Download Chapter 5 Merchandising Operations

Chapter 5
Merchandising Operations
Financial Statements of a Service Company and a Merchandiser:
-
Service Companies:
 Revenues earned through performance of services.
 Examples: Dentists, Accounting Firms, Attorneys.
-
Merchandising Companies:
 Revenues earned through sales of merchandise.
 Examples: Restaurants, Dept. Stores.
Income Statement:
Service Company
Century 21 Real Estate
Income Statement
Year Ended December June 30, 2008
Service revenue
$ x,xxx
Expenses:
Salary expense
x
Depreciation expense
x
Rent expense
x
Net income
$ x,xxx
Merchandising Company
General Motors Corporation
Income Statement
Year Ended December 31, 2008
Sales revenue
Cost of goods sold
Gross profit
Operating expenses:
Salary expense
Depreciation expense
Rent expense
Net income
$ x,xxx
x
x,xxx
x
x
x
x
$ x,xxx
Merchandising Company
General Motors Corporation
The balance sheet
Year Ended December 31, 2008
Current assets:
Cash
Short-term investments
Accounts receivable, net
Inventory
Prepaid expenses
$x
x
x
x
x
x
Balance Sheet:
Service Company
Century 21 Real Estate
The balance sheet
Year Ended December June 30, 2008
Current assets:
Cash
Short-term investments
Accounts receivable, net
Prepaid expenses
$x
x
x
x
x
What Are the Merchandising Operations?
Merchandising consists of buying and selling products rather than the services. Merchandisers have some new
balance sheet and income statement items.

Balance Sheet
Inventory, an asset.
Author; Dr. Helal Afify ~~ Editor; Omar Abu Jbara


Income Statement
Sales revenue (often abbreviated as Sales).
Cost of good sold, an expense
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Account for the purchase of inventory
The operating Cycle of a Merchandising Business
1- Begins when the company purchases inventory.
2- Then sells the inventory.
3- And, last, collect cash from customers.
Inventory Accounting Systems:
1. Periodic system:
- Does not keep a running record of all goods bought and sold.
- Inventory counted at least once a year
- Used for inexpensive goods
2. Perpetual system:
- Keeps a running record of all goods bought and sold.
- Used for all types of goods.
Perpetual Inventory System
 The accounting inventory system in which the
business keeps a running record of all inventory as
it is bought and sold. The inventory account is
continuously updated to reflect items on hand.
 Record of quantity of goods is constantly updated.
 Better control of inventory.
 Popular now due to bar codes and computer
scanning.
Periodic Inventory System
 A system in which the business does not keep a
running or continuous record of inventory on hand.
At the end of the period, it makes a physical count
of on-hand inventory and uses this information to
prepare the financial statements.
 Goods counted periodically to determine quantity.
 Used by small businesses.
 Less popular now because of computerized
inventory systems.
Accounting for Inventory
-
Inventory (balance sheet) = Number of units of inventory on hand × Cost per unit of inventory.
Inventory (income statement) = Number of units of inventory sold × Cost per unit of inventory.
Purchase of Inventory:
 Purchase Discounts:
- Discount for early payment.
- A deduction from the invoice price granted to encourage early payment of the amount due.
- Expressed as follows 1/10, n/30 (Credit terms 1/10, n/30 means 1% discount if paid within 10 days. If the
discount period is missed, the full amount is due within 30 days. This decreases the cost of the inventory).
Author; Dr. Helal Afify ~~ Editor; Omar Abu Jbara
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 Purchase Returns and Allowances:
- Purchase Return: Merchandise returned by the purchaser to the supplier.
- Purchase Allowance: A reduction in the cost of defective merchandise received by a purchaser from a supplier.
 Transportation Costs:
Someone must pay the transportation cost of shipping inventory from seller to buyer. The purchase
agreement specifies FOB (free on board) to indicate who pays the freight.
- FOB shipping point: means Title passes at origin and buyer pays the freight.
- FOB destination: means Title passes at destination and Seller pays the freight.
Freight costs are either freight in or freight out:
-
Freight in: is the transportation cost on purchased goods.
 Amount paid to have merchandise shipped from the supplier.
