that $900 of the items were not the merchandise ordered. Debit memorandum #18 is issued to Maxim Systems. 35

Purchases Returns and Allowances Mar. 7 Accounts Payable—Maxim Systems Merchandise Inventory 900 00 Debit Memo No. 18 36

Purchases Returns and Allowances On May 2, Net. Solutions purchased $5, 000 of merchandise from Delta Data Link, subject to terms 2/10, n/30. May 2 Merchandise Inventory Accounts Payable—Delta Data 5 000 00 Purchased merchandise. 37

Purchases Returns and Allowances On May 4, Net. Solutions returns $3, 000 of the merchandise. May 4 Accounts Payable—Delta Data Links Merchandise Inventory 3 000 00 Returned portion of merchandise purchased. 38

Purchases Returns and Allowances On May 12, Net. Solutions pays the amount due. May 12 Accounts Payable—Delta Data Links Cash Merchandise Inventory Paid invoice. 2 000 00 ($5, 000 – $3, 000) x 2% 1 960 00 40 00 39

Transportation Costs FOB Shipping Point Buyer pays freight costs and debits Merchandise Inventory Fruit Express Title passes to buyer as shipment leaves shipping point. 40

FOB Shipping Point June 10 Merchandise Inventory Accounts Payable—Magna Data 900 00 Purchased merchandise, terms FOB shipping point. 10 Merchandise Inventory Cash 50 00 Paid shipping cost on merchandise purchased. On June 10, Net. Solutions buys merchandise from Magna Data on account, $900, terms FOB shipping point and pays the transportation cost of $50. 41

FOB Destination Seller pays freight costs and debits Transportation Out Fruit Express Title passes to buyer upon arrival at destination. 42

FOB Destination June 15 Accounts Receivable—Kranz Co. Sales Sold merchandise, terms FOB destination. 15 Cost of Merchandise Sold Merchandise Inventory 700 00 480 00 Cost of sale of Kranz Co. On June 15, Net. Solutions sells merchandise to Kranz Company on account, $700, terms FOB destination. The cost of the merchandise sold is $480. Net. Solutions pays the transportation cost of $40. 43

FOB Destination June 15 Transportation Out Cash 40 00 Paid shipping cost on merchandise sold. On June 15, Net. Solutions sells merchandise to Kranz Company on account, $700, terms FOB destination. The cost of the merchandise sold is $480. Net. Solutions pays the transportation cost of $40. 44

Sales Taxes Aug. 12 Accounts Receivable—Lemon Co. 106 00 Sales Taxes Payable Invoice No. 339 100 00 6 00 On August 12, merchandise is sold on account to Lemon Company, $100. The state has a 6% sales tax. 45

Sales Taxes Sept. 15 Sales Tax Payable Cash Payment for sales taxes collected during August. 2 900 00 On September 15, the seller sends in a payment of $2, 900 to the taxing unit for the August taxes collected. 46

Illustration of Accounting for Merchandise Transactions Scully Company (Seller) Accounts Receivable—Burton Co. Sales 7, 500 Cost of Merchandise Sold Merchandise Inventory 4, 500 7, 500 4, 500 Burton Company (Buyer) Merchandise Inventory. Accounts Payable—Scully Co. 7, 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. 47

Illustration of Accounting for Merchandise Transactions Scully Company (Seller) No entry. Burton Company (Buyer) Merchandise Inventory Cash 150 July 2. Burton Company paid transportation charges of $150 on July 1 purchase from Scully Company. 48

Illustration of Accounting for Merchandise Transactions Scully Company (Seller) Accounts Receivable—Burton Co. Sales 5, 000 Cost of Merchandise Sold Merchandise Inventory 3, 500 5, 000 3, 500 Burton Company (Buyer) Merchandise Inventory. Accounts Payable—Scully Co. 5, 000 July 5. Scully Company sold merchandise on account to Burton Co. , $5, 000, terms FOB shipping point, n/30. The cost of the merchandise sold was $3, 500. 49

Illustration of Accounting for Merchandise Transactions Scully Company (Seller) Transportation Out Cash 250 Burton Company (Buyer) No entry. July 7. Scully Company paid transportation costs of $250 for delivery of merchandise sold to Burton Company on July 5. 50

