Chapter 5 -1 Merchandising Operations and the

Chapter 5 -1

Merchandising Operations and the Multiple-Step Income Statement Chapter 5 -2 Financial Accounting, Fifth Edition

Merchandising Operations Merchandising Companies Buy and Sell Goods Wholesaler Retailer Consumer The primary source of revenues is referred to as sales revenue or sales. Chapter 5 -3 SO 1 Identify the differences between service and merchandising companies.

Merchandising Operations Income Measurement Sales Revenue Less Cost of Goods Sold Not used in a Service business. Equals Gross Profit Cost of goods sold is the total cost of merchandise sold during the period. Chapter 5 -4 Illustration 5 -1 Income measurement process for a merchandising company Less Operating Expenses Equals Net Income (Loss) SO 1 Identify the differences between service and merchandising companies.

Merchandising Operations Operating Cycles Illustration 5 -2 The operating cycle of a merchandising company ordinarily is longer than that of a service company. Chapter 5 -5 SO 1 Identify the differences between service and merchandising companies.

Merchandising Operations Flow of Costs Illustration 5 -3 Companies use either a perpetual inventory system or a periodic inventory system to account for inventory. Chapter 5 -6 SO 1 Identify the differences between service and merchandising companies.

Merchandising Operations Flow of Costs Perpetual System ü Maintain detailed records of the cost of each inventory purchase and sale. ü Records continuously show inventory that should be on hand. ü Company determines cost of goods sold each time a sale occurs. Chapter 5 -7 SO 1 Identify the differences between service and merchandising companies.

Merchandising Operations Flow of Costs Periodic System ü ü Do not keep detailed records of the goods on hand. Determine cost of goods sold only at end of accounting period. Physical inventory count to determine cost of goods on hand. Calculation of Cost of Goods Sold: Beginning inventory Add: Purchases, net Goods available for sale Less: Ending inventory Cost of goods sold Chapter 5 -8 $ 100, 000 800, 000 900, 000 125, 000 $ 775, 000 SO 1 Identify the differences between service and merchandising companies.

Merchandising Operations Flow of Costs Additional Consideration Perpetual System: Ø Traditionally used for merchandise with high unit values. Ø Provides better control over inventories. Ø Requires additional clerical work and additional cost to maintain inventory records. Chapter 5 -9 SO 1 Identify the differences between service and merchandising companies.

Recording Purchases of Merchandise Made using cash or credit (on account). Normally recorded when goods are received. Purchase invoice should support each credit Chapter 5 -10 Illustration 5 -5 purchase. SO 2 Explain the recording of purchases under a perpetual inventory system.

Recording Purchases of Merchandise Illustration 5 -5 Illustration: 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 Merchandise inventory Accounts payable Chapter 5 -11 3, 800 SO 2 Explain the recording of purchases under a perpetual inventory system.

Recording Purchases of Merchandise Freight Costs – Terms of Sale Illustration 5 -6 Seller places goods Free On Board the carrier, and buyer pays freight costs. Seller places goods Free On Board to the buyer’s place of business, and seller pays freight costs. Chapter 5 -12 Freight costs incurred by the seller are an operating expense.

Recording Purchases of Merchandise Illustration: Assume upon delivery of the goods on May 6, Sauk Stereo pays Haul-It Freight Company $150 for freight charges, the entry on Sauk Stereo’s books is: May 6 Merchandise inventory 150 Cash 150 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 Cash Chapter 5 -13 150 SO 2 Explain the recording of purchases under a perpetual inventory system.

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. Chapter 5 -14 SO 2 Explain the recording of purchases under a perpetual inventory system.

Recording Purchases of Merchandise Illustration: Assume that on May 8 Sauk Stereo returned to PW Audio Supply goods costing $300. May 8 Accounts payable Merchandise inventory Chapter 5 -15 300 SO 2 Explain the recording of purchases under a perpetual inventory system.

Recording Purchases of Merchandise Purchase Discounts Credit terms may permit buyer to claim a cash discount for prompt payment. Advantages: Purchaser saves money. Seller shortens the operating cycle. Example: Credit terms of 2/10, n/30, is read “two-ten, net thirty. ” 2% cash discount if payment is made within 10 days. Otherwise, net amount due within 30 days. Chapter 5 -16 SO 2 Explain the recording of purchases under a perpetual inventory system.

Recording Purchases of Merchandise Purchase Discounts - 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. Chapter 5 -17 SO 2 Explain the recording of purchases under a perpetual inventory system.

Recording Purchases of Merchandise Illustration: 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 makes to record its May 14 payment. May 14 Accounts payable Merchandise Inventory Cash 3, 500 70 3, 430 (Discount = $3, 500 x 2% = $70) Chapter 5 -18 SO 2 Explain the recording of purchases under a perpetual inventory system.

Recording Purchases of Merchandise Illustration: If Sauk Stereo failed to take the discount, and instead made full payment of $3, 500 on June 3, the journal entry would be: June 3 Accounts payable Cash Chapter 5 -19 3, 500 SO 2 Explain the recording of purchases under a perpetual inventory system.

