Chapter 4 - Accounting for Merchandising Operations

Service Company

provides services to its customers

merchandiser

earns net income by buying and selling merchandise

merchandise

products/goods that a company buys to resell

wholesaler

buys products from manufactures and sells them to retailers

retailer

buys products from manufactures/wholesalers and sells them to consumers like us

Reporting Income: Service Company Formula

Revenue-Expenses=Net Income

Reporting Income: Merchandiser Formula

Net Sales - Cost of Goods Sold = Gross Profit - Expenses = Net Income

Gross Profit Formula & different name

net sales - cost of goods sold = Gross Profit (also called Gross Margin)

Cost of Goods Sold

the expense of buying and preparing the merchandise

reflects the cost of merchandise sold to customers during the period

Merchandise Inventory

products that a company owns and intends to sell

Inventory Costs

• Cost to buy goods

• any shipping costs to the store

• make them ready for sale

Merchandise Inventory is reposted as a _________ on the balance sheet

Current Asset

Merchandise Sold: costs removed from the balance sheet and reported on income statement as an expense as _________

Cost of Goods Sold

Operating Cycle for a Merchandiser

CASH —> Purchases—>Merchandise Inventory—>Credit Sales—>Accounts Receivable—> Cash Collection—>CASH

What is the largest expense on merchandiser’s income statement

Cost of Goods Sold

What are the two formulas to get the Merchandise Available for Sale

• Net Purchases + Beginning Inventory=

• Cost of Goods Sold + Ending Inventory

Perpetual Inventory System

updates accounting records for each purchase and sale of inventory ( for inventory for sale and sold)

Periodic Inventory System

updates accounting record for purchases sales of inventory only at the end of the PERIOD

tech alls people to strategically react and increase profit (mom and pops)

Assume the $1200 of merchandise is purchased for cash and buyer uses a perpetual inventory system

Example of Purchases WITHOUT Cash Discounts

Merchandise Inventory 1200

…… Cash………………………..1200

Merchandise Inventory includes all of the following

-purchase cost

any shipping fee owed

tax required

other cost necessary to prepare the merchandise for sale

Credit Terms

include the amounts and timing of payments from buyer to seller

Credit Period

amount of time allowed before full payment is due

“2/10,n/30“

seller requirements payment withing 30 days after the invoice (net 30 days)

promote cash discount to encourage buyer to pay earlier

Assume that the Nov.2 purchase of $1,200 in merchandise is on credit w/ terms of 2/10,n/30. The cost of the merchandise purchased is recorded in Merchandise Inventory. However, the credit to Accounts Payable because purchase is on credit. The discount period extends through Nov.12, which is exactly 10 days discount period expires, how much cash must the buyer pay?

Examples of Purchases WITH Cash Discount

Merchandise Inventory 1200

……. Accounts Payable …………1200

FOB stands for

Freight on Board

Amount of Cash the Buyer Must Pay Formula

Invoice Amount

Less: Returns of Merchandise

Amount Due (if discount not taken)

Less: Discount (Amount due x Discount %)

Amount of Cash Paid

Assume Invoice Amount is 1200, discount is 24 dollars, and done on credit terms. Later, Payment is done in cash, within the time frame for the discount. Record Journal Entry

Accounts Payable…… 1200

….. Merchandise Inventory……. 24

….. Cash ……………………….. 1176

“Payment in Full”

assume that the buyer takes advantage of the discount and payment is made within the discount period

Assume that the buyer contacted the seller to report that some of the merchandise was defective and the seller is willing to negotiate a lower price if the buyer will accept merchandise (not yet paid)

Example of Purchases w/ Returns and Allowances

Accounts Payable… 300

…. Merchandise Inventory … 300

allowance

reduction in price

Suppose $1000 of merchandise is purchased on June 1, terms 2/10,n/60. Record Journal Entry

