Chapter5 Accounting for Merchandising Operations Recording Purchases of

Chapter-5: Accounting for Merchandising Operations Recording Purchases of Merchandise Recording Sales of Merchandise Completing the Accounting Cycle Forms of Financial Statement 1

Merchandising Operations Merchandising Companies Buy and Sell Goods Wholesaler Retailer Consumer The primary source of revenues is referred to as sales revenue or sales. 2

Merchandising Operations Income Measurement Not used in a Service business. Cost of goods sold is the total cost of merchandise sold during the period. 3

Merchandising Operations Operating Cycles The operating cycle of a merchandising company ordinarily is longer than that of a service company. 4

Merchandising Operations Flow of Costs Companies use either a perpetual inventory system or a periodic inventory system to account for inventory. 5

Merchandising Operations Flow of Costs Perpetual System u Maintain detailed records of the cost of each inventory purchase and sale. u Records continuously show inventory that should be on hand. u Company determines cost of goods sold each time a sale occurs. Periodic System u Do not keep detailed records of the goods on hand. u Cost of goods sold determined by count at the end of the accounting period. 6

Merchandising Operations Calculation of COGS Beginning inventory Add: Purchases, net Goods available for sale Less: Ending inventory Cost of goods sold $ 100, 000 800, 000 900, 000 125, 000 $ 775, 000 7

Merchandising Operations Additional Consideration Perpetual System: u Traditionally used for merchandise with high unit values. u Provides better control over inventories. u Requires additional clerical work and additional cost to maintain inventory records. u Nowadays fully computerized system makes it easier to record 8

Recording Purchases of Merchandise (Perpetual system) u Companies purchase inventory using cash or credit (on account). u Normally recorded when goods are received. u Purchase invoice should support each credit purchase. 9

Recording Purchases of Merchandise Example: Sauk Stereo (the buyer) uses as a purchase invoice, the sales invoice prepared by PW Audio Supply, Inc. (the seller). Prepare the journal entry for Sauk Stereo for the invoice from PW Audio Supply. May 4 Inventory (or, Merchandise Inventory) 3, 800 Accounts payable 3, 800 (to record goods purchased on account from PW Audio Supply) 10

Recording Purchases of Merchandise Freight Costs – FOB Shipping Point Seller places goods Free On Board the carrier, and buyer pays freight costs. Example: Assume upon delivery of the goods on May 6, Sauk Stereo pays Acme Freight Company $150 for freight charges, the entry on Sauk Stereo’s books is: May 6 Inventory Cash 150 11

Recording Purchases of Merchandise Freight Costs – FOB Destination Seller places goods Free On Board to the buyer’s place of business, and seller pays freight costs. Example: Assume the freight terms on the invoice in Illustration 5 -5 had required PW Audio Supply to pay the freight charges, the entry by PW Audio Supply would have been: May 4 Freight-out (or, Delivery Expense) 150 Cash 150 Freight costs incurred by the seller are an operating expense. 12

Recording Purchases of Merchandise 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. Example: Assume that on May 8 Sauk Stereo returned to PW Audio Supply goods costing $300. May 8 Accounts payable Inventory 300 13

Recording Purchases of Merchandise Purchase Discounts Sellers may permit buyer to claim a cash discount for prompt payment through Credit Terms. Credit terms specify the amount of cash discount and time period in which discount is offered. Advantages: u Purchaser saves money. u Seller shortens the operating cycle. 14

Recording Purchases of Merchandise Purchase Discounts: Examples of Credit Terms 2/10, n/30 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. 15

Recording Purchases of Merchandise Purchase Discounts Example: 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. (terms: 2/10, n/30) May 14 Accounts payable Inventory Cash 3, 500 70 3, 430 (Discount = $3, 500 x 2% = $70) 16

Recording Purchases of Merchandise Purchase Discounts Should discounts be taken when offered? ◦ If cash is sitting idle and not generating any return then discount should be taken ◦ If cash is generating a return then compare the income with the discount amount and take the one with higher advantage. Examples of returns: Bank interests, Stock profits, Bond interests etc. 17

