5 - Merchandise Operations

receive cash → perform services → accounts receivable → receive cash

service company business operating cycle

receive cash → buy inventory → sell inventory → accounts receivable → receive cash

merchandising company business operating cycle

Sales Revenue - Operating Expenses = Net Income (Loss)

service business income measurement

Sales Revenue - COGS = Gross Profit - Operating Expenses = Net Income (Loss)

merchandising business income measurement

beginning inventory + cost of goods purchased = cost of goods available for sale - ending inventory = cost of goods sold

coost flow

Merchandise Inventory

current asset; products/goods for sale which is recorded in the balance sheet at cost

Wholesaler

intermediary between a manufacturer and retailer or other wholesalers; buys by bulk

Retailer

intermediary between a manufacturer or wholesalers and the final consumers

Operating Cycle

length of time from purchase of inventory to collection of receivables

Catalog/List Price

original selling price

Invoice

a document stating the quantity and cost of inventory

Invoice Price

list price less trade discount or equals to list price (no trade discount)

Perpetual Inventory Systems

• continuous updating/recording of inventory transactions (purchase and sale)

• determines COGS each time a sale occurs

• for big/slow moving items i.e. car, jewelry

Periodic Inventory System

• updating/recording of inventory only at the end of the period

• COGS determined by count

• for small and fast moving items i.e. hardware/grocery items

• Beginning Inventory + Net Purchases = Goods Available for Sale

• Goods Available for Sale - Ending Inventory = COGS

Perpetual Journalizing

accounts that are closed at the end of the accounting period

Periodic Journalizing

accounts that are carried over to the next period

DR. Merchandise Inventory CR. Accounts Payable

Purchases - Perpetual

DR. Purchases CR. Accounts Payable

Purchases - Periodic

DR. Merchandise Inventory CR. Accounts Payable

Purchases with Trade Discount - Perpetual

DR. Purchases CR. Accounts Payable

Purchases with Trade Discount - Periodic

trade discount rule

record on final cost

DR. Accounts Payable CR. Merchandise Inventory CR. Cash

Purchase Discount - Perpetual

DR. Accounts Payable CR. Purchase Discount CR. Cash

Purchase Discount - Periodic

Accounts Payable * Discount Rate

Merchandise Inventory

Accounts Payable * (1 - Discount Rate)

Cash

Purchase Discount

reduction of inventory cost when buyer pays within discount period

2/10, n/30

2% discount if paid within 10 days, otherwise net amount due within 30 days

1/10 EOM

1% discount if paid within 10 days following the month end (or the first 10 days of the next month)

n/10 EOM

Pay net amount within 10 days following the month end (or the first 10 days of the next month)

DR. Accounts Payable CR. Merchandise Inventory

Purchase Returns - Perpetual

DR. Accounts Payable CR. Purchase Returns and Allowances

Purchase Returns - Periodic

Purchase Returns

defective goods or returns out of specification

DDR. Accounts Payable CR. Merchandise Inventory

Purchase Allowance - Perpetual

DR. Accounts Payable CR. Purchase Returns and Allowances

Purchase Allowance - Periodic

Purchase Allowance

buyer keeps the goods but asks reduction of cost

DR. Merchandise Inventory CR. Cash

Transportation In/Freight In/FOB Shipping Point - Perpetual (collect)

DR. Transportation In CR. Cash

Transportation In/Freight In/FOB Shipping Point - Periodic (collect)

Transportation In / Freight In / FOB Shipping Point (collect)

• seller places the goods free on board and buyer pays freight costs

• buyer bears the risk of damage or loss when goods are in transit

• the goods are part of the buyer’s inventory when they are in transit since ownership has transferred to the buyer

• no entry (transportation cost) on the seller

DR. Merchandise Inventory CR. Accounts Payable

Transportation In/Freight In/FOB Shipping Point - Perpetual (prepaid): Buyer’s Books

DR. Transportation In CR. Accounts Payable

Transportation In/Freight In/FOB Shipping Point - Periodic (prepaid): Buyer’s Books

DR. Accounts Receivable CR. Cash

Transportation In/Freight In/FOB Shipping Pont - Periodic (prepaid): Seller’s Books

Transportation In / Freight In / FOB Shipping Point (prepaid)

if the buyer requests the seller to pay initially for transportation cost, the seller doesn’t record transportation cost

DR. Delivery Expense Cr. Cash

Transportation Out/Freight Out/FOB Destination - Perpetual (prepaid)

DR. Transportation Out / Delivery Expense CR. Cash

Transportation Out/Freight Out/FOB Destination - Periodic (prepaid)

Transportation Out / Freight Out / FOB Destination (prepaid)

• prepaid: seller places the goods free on board and seller pays freight costs

• the seller does not record revenue from this sale until the goods arrive at the destination because this transaction is not complete before that point

• no entry (transportation cost) for buyer on prepaid (seller pays)

