Chapter 5 Merchandising Operations Multimedia Slides by Gail

Chapter 5 Merchandising Operations Multimedia Slides by: Gail A. Mestas, MAcc, New Mexico State University

Learning Objectives 1. Identify the management issues related to merchandising businesses. 2. Compare the income statements for service and merchandising concerns, and define the components of the merchandising income statement. 3. Define and distinguish the terms of sale for merchandising transactions. 4. Prepare an income statement and record merchandising transactions under the perpetual inventory system. Copyright © Houghton Mifflin Company. All rights reserved. 2

Supplemental Objectives 5. Prepare an income statement and record merchandising transactions under the periodic inventory system. 6. Prepare a work sheet and closing entries for a merchandising concern using the perpetual inventory system. 7. Prepare a work sheet and closing entries for a merchandising concern using the periodic inventory system. 8. Apply sales and purchases discounts to merchandising transactions. Copyright © Houghton Mifflin Company. All rights reserved. 3

Management Issues in Merchandising Businesses • Objective 1 – Identify the management issues related

Merchandising Businesses … earn income by buying and selling products or merchandise • Can be wholesalers or retailers • Use the same basic accounting methods as service companies – The process is more complex than for service companies because of the buying and selling of merchandise • The goods on hand for sale to customers are called merchandise inventory Copyright © Houghton Mifflin Company. All rights reserved. 5

Management Issues in Merchandising Businesses • Cash flow management • Profitability management • Choice of inventory system • Control of merchandising operations Copyright © Houghton Mifflin Company. All rights reserved. 6

Cash Flow Management … involves managing a company’s receipts and payments of cash • If bills cannot be paid when due, the company may be forced out of business • Merchandising businesses engage in a series of transactions called the operating cycle Copyright © Houghton Mifflin Company. All rights reserved. 7

The Operating Cycle • Transactions in the operating cycle include – Purchase of merchandise inventory for cash or credit – Payment for purchases made on credit – Sales of merchandise inventory for cash or on credit – Collection of cash from credit sales Copyright © Houghton Mifflin Company. All rights reserved. 8

The Operating Cycle of Merchandising Concerns 1. Merchandise inventory is purchased for cash or on credit 2. Payments are made for purchases on credit Purchase for cash Cash Payment of cash Accounts Payable Purchase on credit Merchandise Inventory Sales for cash Collection of cash 3. Merchandise is sold for cash or on credit Copyright © Houghton Mifflin Company. All rights reserved. Accounts Receivable Sales on credit 4. Cash is collected from credit sales 9

The Financing Period … is the time period from the purchase of inventory until it is ultimately sold and collected less the amount of time creditors give the company to pay for the inventory • Also called the cash gap • This is the period of time the company will be without cash from a particular series of transactions • The company will need to have funds available or borrow from the bank • This is why cash flow management is important Copyright © Houghton Mifflin Company. All rights reserved. 10

The Financing Period Illustrated Inventory sold Inventory purchased Cash paid The financing period, or cash gap, is 90 days (120 days – 30 days) Cash received 1. Inventory is purchased on credit (Accounts Payable) 2. Terms for payment are 30 days (Cash is paid) 3. Average days to sell inventory is 60 days – sold on credit (Accounts Receivable) 4. Average days to collect on receivables is 60 days (Cash is received) Copyright © Houghton Mifflin Company. All rights reserved. 11

The Financing Period (cont’d) • The financing period – Varies for different companies – Can be 120 days, or even longer, for merchandising companies • Example • Target’s financing period is shorter because it sells most of its merchandise for cash Copyright © Houghton Mifflin Company. All rights reserved. 12

Cash Versus Credit Types of payments for purchases Cash Bank credit card Store credit Funds from these sales are available to the merchandiser immediately Merchandiser must wait a period of time before receiving cash • Retailers reduce their financing period (improve their cash flow) by selling as much as possible for cash – Encourage sales by cash or bank credit card Copyright © Houghton Mifflin Company. All rights reserved. 13

Profitability Management … is a complex activity that includes achieving a satisfactory gross margin and maintaining acceptable levels of operating expenses Copyright © Houghton Mifflin Company. All rights reserved. 14