 Additional cost of the merchandise inventory.
 Transportation cost on purchased goods. Inward freight costs of acquiring merchandise.
 Transportation-In is part of cost of goods sold.
 Debit inventory.
-
Freight out: is the transportation cost on goods sold.
 Transportation Out/Delivery Expense.
 Outgoing freight costs that must be paid by the seller.
 Transportation cost on goods sold.
 Debit an expense (delivery expense). Delivery Expense is a selling expense on the income statement!
Transportation Costs:
FOB Shipping Point
 Buyer takes ownership of inventory when goods leave
seller’s place of business.
 Purchaser normally pays freight charges
 Freight-in.
 Increases cost of inventory.
FOB Destination
 Buyer takes ownership of inventory when goods
arrive.
 Seller normally pays freight
 Freight-out.
 Selling expense.
Computing the Cost of Inventory:
Net cost of inventory = Purchases of inventory – Purchase returns and Allowances – Purchase Discounts + Freight in.
Applying the Perpetual Inventory System:
Inventory and cost of Goods Sold are continually updated during the accounting period, as purchases, sales, and
other inventory transactions take place.
Transactions Related to Purchases of Merchandise:
• Purchases of Merchandise on Credit:
 The cost of merchandise purchased is placed in the Merchandise Inventory account at the time of purchase.
• Transportation Costs on Purchases:
 Accumulated in a Freight In / Transportation In account.
 In some cases, the seller pays the freight charges and bills them to the buyer as a separate item on the invoice.
• Purchases Returns:
 A return of the goods from the buyer or seller for cash or credit.
• Purchases Allowances:
 A reduction made in the selling price of the merchandise, granted by the seller so that the buyer will keep the
goods.
• Payments on Account.
• Payments by cash (or checks) to suppliers.
Author; Dr. Helal Afify ~~ Editor; Omar Abu Jbara
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Account for the sale of inventory:
Sale of Inventory:
 Sales Revenue:
-
Amount earned from selling inventory.
Revenue account
 Cost of Goods Sold:
-
Cost of inventory that has been sold to customers.
Expense account.
 Sales Returns & Allowances :
-
When customer returns goods or the seller grants a reduction in price to customer
Contra-revenue account (debit balance).
 Sales Discounts:
-
If customer pays within the discount period allowed by the seller:
Contra-revenue account (debit balance).
 Delivery Expense (Freight Out).
-
Net Sales Revenue = Sales Revenue – Sales returns and Allowances – Purchase Discounts.
Net Sales - Cost of Goods Sold = Gross profit.
Remember, there are always two entries to record a sale when using the perpetual inventory system.
One to record the selling price to the customer and the second to remove the inventory from your books
at the amount your company paid to acquire it.
Transactions Related to Sales of Merchandise:
At the time of sale, the cost of merchandise is transferred from the Merchandise Inventory account to the Cost
of Goods Sold account. In the case of a return, the cost of the merchandise is transferred from Cost of Goods
Sold back to Merchandise Inventory.
• Sales of Merchandise on Credit:
 Two entries are necessary.
 Record the sale as a debit to Accounts Receivable.
 Update the Cost of Goods sold by transferring from Merchandise Inventory.
• Cash sales of Merchandise:
 Debit Cash for the amount of the sale.
• Payment of Delivery Costs:
 Accumulated in the Freight Out Expense account.
 Shown as a selling expense on the income statement.
• Returns of Merchandise Sold:
 Accumulated in the Sales Return and Allowances account, a contra-revenue account, with a normal
debit balance, deducted from Sales in the income statement.
 The cost of merchandise must also be transferred from the COGS account back into the
Merchandise Inventory account.
• Receipts on Account.
• Receipts of cash (or checks) from credit customers recorded as credits to Accounts Receivable.
Author; Dr. Helal Afify ~~ Editor; Omar Abu Jbara
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Example (p. 269):
Suppose liberty Sales Co. engaged in the following transactions during June of current year:
Purchased inventory on credit terms of 1/10 net eom (end of month), $1,600.
Returned 40% of the inventory purchased on June 3. It was defective.
Sold goods for cash, $920 (cost, $550).
Purchased goods for $5,000. Credit terms were 3/15, net 30.