Recording Purchases of Merchandise Example: 18

Recording Purchases of Merchandise Summary of Purchasing Transactions 4 th - Purchase 6 th – Freight-in Balance $3, 800 150 $300 70 8 th - Return 14 th - Discount $3, 580 19

Recording Sales of Merchandise (Perpetual system) u Made using cash or credit (on account). u Normally recorded when earned, usually when goods transfer from seller to buyer. u Sales invoice should support each credit sale. 20

Recording Sales of Merchandise Journal Entries to Record a Sale #1 Cash or Accounts receivable XXX Sales revenue #2 Cost of goods sold Inventory XXX XXX Selling Price Cost 21

Recording Sales of Merchandise Example: 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. May 4 Accounts receivable 3, 800 Sales revenue 4 Cost of goods sold Inventory 3, 800 2, 400 22

Recording Sales of Merchandise Sales Returns and Allowances u “Flipside” of purchase returns and allowances. u Customer/Client may be dissatisfied because goods are damaged or defective, of inferior quality, or do not meet specifications. u Contra-revenue account (Sales returns and allowances ) (debit). u Sales not reduced (debited) because: ► Would obscure importance of sales returns and allowances as a percentage of sales. ► Could distort comparisons. 23

Recording Sales of Merchandise Example: 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. May 8 Sales returns and allowances 300 Accounts receivable 8 Inventory Cost of goods sold 300 140 24

Recording Sales of Merchandise Example: Assume the returned goods were defective and had a scrap value of $50, PW Audio would make the following entries: May 8 Sales returns and allowances 300 Accounts receivable 8 Inventory Cost of goods sold 300 50 50 25

Recording Sales of Merchandise Sales Discount u Offered to customers to promote prompt payment. u “Flipside” of purchase discount. u Contra-revenue account (Sales discounts) (debit). u *(3800 -300 -70=3430) 26

Recording Sales of Merchandise Example: 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 Cash Sales discounts Accounts receivable 3, 430 70* 3, 500 * [($3, 800 – $300) X 2%] 27

Completing the Accounting Cycle Adjusting Entries u Generally the same as a service company. u One additional adjustment to make the records agree with the actual inventory on hand. Ø u In perpetual inventory system adjustment is required only when records are incorrect due to recording errors, theft or waste. Involves adjusting Inventory and Cost of Goods Sold. 28

Completing the Accounting Cycle Example: 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. Cost of goods sold Inventory 500 29

Completing the Accounting Cycle Closing Entries 30

Completing the Accounting Cycle Closing Entries 31

Forms of Financial Statements Multiple-Step Income Statement u Shows several steps in determining net income. u Two steps relate to principal operating activities. u Distinguishes between operating and non-operating activities. u The multi-step income statement involves the use of multiple sub-totals within the income statement, which makes it easier for readers to aggregate selected types of information within the report. u The usual subtotals are for the gross margin, operating expenses, and other income, which allow readers to determine how much the company earns just from its manufacturing activities (the gross margin), what it spends on supporting operations (the operating expense total) and what component of its results do not relate to its core activities (the other income total). 32

Forms of Financial Statement Multiple Step Income Statement Key Items: u Net sales u Gross profit rate 33

Forms of Financial Statement Multiple Step Income Statement Key Items: u Net sales u Gross profit u Operating expenses: Operating expenses are those expenditures that a business incurs to engage in any activities not directly associated with the production of goods or services. (Selling, general & administrative exp) 34

Forms of Financial Statement Multiple-Step Income Statement Key Items: u Net sales u Gross profit u Operating expenses u Non-operating activities u Net income 35

Forms of Financial Statement Multiple. Step Income Statement 36

Forms of Financial Statement Single-Step Income Statement u Subtract total expenses from total revenues u Two reasons for using the single-step format: 1. Company does not realize any profit until total revenues exceed total expenses. 2. Format is simpler and easier to read. 37

Forms of Financial Statement Single-Step Income Statement 38

Forms of Financial Statement Classified Balance Sheet 39