Profitability Management (cont’d) • Achieving a satisfactory gross margin depends on – Setting appropriate prices for merchandise – Purchasing merchandise at favorable prices and terms • Maintaining acceptable levels of operating costs depends on – Controlling expenses • Using an operating budget is an efficient way to control expenses – Operating efficiently Copyright © Houghton Mifflin Company. All rights reserved. 15

Operating Budgets … consist of detailed listings of projected selling expenses and general and administrative expenses for a company • Reflect management’s operating plans • At year-end and key times during the year, management should compare actual and budgeted expenses and make adjustments to operations Copyright © Houghton Mifflin Company. All rights reserved. 16

Choice of Inventory System • Two basic systems – Perpetual inventory system – Periodic inventory system • Management must choose the system or combination of systems that is best for achieving the company’s goals Copyright © Houghton Mifflin Company. All rights reserved. 17

Perpetual Inventory System …determines inventory by keeping continuous records of the quantity and, usually, the cost of individual items as they are bought and sold Copyright © Houghton Mifflin Company. All rights reserved. 18

Perpetual Inventory System (cont’d) • Detailed data enable management to – Determine product availability • Can respond to customers’ inquiries – Avoid running out of stock • Able to order inventory more effectively – Control financial costs associated with investments in inventory Copyright © Houghton Mifflin Company. All rights reserved. 19

Accounting for Inventory Under the Perpetual System • Purchases – The cost of each item is recorded in the Merchandise Inventory account • Sales – The cost of each item is transferred from the Merchandise Inventory account to the Cost of Goods Sold account • Therefore – Merchandise Inventory account balance = Cost of goods on hand – Cost of Goods Sold account balance = Cost of merchandise sold to customers Copyright © Houghton Mifflin Company. All rights reserved. 20

Periodic Inventory System … determines inventory by a physical count taken at the end of the accounting period • No detailed records of the actual inventory on hand are maintained during the accounting period • Amount of inventory on hand is accurate only on the balance sheet date Copyright © Houghton Mifflin Company. All rights reserved. 21

Periodic Inventory System • Used to reduce the amount of clerical work • Lack of records could lead to lost sales or high operating costs • More likely to be used by – Smaller companies – Companies that sell high volumes of low value items • • • Drugstores Automobile parts stores Department stores Discount stores Grain companies Copyright © Houghton Mifflin Company. All rights reserved. 22

Perpetual Inventory System • More likely to be used by – Larger companies – Companies that sell high-value items • Automobiles • Appliances Copyright © Houghton Mifflin Company. All rights reserved. 23

Control of Merchandising Operations • Principal transactions of merchandising businesses are – Buying assets – Selling assets • Involve cash, accounts receivable, and merchandise inventory • These assets are vulnerable to theft and embezzlement – Management must use internal controls to protect these assets Copyright © Houghton Mifflin Company. All rights reserved. 24

Internal Control • Internal control is created by establishing – An environment of control

Physical Inventory • A physical count of all merchandise on hand – Required under both the perpetual and periodic inventory systems – Under the perpetual inventory system, the actual count is compared to accounting records to determine any shortages that may exist • Used to facilitate control over merchandise inventory Copyright © Houghton Mifflin Company. All rights reserved. 26

Merchandise Inventory …includes all goods intended for sale that are owned by a business • Includes all goods intended for sale, regardless of where they are located, such as – Goods in transit if title has passed to the merchant – Damaged or obsolete goods that can be sold at reduced prices • Does not include – Merchandise that has been sold – Damaged or obsolete goods that cannot be sold Copyright © Houghton Mifflin Company. All rights reserved. 27

Inventory Losses • Result from spoilage, shoplifting, and theft by employees • Periodic inventory system – No means to identify losses because the costs are automatically included in cost of goods sold • Perpetual inventory system – Losses equal the difference between the inventory records and the physical count – Update inventory by crediting Merchandise Inventory and debiting Cost of Goods Sold Copyright © Houghton Mifflin Company. All rights reserved. 28

Discussion Q. What four issues must managers of merchandising businesses face? A. The four issues that managers of merchandising businesses face are 1. Cash flow management 2. Profitability management 3. Choosing between the periodic and the perpetual inventory systems, and 4. Establishing an internal control structure that protects the business’s assets Copyright © Houghton Mifflin Company. All rights reserved. 29