DR. Delivery Expense CR. Accounts Payable

Transportation Out/Freight Out - Perpetual (collect): Seller’s books

DR. Transportation Out/Delivery Expense CR. Accounts Payable

Transportation Out/Freight Out - Periodic (collect): Seller’s books

DR. Accounts Payable CR. Cash

Transportation Out - Periodic (collect): Buyer’s books

Transportation Out / Freight Out (collect)

seller places the goods free on board and seller pays freight costs

DR. Accounts Receivable CR. Sales

DR. Cost of Goods Sold CR. Merchandise Inventory

Sales - Perpetual

DR. Accounts Receivable CR. Sales

Sales - Periodic

DR. Sales Returns & Allowances CR. Accounts Receivable

DR. Merchandise Inventory CR. Cost of Goods Sold

Sales Returns - Perpetual

DR. Sales Returns & Allowances CR. Accounts Receivable

Sales Returns - Periodic

DR. Cash DR. Sales Discount CR. Accounts Receivable

Sales Discount - Perpetual

DR. Cash DR. Sales Discount CR. Accounts Receivable

Sales Discount - Periodic

DR. Cost of Goods Sold CR. Merchandise Inventory

Shrinkage - Perpetual

Shrinkage

inventory loss due to theft, spoilage, wastage, and obsolescence

Periodic COGS

Beginning Inventory

Add: Purchases

Add: Transportation-in

Less: Purchase Discounts

Less: Purchase Returns and Allowances

—-

Cost of Goods Available for Sale

Less: Ending Inventory

—

Cost of Goods Sold

Periodic Net Purchases

Purchases

Add: Transportation-in

Less: Purchase Discount

Less: Purchase Returns and Allowances

—-

Net Purchases

DR. Inventory on Consignment CR. Merchandise Inventory

To record goods out on consignment

Consignment - Consignor’s Books

DR. Cost of Goods Sold CR. Inventory on Consignment

To record cost of consigned goods

DR. Accounts Receivable/Cash CR. Sales Revenue

to record consignor’s sales value

Consignment - Once sold by Consignee

Consignment

consignor (supplier) ships goods to consignee who attempts to sell them

Consignor

owner of the goods and records goods out on consignment

Consignee

• receiver/seller of the goods (not considered owner of the goods)

• records goods held on consignment

beginning inventory Understated

• COGS Understated

• Net Income Overstated

• Subtract Net Income

Beginning Inventory Overstated

• COGS Overstated

• Net Income Understated

• Add Net Income

Ending Inventory Understated

• COGS Overstated

• Net Income Understated

• Add Net Income

Ending Inventory Overstated

• COGS Understated

• Net Income Overstated

• Subtract Net Income

Beginning Inventory

Same effect on COGS but Opposite as Net Income

Ending Inventory

Opposite effect on COGS but Same effect as Net Income

Gross Profit Rate based on Sales (Sales = 100%)

• Sales = COGS / (1 - Gross Profit Rate)

• COGS = Sales × (1 - Gross Profit Rate)

• Gross Profit = Sales × Gross Profit Rate

• Use when the percentage is of Sales (e.g. “Gross profit is 30% of sales”)

Gross Profit based on COGS (COGS = 100%)

• Sales - COGS × (1 + Gross Profit Rate)

• COGS = Sales / (1 + Gross Profit Rate)

• Gross Profit = COGS × Gross Profit Rate

• Use when the percentage is of COGS (e.g. “Gross profit is 50% of COGS”)

(Beginning A/R + Credit Sales) - (Cash Receipts net of discount + Sales Discount + Sales Returns & Allowances) = Ending A/R

Accounts Receivable T-account

(Beginning A/P + Purchases) - (Cash Payment net of disc, R&A + Purchase Discount + Purchase Returns & Allowances) = Ending A/P

Accounts Payable T-account

(Beginning Inventory + Purchases + Transportation-In) - (COGS + Purchase Discount + Purchase Returns & Allowances) = Ending Inventory

Merchandise Inventory T-account

Value Added Tax

12% tax inclusive in all selling prices

Input Vat

12% of the cost of merchandise inventory of the buyer

Selling Price/1.12 or AR/1.12 or Cash/1.12

Sales of Seller

Sales * 0.12 (Credit Balance)

Output Tax of Seller

Discount Rate * (Sales - Sales R&A)

Sales Discount of Seller

Buying Price/1.12 or AP/1.12 or Cash/1.12

Merchandise Inventory of Buyer

Sales*0.12 (Debit Balance)

Output Tax of Buyer

Discount Rate * (Sales - Sales R&A)

Sales Discount of Buyer

Closing Entries

• accounts affecting the determination of net income are closed to income summary

• in journalizing, all debit column amounts are credited, and all credit columns amounts are debited

• beginning inventory balance is debited to income summary and credited to inventory

• ending inventory balance is debited to inventory and credited to income summary

DR. Service Revenue CR. Income Summary

Close credit balance accounts

DR. Income Summary CR. Cost of Goods Sold CR. Expense CR. Sales Returns and Allowances CR. Sales Discounts CR. Freight-Out

Close debit balance accounts

DR. Income Summary CR. Retained Earnings

To close net income to retained earnings

DR. Retained Earnings CR. Dividends

To close dividends to retained earnings