Merchandise Inventory … 1000

…. Accounts Payable …………1000

Suppose on June 3, before paying invoice, buyer decided to return $100 of the merchandise. Record Journal Entry

Accounts payable….. 100

….Merchandise Inventory…..100

Suppose on June 11, , last day in the 10 day discount period, buyer pays amount due. (keeping in mind that on June 3, before paying invoice, buyer decided to return $100 of the merchandise.) Record Journal Entry

Accounts Payable…. 900

…. Merchandise Inventory .. 18

…. Cash……………………..882

Transportation/Shipping

buyer/seller must agree on who is responsible for paying transportation and who bears the risk of loss during transit

FOB Shipping Point

Ownership Transfer At: shipping point

Good in Transit Owned by: buyer (can be included in THEIR cost of purchased merchandise)

Transportation Cost Paid By: buyer

FOB Destination

Ownership Transfer At: destination( buyer’s business)

Good in Transit Owned by: seller (can be included in THEIR cost of purchased merchandise)

Transportation Cost Paid By: seller

Assume Purchase Terms : FOB Shipping Point. Record Journal Entry.

Merchandise Inventory…. 75

….Cash………………………..75

Assume Purchase Terms : FOB Destination. Record Journal Entry.

Delivery Expense* …. 75

…. Cash………………….75

* also called “Transportation-Out” or “Freight-Out”

Itemized Costs of Purchases Formula

Invoice Cost of Merchandise Purchases

Less: Purchases discount received

…….. Purchases returns and allowances

Add: Costs of Transportation

Total Ned Costs of Merchandise Purchases

Perpetual Inventory System does NOT provide separate records (accounts)

They are recorded in _______________ - information outside the usual ledger accounts

Supplementary Records

Accounting under the Perpetual System requires that each sales transaction for a merchandiser (cash or credit)

1. revenue recorded (and asset increased) from the customer

2. Cost of Goods sold incurred (and asset decreased) the customer

Assumer that 2400 of merchandise is sold on credit to a customer on November 3 and that the seller uses a perpetual inventory system. Record Journal Entry

Example of Sales WITHOUT Cash Discounts

1. Accounts Receivable …. 2400

………… Sales …………………… 2400

sales on credit

2. Cost of Goods Sold ….. 1600

………… Merchandise Inventory …. 1600

to record the cost of Nov. 3 sale

Credit Sale for 1000 on Nov. 12 with the terms of 2/10,n/60. Record Journal entry.

Example of Sales WITH Cash Discounts

Accounts Receivable … 1000

…. Sales …………………….. 1000

Assuming that the customer pays the amount due before the discount period expires. Record what the journal entry would look like (keep in mind it was in terms of credit)

Cash…………….. 980

Sales Discount….. 20

…. Accounts Receivable… 1000

Sales Return

a REVENUE ACCOUNT

merchandise that customers return to seller after a sale

Sales Allowance

reductions in the selling price of merchandise sold to customers

Sales Returns & Allowances

a CONTRA REVENUE ACCOUNT

is deducted from sales when computing net sales

Assume seller has a sale of merchandise for Nov.3 for 2400 that has cost 1600. Then, customer returns part of the merchandise on Nov. 6 and the returned items sell for 800 and had cost 600. Record 2 journal entries. (Revenue and Cost)

Example of Sales WITH Returns

Revenue:

Sales and Returns Allowances…. 800

….Accounts Receivable……………….800

Cost:

Merchandise Inventory….600

Cost of Goods Sold………….600

returned goods to inventory

Assume that the 800 of merchandise sold on Nov.3, but the buyer decided to keep it because the seller offer a 100 price reduction. Record journal Entry

Nov. 3

Accounts Receivable….. 2400

Sales……………………………..2400

Different Day

Sales Returns and Allowances …. 100

…. Accounts Receivable…………………100

Shrinkage

inventory losses as a result of theft or deterioration

• Computed: Comparing a physical count of inventory with recorded amounts

Assume that the seller’s merchandise inventory account has a general ledger balance of 21250 on December 31st. After a physical count of inventory is completed, the seller determine that only 21000 of inventory is available. record Journal Entry