Income Statement for a Merchandising Concern • Objective 2 – Compare the income statements for service and merchandising concerns, and define the components of the merchandising income statement Copyright © Houghton Mifflin Company. All rights reserved. 30

Income Statement for a Merchandiser • Consists of three major parts 1. Net sales 2. Cost of goods sold 3. Operating expenses There is also a subtotal for gross margin (Net Sales – Cost of Goods Sold) Income statements for service businesses do not include gross margin computations Copyright © Houghton Mifflin Company. All rights reserved. 31

The Components of Income Statements for Service and Merchandising Companies

Net Sales …consists of the gross proceeds from sales of merchandise • Also simply called sales • Amount of sales and trends in net sales over time are used to analyze a company’s progress Copyright © Houghton Mifflin Company. All rights reserved. 33

Net Sales = Gross Sales – Sales Returns and Allowances – Discounts Gross Sales = Total Cash Sales + Total Credit Sales during a given accounting period • This follows the revenue recognition rule – Revenue is recognized even though cash may not be collected until the following accounting period Sales Returns and Allowances • A contra-revenue account • Used to accumulate cash refunds, credits on account, and allowances off selling prices for defective or unsatisfactory merchandise Copyright © Houghton Mifflin Company. All rights reserved. 34

Cost of Goods Sold … is the amount paid for merchandise sold, or the cost to manufacture products that were sold, during an accounting period • Also called cost of sales Copyright © Houghton Mifflin Company. All rights reserved. 35

Gross Margin …is the difference between net sales and cost of goods sold Net Sales – Cost of Goods Sold = Gross Margin • Also called gross profit Copyright © Houghton Mifflin Company. All rights reserved. 36

Gross Margin • Management is interested in both the amount of gross margin and the percentage of gross margin • Both are useful in planning business operations Copyright © Houghton Mifflin Company. All rights reserved. 37

Operating Expenses … are the expenses other than cost of goods sold that are incurred in running a business • Operating expenses are grouped into categories – Selling expenses – General and administrative expenses • Careful planning and control of operating expenses can improve a company’s profitability Copyright © Houghton Mifflin Company. All rights reserved. 38

Selling Expenses • Include – – Cost of storing goods Cost of preparing goods for sale Advertising and promoting sales Delivering goods to the buyer • Called freight out expense or delivery expense – General occupancy expenses (may be allocated among selling expenses and general and administrative expenses) • Rent expense • Utilities expense • Insurance expense Copyright © Houghton Mifflin Company. All rights reserved. 39

General and Administrative Expenses • Include – General office expenses • Accounting • Personnel • Credit and collections • Expenses that apply to overall operations – General occupancy expenses (may be allocated among general and administrative expenses and selling expenses) • Rent expense • Utilities expense • Insurance expense Copyright © Houghton Mifflin Company. All rights reserved. 40

Net Income … is what remains of gross margin after operating expenses are deducted • It is the final figure, or “bottom line, ” of the income statement • Represents the amount of business earnings that accrue to the owners • Management and owners use net income to measure whether a business has operated successfully during the past accounting period Copyright © Houghton Mifflin Company. All rights reserved. 41

Discussion Q. What are three major parts of an income statement for a merchandising company? – Net sales – Cost of goods sold – Operating expenses Copyright © Houghton Mifflin Company. All rights reserved. 42

Terms of Sale • Objective 3 – Define and distinguish the terms of sale

Trade Discounts … are reductions off list or catalog prices • Offered by manufacturers and wholesalers • Usually 30 percent or more • Example – An article is listed at $1, 000 with a trade discount of 40 percent – Sale price = $1, 000(1. 00 – 0. 40) = $600 Copyright © Houghton Mifflin Company. All rights reserved. 44

Trade Discount Terms n/10 (net 10) Amount is due 10 days after the invoice date n/10 eom (net 10 end-of-month) Amount is due 10 days after the end of the month in which the invoice is dated Copyright © Houghton Mifflin Company. All rights reserved. 45

Sales Discounts …give buyers discounts for early payment • Are intended to increase the seller’s liquidity by reducing the amount of money tied up in accounts receivable • It is usually advantageous for buyers to take advantage of sales discounts Copyright © Houghton Mifflin Company. All rights reserved. 46