Recording Purchases of Merchandise Purchase Discounts Should discounts be taken when offered? Passing up the discount offered equates to paying an interest rate of 2% on the use of $3, 500 for 20 days. Example: 2% for 20 days = Annual rate of 36. 5% (365/20 = 18. 25 twenty-day periods x 2% = 36. 5%) Chapter 5 -20 SO 2 Explain the recording of purchases under a perpetual inventory system.

Recording Purchases of Merchandise Summary of Purchasing Transactions Illustration 4 th - Purchase 6 th – Freight-in Balance Chapter 5 -21 $3, 500 150 $300 70 8 th - Return 14 th - Discount $3, 280 SO 2 Explain the recording of purchases under a perpetual inventory system.

l Chapter 5 -22 Do E 5 -3

Recording Sales of Merchandise Made for cash or credit (on account). Normally recorded when earned, usually when goods transfer from seller to buyer. Sales invoice should support each credit Chapter 5 -23 Illustration 5 -5 sale. SO 3 Explain the recording of sales revenues under a perpetual inventory system.

Recording Sales of Merchandise Two Journal Entries to Record a Sale #1 #2 Chapter 5 -24 Cash or Accounts receivable Sales XXX Cost of goods sold Merchandise inventory XXX XXX Selling Price Cost SO 3 Explain the recording of sales revenues under a perpetual inventory system.

Recording Sales of Merchandise Illustration: 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 4 3, 800 Cost of goods sold Merchandise inventory Chapter 5 -25 2, 400 SO 3 Explain the recording of sales revenues under a perpetual inventory system.

Recording Sales of Merchandise Sales Returns and Allowances “Flipside” of purchase returns and allowances. Contra-revenue account (debit). Sales not reduced (debited) because: Ø would obscure importance of sales returns and allowances as a percentage of sales. Ø could distort comparisons between total sales in different accounting periods. Chapter 5 -26 SO 3 Explain the recording of sales revenues under a perpetual inventory system.

Recording Sales of Merchandise Illustration: 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 Merchandise inventory Cost of goods sold Chapter 5 -27 300 140 SO 3 Explain the recording of sales revenues under a perpetual inventory system.

Recording Sales of Merchandise Illustration: 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 Merchandise inventory Cost of goods sold Chapter 5 -28 300 50 50 SO 3 Explain the recording of sales revenues under a perpetual inventory system.

Recording Sales of Merchandise Sales Discount Offered to customers to promote prompt payment. “Flipside” of purchase discount. Contra-revenue account (debit). Chapter 5 -29 SO 3 Explain the recording of sales revenues under a perpetual inventory system.

Recording Sales of Merchandise Illustration: 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 3, 430 Sales discounts Accounts receivable 70 * 3, 500 * [($3, 800 – $300) X 2%] Chapter 5 -30 SO 3 Explain the recording of sales revenues under a perpetual inventory system.

l Chapter 5 -31 Do E 5 -1 and E 5 -4

Income Statement Presentation Single-Step Income Statement Subtract total expenses from total revenues Two reasons for using the single-step format: 1) Company does not realize any type of profit until total revenues exceed total expenses. 2) Format is simpler and easier to read. Chapter 5 -32 SO 4 Distinguish between a single-step and a multiple-step income statement.

Income Statement Presentation Single. Step Chapter 5 -33 Illustration 5 -7 SO 4 Distinguish between a single-step and a multiple-step income statement.

Income Statement Presentation Multiple-Step Income Statement Considered more useful because it highlights the components of net income. Three important line items: ü gross profit, ü income from operations, and ü net income. Chapter 5 -34 SO 4 Distinguish between a single-step and a multiple-step income statement.

Illustration 5 -11 Income Statement Presentation Chapter 5 -35

Income Statement Presentation Nonoperating Activities Various revenues and expenses and gains and losses that are unrelated to the company’s main line of operations. Illustration 5 -10 Chapter 5 -36 SO 4 Distinguish between a single-step and a multiple-step income statement.

Income Statement Presentation Determining Cost of Goods Sold Under a Periodic System No running account of changes in inventory. Ending inventory determined by physical count. Directly adjust Merchandise Inventory account for any transaction that affects inventory. Chapter 5 -37 SO 5 Determine cost of goods sold under a periodic system.

Income Statement Presentation Determining Cost of Goods Sold Under a Periodic System Illustration 5 -13 Cost of goods sold for a merchandiser using a periodic inventory system Chapter 5 -38 SO 5 Determine cost of goods sold under a periodic system.

l Chapter 5 -39 Do E 5 -10

Evaluating Profitability Gross Profit Rate A company’s gross profit may be expressed as a percentage by dividing the amount of gross profit by net sales. A decline in the gross profit rate might have several causes. Ø The company may have begun to sell products with a lower “markup. ” Ø Increased competition may result in a lower selling price. Ø Company may be forced to pay higher prices to its suppliers without being able to pass these costs on to its customers. Chapter 5 -40 SO 6 Explain the factors affecting profitability.