Paid a $260 freight bill on goods purchased.
Sold inventory for $2,000 on credit terms of 2/10, n/30 (cost, $1,180).
Received returned goods from the customer of the June 18 sale, $800 (cost, $480).
Borrowed money from the bank to take advantage of the discount offered on the June 15
purchase. Signed a note payable to the bank for the amount, $4,850.
24 Paid supplier for goods purchased on June 15, less the discount.
28 Received cash in full settlement of the account from the customer who purchased inventory on
June 18, less the return on June 22, and less the discount.
29 Paid the amount owed on account from the purchase of June 3, less the June 9 return.
June 3
9
12
15
16
18
22
24
Requirements:
1- Journalize the preceding transactions for Liberty.
2- Set up T-accounts and post the journal entries to show the ending balances in the Inventory and
the Cost of Good Sold accounts.
3- Assume that the note payable signed on June 24 requires the payment of $90 interest expense.
Was borrowing funds to take the cash discount a wise or unwise decision?
Solution: Requirement 1: Journalizing:
June
3
9
12
12
15
16
18
18
Inventory
Accounts Payable
Purchased inventory on account.
Accounts Payable ($1,600 × 0.40)
Inventory
Returned inventory.
Cash
Sales Revenue
Cash sale.
Cost of Good Sold
Inventory
Recorded the cost of good sold
Inventory
Accounts Payable
Purchased inventory on account.
Inventory
Cash
Paid a freight bill.
Accounts Receivable
Sales Revenue
Sales on account.
Cost of Good Sold
Inventory
Recorded the cost of goods sold.
Author; Dr. Helal Afify ~~ Editor; Omar Abu Jbara
1,600
1,600
640
640
920
920
550
550
5,000
5,000
260
260
2,000
2,000
1,180
1,180
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22 Sales Returns and Allowances
Accounts Receivable
Received returned goods.
22 Inventory
Cost of Good Sold
Placed goods back in inventory.
24 Cash
Note Payable
Borrowed money from the bank.
24 Accounts Payable
Inventory ($5,000 × 0.03)
Cash ($5,000 × 0.97) or ($5,000 - $150)
Paid within discount period.
28 Cash [($2,000 - $800) × 0.98]
800
800
480
480
4,850
4,850
5,000
150
4,850
1176
24
Sales Discounts [($2,000 - $800) × 0.02] or ($2,000 - $1,176)
Accounts Receivable
Cash collection within the discount period.
29 Accounts Payable ($1,600 - $640)
Cash
Paid after discount period.
1,200
960
960
Requirement 2: Preparing T- accounts:
Inventory
June 3
15
16
22
Bal.
1,600
5,000
260
480
4,820
June 9
12
18
24
Cost of Good Sold
640
550
1,180
150
June 12
18
Bal.
550
1,180
1,250
June 22
480
Requirement 3:
Liberty’s decision to borrow funds was wise because the discount received ($150) exceeded the interest paid
($90). Thus liberty was $60 better off.
Adjusting and Closing the Accounts of a Merchandiser:
Adjusting Inventory:
•
•
•
If physical count of inventory is different from amount on the books – Inventory Shrinkage
Debit Cost of Goods Sold
Credit Inventory
Closing Entries:
1.
2.
3.
4.
Close all income statement accounts with credit balances to Income Summary
Close all income statement accounts with debit balances to Income Summary
Close Income Summary to Capital
Close Withdrawals to Capital
Author; Dr. Helal Afify ~~ Editor; Omar Abu Jbara
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Preparing a Merchandiser’s Financial Statements:
Inventory vs. Cost of Goods Sold:
Inventory
Beginning
Purchases
Ending
Inventory Sold
Cost of Goods Sold
Inventory Sold
As Inventory is Sold we remove it’s cost from the Asset side of A=L+E and Insert it’s cost into an Expense on
the Equity side of A = L + E.
This property exists for all Assets: As they are used up or sold the cost transfers from the balance sheet as a
future economic resource (asset) to the income statement as an expense incurred to generate revenue.
Relationship between Balance Sheet and Income Statement:


Income Statement Items:
- Sales revenue is based on sale price of inventory sold.