Sales Discount Terms 2/10, n/30 • Amount may be paid within 10 days of the invoice date with a 2 percent discount • Or wait up to 30 days and pay the full amount Copyright © Houghton Mifflin Company. All rights reserved. 47

Shipping Terms FOB Shipping Point • Title of merchandise passes from seller to buyer at the point merchandise is shipped • Buyer pays shipping costs FOB destination • Title of merchandise passes from seller to buyer when the merchandise reaches its destination • Seller pays shipping costs FOB means “free on board” Copyright © Houghton Mifflin Company. All rights reserved. 48

Credit Card Sales • If seller accepts a credit card payment, the customer signs a sales invoice • The sale is communicated to the seller’s bank and a cash deposit is made in the seller’s account – Seller does not have to establish customer's credit, collect from the customer, or tie up money in accounts receivable • The seller pays the lender (credit card company) from 2 to 6 percent of the sale amount for the service Copyright © Houghton Mifflin Company. All rights reserved. 49

Accounting for Credit Card Sales • Example – A customer charges a $1, 000 purchase on a Visa credit card – Visa charges a 4 percent discount on sales – The seller will pay Visa $40 ($1, 000 x. 40) • Journal entry Copyright © Houghton Mifflin Company. All rights reserved. 50

Discussion Q. What is the difference between a trade discount and a sales discount? A. Trade discount • A deduction off a list or catalog price Sales discount • A discount given to a buyer for early payment for sales made on credit Copyright © Houghton Mifflin Company. All rights reserved. 51

Applying the Perpetual Inventory System • Objective 4 – Prepare an income statement and record merchandising transactions under the perpetual inventory system Copyright © Houghton Mifflin Company. All rights reserved. 52

Income Statement When Using the Perpetual Inventory System The Cost of Goods Sold account is continually updated during the accounting period Copyright © Houghton Mifflin Company. All rights reserved. The Merchandise Inventory account on the balance sheet is updated at the same time 53

Transactions Related to the Purchase of Merchandise • Purchases of merchandise on credit • Transportation costs on purchases • Purchases returns and allowances • Payments on account Copyright © Houghton Mifflin Company. All rights reserved. 54

Purchases of Merchandise on Credit Oct. 3: Received merchandise purchased on credit from Neebok Company, invoice dated October 1, terms n/10, FOB shipping point, $4, 890 Under the perpetual inventory system, the cost of merchandise purchased is placed in the Merchandise Inventory account at the time of purchase Copyright © Houghton Mifflin Company. All rights reserved. 55

Transportation Costs on Purchases Oct. 4: Received bill from Transfer Freight Company for transportation costs on October 3 shipment, invoice dated October 1, terms n/10, $160 Freight In, or Transportation In, is the transportation cost of receiving merchandise Copyright © Houghton Mifflin Company. All rights reserved. Transportation costs are accumulated in the Freight In account, which is a component of cost of goods sold 56

Purchases Returns and Allowances Oct. 6: Returned merchandise received from Neebok Company on October 3 for credit, $480 Under the perpetual inventory system, the returned merchandise is removed from the Merchandise Inventory account Copyright © Houghton Mifflin Company. All rights reserved. 57

Payments on Account Oct. 10: Paid in full the amount due to Neebok Company for the purchase of October 3, part of which was returned on October 6 Copyright © Houghton Mifflin Company. All rights reserved. 58

Transactions Related to Sales of Merchandise • Sales of merchandise on credit • Payment of delivery costs • Returns of merchandise sold • Receipts on account Copyright © Houghton Mifflin Company. All rights reserved. 59

Sales of Merchandise on Credit Oct. 7: Sold merchandise on credit to Gonzales Distributors, terms n/30, FOB destination, $1, 200; the cost of the merchandise was $720 Under the perpetual inventory system, two entries are necessary. Copyright © Houghton Mifflin Company. All rights reserved. The sale is recorded and Cost of Goods Sold is updated by a transfer from Merchandise Inventory 60

Payment of Delivery Costs Oct. 8: Paid transportation costs for the sale on October 7, $78 Freight Out Expense, or Delivery Expense, is often paid by the seller to facilitate sales Copyright © Houghton Mifflin Company. All rights reserved. Delivery costs are accumulated in the Freight Out Expense account, which is shown as a selling expense on the income statement 61