Example of Adjusting Entries for Inventory Shrinkage

Cost of Goods Sold…. 250

….. Merchandise Inventory…. 250

Temporary Accounts Unique to Merchandisers (state each account and if debit or credit)

• Sales (credit)

• Sales Discount (debit)

• Sales Returns and Allowances (debit)

• Cost of Goods Sold (debit)

Closing Entries Steps

1. Close Credit Balances in Temporary Accounts to Income Statement

2. Close Debits Balances in Temporary Accounts to Income Statement

3. Close Income Summary to Retained Earnings

4. Close Dividends to Retained Earnings

STEP 1: Close Credit Balances in Temporary Accounts to Income Statement

record journal entry

Sales

…… Income Summary

STEP 2: Close Debit Balances in Temporary Accounts to Income Statement

record journal entry

Income Summary

…. Sales Discounts

…. Sales Returns & Allowances

…. Cost of Goods Sold

…. Depreciation Expense

…. Salaries Expense

…. Insurance Expense

…. Rent Expense

…. Supplies Expense

…. Advertising Expense

STEP 3: Close Income Summary to Retained Earnings

record journal entry

Income Summary

…. Retained Earnings

STEP 3: Close Dividends Accounts to Retained Earnings

record journal entry

Retained Earnings

…. Dividends

Multiple Step Income Statement Format

shows details for net sales and many other costs and expenses, and reports subtotals for various categories of items

Multiple Step Income Statement Format Formula

Sales

Less: Sales Discount

…….. Sales Returns and Allowances

Net Sales

Cost of Goods Sold

Gross Profit

Operating Expenses Include what two types of Expenses?

selling expenses and general and administrative expense

Examples of Selling Expenses & Definition

• cost to market and distribute products and services

• Depreciation Expense - Store Equipment

• Rent Expense - selling space

• Store supplies expense

• Advertising Expense

TOTAL SELLING EXPENSE

Examples of General & Administrative Expense & Definition

• cost to administer a company’s overall operations

• Depreciation Expense - Office Equipment

• Office Salaries Expense

• Insurance Expense

• Rent Expense - Office Space

• Office Supplies Expense

TOTAL GENERAL & ADMINISTRATIVE EXPENSES

Total Operating Expense Formula

TOTAL SELLING EXPENSE + TOTAL GENERAL & ADMINISTRATIVE EXPENSES

Income from Operations Formula

Gross Profit - Total Operating Expense

Examples of Other Revenues and Gains (expenses & losses)

• Interest Revenue

• Gain on sale of building

• Interest Expense

TOTAL OTHER REVENUE AND GAINS

Net Income Formula

Income from Operations - Total Other Revenue and Gains

Examples of Revenue & Gains

• Interest Revenue

• Dividend Revenue

• Rent Revenue

• Gains from asset disposals

Examples of Expenses & Losses

• interest expense

• losses from asset disposals

• casualty losses

Classified Balance Sheet ( Order)

CURRENT ASSETS

Cash

Accounts Receivable

Merchandise Inventory

Office Supplies

Prepaid Insurance

TOTAL CURRENT ASSETS

*the higher on the list, the faster its liquidity is

Liquidity

company’s ability to pay its current liabilities

Acid Test Ratio

Quick Assets/Current Liabilities

Cash and Cash Equivalents+ Short-term Investment + Current Receivables

Acid Test Ratio : Answers

• _____ than 1.0- quick assets exceed current liabilities

• _____ than 1.0- current liabilities exceed quick assets

• MORE than 1.0- quick assets exceed current liabilities

• LESS than 1.0- current liabilities exceed quick assets

Gross Margin Ratio (gross profit)

Gross Margin/Net Sales

Net Sales-cost of goods sold