Illustration of Accounting for Merchandise Transactions Scully Company (Seller) Sales Returns and Allowances Accounts Receivable—Burton Co. Merchandise Inventory Cost of Merchandise Sold 1, 000 700 Burton Company (Buyer) Accounts Payable—Scully Co. Merchandise Inventory 1, 000 July 13. Scully Company issued Burton Company a credit memorandum for $1, 000 of merchandise returned from a July 5 purchase on account. The cost of the merchandise was $700. 51

Illustration of Accounting for Merchandise Transactions Scully Company (Seller) Cash Accounts Receivable—Burton Co. 4, 000 Burton Company (Buyer) Accounts Payable—Scully Co. Cash 4, 000 July 15. Scully Company received payment from Burton Company for purchase of July 5. 52

Illustration of Accounting for Merchandise Transactions Continued (Seller) Cost of Merchandise Sold Merchandise Inventory 7, 200 Burton Company (Buyer) July 18. Scully Company sold merchandise on account to Burton Company, $12, 000, terms FOB shipping point, 2/10, n/eom. Scully prepaid transportation costs of $500, which were added to the invoice. The cost of the merchandise sold was $7, 200. 53

Illustration of Accounting for Merchandise Transactions Scully Company (Seller) Cost of Merchandise Sold Merchandise Inventory 7, 200 Burton Company (Buyer) Merchandise Inventory Accounts Payable—Scully Co. 12, 500 July 18. Scully Company sold merchandise on account to Burton Company, $12, 000, terms FOB shipping point, 2/10, n/eom. Scully prepaid transportation costs of $500, which were added to the invoice. The cost of the merchandise sold was $7, 200. 54

Illustration of Accounting for Merchandise Transactions Scully Company (Seller) Cash Sales Discounts Accounts Receivable—Burton Co. 12, 260 240 12, 500 Burton Company (Buyer) Accounts Payable—Scully Co. Merchandise Inventory Cash 12, 500 July 28. Scully Company received payment from Burton Company for purchase of July 18, less discount (2% x $12, 000). 240 12, 260 55

Net. Solutions Chart of Accounts Balance Sheet Accounts 110 112 115 116 117 120 123 124 125 126 100 Assets Cash Accounts Receivable Merchandise Inventory Office Supplies Prepaid Insurance Land Store Equipment Accumulated Depreciation— Store Equipment Office Equipment Accumulated Depreciation— Office Equipment 210 211 212 215 200 Liabilities Accounts Payable Salaries Payable Unearned Rent Notes Payable 300 311 312 313 Stockholders’ Equity Capital Stock Retained Earnings Dividends Income Summary 56

Net. Solutions Chart of Accounts Income Statement Accounts 400 Revenues 410 Sales 411 Sales Returns and Allowances 412 Sales Discounts 600 Other Income 610 Rent Revenue 700 Other Expense 710 Interest Expense 500 Costs and Expenses 510 Cost of Merchandise Sold 520 Sales Salaries Expense 521 Advertising Expense 522 Depreciation Expense— Store Equipment 523 Transportation Out 529 Miscellaneous Selling Expense 530 Office Salaries Expense 531 Rent Expense 532 Depreciation Expense— Office Equipment 533 Insurance Expense 534 Office Supplies Expense 539 Miscellaneous Admin. Expense 57

Merchandise Inventory Shrinkage Net. Solutions inventory records indicate that $63, 950 of merchandise should be available for sale on December 31, 2007. The physical count reveals that only $62, 150 is actually available. 58

Merchandise Inventory Shrinkage Adjusting Entry Dec. 31 Cost of Merchandise Sold 1 800 00 Merchandise Inventory 1 800 00 Inventory records $63, 950 Inventory count 62, 150 Inventory shortage $ 1, 800 59

Profitability Measures -- Effective Use of Assets Ratio of Net Sales to Assets Net sales Total assets: Beginning of year End of year Average Ratio of net sales to assets Sears Penney $41, 366, 000 $31, 846, 000 $50, 409, 000 $19, 742, 000 $44, 317, 000 $20, 908, 000 $47, 363, 000 $20, 325, 000. 87 to 1 1. 57 to 1 Ratio Use: To assess the effectiveness in the use of assets to generate sales. 60