Returns of Merchandise Sold Oct. 9: Return of merchandise sold on October 7 accepted from Gonzales Distributors for full credit and returned to merchandise inventory, $300; the cost of the merchandise was $180 The Sales Returns and Allowances account gives management a readily available measure of unsatisfactory products or customer dissatisfaction, which can be indicated by returns and allowances Copyright © Houghton Mifflin Company. All rights reserved. 62

Returns of Merchandise Sold Oct. 9: Return of merchandise sold on October 7 accepted from Gonzales Distributors for full credit and returned to merchandise inventory, $300; the cost of the merchandise was $180 If merchandise is not returned or will not be resold, this transaction is not recorded Under the perpetual inventory system, the cost of the returned merchandise must be transferred from Cost of Goods Sold to Merchandise Inventory Copyright © Houghton Mifflin Company. All rights reserved. 63

Receipts on Account Nov. 5: Received payment in full from Gonzales Distributors for sale of merchandise on October 7, less the return on October 9 Copyright © Houghton Mifflin Company. All rights reserved. 64

Discussion Q. How are merchandising transactions recorded under the perpetual inventory system? A. Merchandising transactions are recorded during the accounting periods, as purchases, sales, and other inventory transactions take place Copyright © Houghton Mifflin Company. All rights reserved. 65

Applying the Periodic Inventory System • Supplemental Objective 5 – Prepare an income statement and record merchandising transactions under the periodic inventory system Copyright © Houghton Mifflin Company. All rights reserved. 66

Applying the Periodic Inventory System • Cost of goods sold must be computed in the income statement when using the periodic inventory system – It is not updated for purchases, sales, and other transactions during the accounting period Copyright © Houghton Mifflin Company. All rights reserved. 67

The Components of Cost of Goods Sold Copyright © Houghton Mifflin Company. All rights

Income Statement When Using the Periodic Inventory System Under the periodic inventory system, cost of goods sold must be computed Cost of goods available for sale must be determined first Copyright © Houghton Mifflin Company. All rights reserved. 69

Cost of Goods Available for Sale … is the sum of two factors, beginning

Net Cost of Purchases Copyright © Houghton Mifflin Company. All rights reserved. 71

Transactions Related to Purchases of Merchandise • Purchases of merchandise on credit • Transportation costs on purchase • Purchases returns and allowances • Payments on account Copyright © Houghton Mifflin Company. All rights reserved. 72

Purchases of Merchandise on Credit Oct. 3: Received merchandise purchased on credit from Neebok Company, invoice dated October 1, terms n/10, FOB shipping point, $4, 890 Under the periodic inventory system, the total cost of merchandise purchased for resale during the period is accumulated in the Purchases account Copyright © Houghton Mifflin Company. All rights reserved. The Purchases account does not indicate whether merchandise has been sold or is still on hand 73

Purchases Returns and Allowances Oct. 6: Returned merchandise received from Neebok Company on October 3 for credit, $480 Under the periodic inventory system, the amount of the allowance or returned merchandise is recorded in the Purchases Returns and Allowances account The Purchases Returns and Allowances account • Is a contra-purchases account • Carries a normal credit balance • Is deducted from purchases on the income statement Copyright © Houghton Mifflin Company. All rights reserved. 75

Sales of Merchandise on Credit Oct. 7: Sold merchandise on credit to Gonzales Distributors, terms n/30, FOB destination, $1, 200 Under the periodic inventory system, only one entry is necessary. The Cost of Goods Sold account is not used because the Merchandise Inventory account is not updated until the end of the accounting period. Copyright © Houghton Mifflin Company. All rights reserved. 78

Returns of Merchandise Sold Oct. 9: Return of merchandise sold on October 7 accepted from Gonzales Distributors for full credit and returned to merchandise inventory, $300 The Sales Returns and Allowances account is used to accumulate returns and allowances to customers for wrong or unsatisfactory merchandise. • The Sales Returns and Allowances account – Is a contra-revenue account – Carries a normal debit balance – Is deducted from sales on the income statement Copyright © Houghton Mifflin Company. All rights reserved. 80

Discussion Q. How are merchandising transactions recorded under the periodic system? A. Merchandising transactions are recorded at the end of the accounting period; therefore, Costs of Goods Sold and Inventory must be computed at that time Copyright © Houghton Mifflin Company. All rights reserved. 82