- Cost of goods sold is based on cost of inventory sold.
- Gross profit (gross margin) is sales revenue less cost of goods sold.
Balance Sheet Item:
- Inventory on the balance sheet is based on cost.
Income Statement Formats:
There are two basic formats for the income statement:
1. Single-Step:
Total revenues minus total expenses; simple, easy to read.
XYZ, Inc.
Income Statement
For the Year Ended Dec. 31, 2008
Revenues:
Sales revenue
Less: Sales discounts
Sales returns and allowances
Net sales revenue
Interest revenue
Total Revenue
Expenses:
Cost of Good Sold
Wage expense
Rent expense
Insurance expense
Depreciation Expense
Supplies expense
Total Expenses
Net income
Author; Dr. Helal Afify ~~ Editor; Omar Abu Jbara
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2. Multiple-Step:
- Contains key subtotals; highlights components and distinguishes activities. More useful than
single-step income statement.
- Gives 3 useful line items:
 Gross Profit.
 Operating Expenses.
 Total from Non-Operating Activities.
XYZ, Inc.
Income Statement
For the Year Ended Dec. 31, 2008
Sales revenue:
Less: Sales discounts
Sales returns and allowances
Net sales revenue
Cost of Good Sold
Gross Profit
Operating Expenses:
Wage expense
Rent expense
Insurance expense
Depreciation Expense
Supplies expense
Operating income
Other revenues and expenses:
Interest revenue
Interest expense
Net income
Non-Operating Activities:
-
Any revenue &/or expense not relating to the company’s main business operations.
Include:
 Gains/Losses from Sale of Investments, Sale of Equipment, etc.
 Interest Income.
 Interest Expense.
Author; Dr. Helal Afify ~~ Editor; Omar Abu Jbara
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Using gross profit percentage and inventory turnover to evaluate a business:
The Gross Profit Percentage (or the gross margin percentage):
-
Percentage of dollar sales available to cover expenses and provide a profit.
Carefully watched measure.
Small increase may indicate rise in income.
Small decrease may indicate trouble.
Gross profit percentage =
Gross Profit
Net Sales revenue
Gross profit percentage =
$32
$65
Example:
Net sales
$65
Cost of sales (33)
Gross profit $32
=
49%
The Rate of Inventory Turnover:
- Measures how rapidly inventory is sold.
- The higher the turnover, the more quickly inventory is sold.
- Ending inventory from the preceding period.
Inventory turnover =
Cost of Good Sold
Average inventory
=
Cost of Good Sold
(Beginning inventory* +
Ending inventory) / 2
= …. Times per year
Example: Rate of Inventory Turnover for Three Merchandisers:
Author; Dr. Helal Afify ~~ Editor; Omar Abu Jbara
Page | 9
Cost of Goods Sold in a Periodic Inventory System:
Inventory and Cost of Goods Sold:
-
Inventory: Products purchased or manufactured for Sale to Customers.
Beginning Inventory: Quantities of Merchandise on hand.
Purchases: New Purchases or Manufactured products.
Ending Inventory: Remaining Unsold Merchandise.
Cost of Goods Sold: Cost of Inventory Sold during accounting Period.
Most that a company can sell during an accounting period.
 Available for Sale = Beginning Inventory + Purchases.
 Goods Available for Sale = Beginning Inventory + Purchases.
 Cost of Goods Sold = Goods Available for Sale - Ending Inventory.
Cost of Goods Sold:
Beginning Inventory
+ Purchases
Less: Purchase discounts
Purchase returns and allowances
Net purchases
Freight in
Cost of Goods Available for Sale
Less: Ending Inventory
Cost of Goods Sold
$38,600
$91,400
(3,000)
(1,200)
87,200
5,200
131000
(40,200)
$90,800
Notes:
-
No detailed records.
Cost of goods sold determined at end of the period by taking a physical count and pricing it.
Inventory account does not change during the year.
Purchases, purchase discounts, purchase returns and allowances are recorded in their respective
accounts.
- No entry is made to record the cost of merchandise sold.
- Inventory is counted at year-end and records are adjusted at that time.
Author; Dr. Helal Afify ~~ Editor; Omar Abu Jbara
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