The Merchandising Work Sheet and Closing Entries: The Perpetual Inventory System • Supplemental Objective 6 – Prepare a work sheet and closing entries for a merchandising concern using the perpetual inventory system Copyright © Houghton Mifflin Company. All rights reserved. 83

Work Sheet and Closing Accounts for a Merchandising Company • Basically the same as for a service company but includes accounts needed to handle merchandising transactions – Treatment of these accounts depends on whether perpetual or periodic inventory system is used Copyright © Houghton Mifflin Company. All rights reserved. 84

Comparison of Merchandising Accounts to be Closed at End of Period Perpetual Inventory System Periodic Inventory System • Sales Returns and Allowances • Cost of Goods Sold • Sales Discounts • Freight In • Purchases Notice that the Merchandise Inventory account is not involved in the closing process under the perpetual inventory system • Purchases Returns and Allowances • Purchases Discounts • Freight In • Merchandise Inventory Copyright © Houghton Mifflin Company. All rights reserved. 85

Merchandise Inventory Account Under the perpetual system, the Merchandise Inventory account is not involved in the closing process because it is up to date at the end of the accounting period Copyright © Houghton Mifflin Company. All rights reserved. Under the periodic system, no entries are made to the Merchandise Inventory account until the closing process at the end of the accounting period 86

Work Sheet Columns 1. 2. 3. 4. 5. Enter balances from ledger accounts to trial balance columns Enter adjusting entries in the Adjustments columns Total columns to prove debits equal credits Extend balances to Income Statement and Balance Sheet columns Record adjusting entries from work sheet to general journal, then post to ledger The Adjusted Trial. XXX Balance XXX columns XXX have XXXbeen omitted because only a few adjusting entries are required for Fenwick Fashions Company Copyright © Houghton Mifflin Company. All rights reserved. 87

Balance Sheet Columns Perpetual Inventory System Ending Merchandise Inventory is in both the Trial

Income Statement Columns Perpetual Inventory System The difference between the Income Statement column totals

Closing Entries Perpetual Inventory System Debit Income Summary and credit the accounts in the

Closing Entries Perpetual Inventory System (cont. ) Copyright © Houghton Mifflin Company. All rights

Closing Entries Perpetual Inventory System (cont. ) Debit the accounts in the Income Statement

Closing Entries Perpetual Inventory System (cont. ) Next, the balances in the Income Summary and Withdrawal accounts are closed to the Capital account Notice that the amount required to close the Income Summary account is equal to net income for the period Copyright © Houghton Mifflin Company. All rights reserved. 93

Discussion Q. Under the perpetual inventory system, is the Merchandise Inventory account involved in the closing process? A. No. Under the perpetual system, the Merchandise Inventory account is not involved in the closing process because it is up to date at the end of the accounting period Copyright © Houghton Mifflin Company. All rights reserved. 94

The Merchandising Work Sheet and Closing Entries: The Periodic Inventory System • Supplemental Objective 7 – Prepare a work sheet and closing entries for a merchandising concern using the periodic inventory system Copyright © Houghton Mifflin Company. All rights reserved. 95

Merchandise Inventory Account • Under the periodic inventory system, the Merchandise Inventory account requires special treatment – Because merchandise purchases are accumulated in the Purchases account • No entries are made to the Merchandise Inventory account during the accounting period Copyright © Houghton Mifflin Company. All rights reserved. 96

Merchandise Inventory Account Periodic Inventory System The beginning balance of the Merchandise Inventory account, which appears in the Trial Balance Debit column, is extended to the Income Statement Debit column Copyright © Houghton Mifflin Company. All rights reserved. 97

Merchandise Inventory Account Periodic Inventory System This has the effect of adding beginning inventory to net purchases because the Purchases account is also in the Income Statement Debit column Copyright © Houghton Mifflin Company. All rights reserved. 98

Merchandise Inventory Account Periodic Inventory System Determined by a physical count The ending balance of the Merchandise Inventory account is then inserted in the Income Statement Credit column Copyright © Houghton Mifflin Company. All rights reserved. 99

Merchandise Inventory Account Periodic Inventory System This has the effect of subtracting ending inventory from goods available for sale in order to calculate cost of goods sold Copyright © Houghton Mifflin Company. All rights reserved. 100

Merchandise Inventory Account Periodic Inventory System Finally, the ending Merchandise Inventory is inserted in the Balance Sheet Debit column because it will appear on the balance sheet Copyright © Houghton Mifflin Company. All rights reserved. 101

Closing Entries Periodic Inventory System Debit Income Summary and credit the accounts in the

Closing Entries Periodic Inventory System (cont. ) Copyright © Houghton Mifflin Company. All rights

Closing Entries Periodic Inventory System (cont. ) Debit the accounts in the Income Statement

Closing Entries Periodic Inventory System (cont. ) Next, the balances in the Income Summary and Withdrawal accounts are closed to the Capital account Copyright © Houghton Mifflin Company. All rights reserved. 106

Accounting for Discounts • Supplemental Objective 8 – Apply sales and purchases discounts to

Sales Discounts …are discounts given to buyers for early payment for sales made on credit • Are recorded only at the time the customer pays • The Sales Discounts account – Is a contra-revenue account – Carries a normal debit balance – Is deducted from sales on the income statement Copyright © Houghton Mifflin Company. All rights reserved. 108

Transactions Involving No Sales Discounts Sept. 20: Sold merchandise to a customer, terms 2/10, n/60, $300 Nov. 19: Customer pays on account for September 20 sale The customer paid the full sale amount of $300 because payment was made after the 10 day sales discount period Copyright © Houghton Mifflin Company. All rights reserved. 109

Transactions Involving Sales Discounts Sept. 20: Sold merchandise to a customer, terms 2/10, n/60, $300 Sept. 29: Customer pays on account for September 20 sale The customer paid only $294 [$300 – ($300 x. 02)] because payment was made within the 10 -day sales discount period Copyright © Houghton Mifflin Company. All rights reserved. 110

Purchases Discounts …are discounts taken by merchants for early payment for merchandise purchased on credit • Usually do not apply to freight, postage, taxes, or other charges appearing on the invoice • The Purchases Discounts account – Is a contra-purchases account – Carries a normal credit balance – Is deducted from purchases on the income statement Copyright © Houghton Mifflin Company. All rights reserved. 111

Transactions Involving No Purchases Discounts Nov. 12: Made a credit purchase of merchandise, terms 2/10, n/30, $1, 500 Nov. 14: Returned merchandise purchased November 12 on credit, $200 Dec. 12: Paid on account for November 12 sale, less amount for returned merchandise The full sale amount of $1, 500, less $200 for returned merchandise, was paid because payment was made after the 10 -day purchases discount period Copyright © Houghton Mifflin Company. All rights reserved. 112

Transactions Involving Purchases Discounts Nov. 12: Made a credit purchase of merchandise, terms 2/10, n/30, $1, 500 Nov. 14: Returned merchandise purchased November 12 on credit, $200 Nov. 22: Paid on account for November 12 sale, less amount for returned merchandise A purchases discount of $26 [($1, 500 - $200) x. 02] was recorded, because payment was made within the 10 -day purchases discount period Copyright © Houghton Mifflin Company. All rights reserved. 113

Discussion Q. What is the normal balance of the Sales Discounts account? Is it an asset, a liability, an expense, or a contra-revenue account? A. The normal balance of the Sales Discounts account is a debit balance Sales Discounts is a contra-revenue account. It is deducted from gross sales on the income statement Copyright © Houghton Mifflin Company. All rights reserved. 114

Time for Review… 1. Identify the management issues related to merchandising businesses 2. Compare the income statements for service and merchandising concerns, and define the components of the merchandising income statement 3. Define and distinguish the terms of sale for merchandising transactions 4. Prepare an income statement and record merchandising transactions under the perpetual inventory system Copyright © Houghton Mifflin Company. All rights reserved. 115

And Finally … 5. Prepare an income statement and record merchandising transactions under the periodic inventory system 6. Prepare a work sheet and closing entries for a merchandising concern using the perpetual inventory system 7. Prepare a work sheet and closing entries for a merchandising concern using the periodic inventory system 8. Apply sales and purchases discounts to merchandising transactions Copyright © Houghton Mifflin Company. All rights reserved. 116