Evaluating Profitability Gross Profit Rate Illustration 5 -15 Why does Wal-Mart have a lower gross profit rate than Target and the industry average? Chapter 5 -41 SO 6 Explain the factors affecting profitability.

Evaluating Profitability Profit Margin Ratio Measures the percentage of each dollar of sales that results in net income. How do the gross profit rate and profit margin ratio differ? Ø Gross profit rate - measures the margin by which selling price exceeds cost of goods sold. Ø Profit margin ratio - measures the extent by which selling price covers all expenses (including cost of goods sold). Chapter 5 -42 SO 6 Explain the factors affecting profitability.

Evaluating Profitability Profit Margin Ratio Illustration 5 -17 How does Wal-Mart compare to its competitors? Keep in mind that an increasing percentage of Wal-Mart’s sales is from low-margin groceries. Chapter 5 -43 SO 6 Explain the factors affecting profitability.

l Chapter 5 -44 Do E 5 -6, E 5 -8, E 5 -9, P 5 -4 A

Evaluating Profitability Earnings have high quality if they provide a full and transparent depiction of how a company performed. Ø In general, a measure significantly less than 1 suggests that a company may be using more aggressive accounting techniques in order to accelerate income recognition. Ø A measure significantly greater than 1 suggests that a company is using conservative accounting techniques which cause it to delay the recognition of income. Chapter 5 -45 SO 7 Identify a quality of earnings indicator.

Periodic Inventory System Recording Merchandise Transactions ü Record revenues when sales are made. ü Do not record cost of merchandise sold on the date of sale. ü Physical inventory count at the end of the period to determine: 1. cost of merchandise on hand 2. cost of goods sold during the period. ü Record purchases of merchandise in Purchases account. ü Purchase returns and allowances, Purchase discounts, and Freight costs are recorded in separate accounts. Chapter 5 -46 SO 8 Explain the recording of purchases and sales of inventory under a periodic inventory system.

Periodic Inventory System Recording Purchases of Merchandise Illustration: On the basis of the sales invoice (Illustration 5 -5) and receipt of the merchandise ordered from PW Audio Supply, Sauk Stereo records the $3, 800 purchase as follows. May 4 Purchases Accounts payable Chapter 5 -47 3, 800 SO 8 Explain the recording of purchases and sales of inventory under a periodic inventory system.

Periodic Inventory System Freight Costs Illustration: If Sauk pays Haul-It Freight Company $150 for freight charges on its purchase from PW Audio Supply on May 6, the entry on Sauk’s books is: May 6 Freight-in (Transportation-in) Cash Chapter 5 -48 150 SO 8 Explain the recording of purchases and sales of inventory under a periodic inventory system.

Periodic Inventory System Purchase Returns and Allowances Illustration: Sauk Stereo returns $300 of goods to PW Audio Supply and prepares the following entry to recognize the return. May 8 Accounts payable 300 Purchase returns and allowances Chapter 5 -49 300 SO 8 Explain the recording of purchases and sales of inventory under a periodic inventory system.

Periodic Inventory System Purchase Discounts Illustration: On May 14 Sauk Stereo pays the balance due on account to PW Audio Supply, taking the 2% cash discount allowed by PW Audio for payment within 10 days. Sauk Stereo records the payment and discount as follows. May 14 Accounts payable Purchase discounts Cash Chapter 5 -50 3, 500 70 3, 430 SO 8 Explain the recording of purchases and sales of inventory under a periodic inventory system.

Periodic Inventory System Recording Sales of Merchandise Illustration: PW Audio Supply, records the sale of $3, 800 of merchandise to Sauk Stereo on May 4 (sales invoice No. 731, Illustration 5 -5) as follows. May 4 Accounts receivable Sales 3, 800 No entry is recorded for cost of goods sold at the time of the sale under a periodic system. Chapter 5 -51 SO 8 Explain the recording of purchases and sales of inventory under a periodic inventory system.

Periodic Inventory System Sales Returns and Allowances Illustration: To record the returned goods received from Sauk Stereo on May 8, PW Audio Supply records the $300 sales return as follows. May 4 Sales returns and allowances Accounts receivable Chapter 5 -52 300 SO 8 Explain the recording of purchases and sales of inventory under a periodic inventory system.

Periodic Inventory System Sales Discounts Illustration: On May 14, PW Audio Supply receives payment of $3, 430 on account from Sauk Stereo. PW Audio honors the 2% cash discount and records the payment of Sauk’s account receivable in full as follows. May 14 Cash 3, 430 Sales discounts Accounts receivable Chapter 5 -53 70 3, 500 SO 8 Explain the recording of purchases and sales of inventory under a periodic inventory system.

Comparison of Entries—Perpetual Vs. Periodic Chapter 5 -54 SO 8 Explain the recording of purchases and sales of inventory under a periodic inventory system.

Comparison of Entries—Perpetual Vs. Periodic Chapter 5 -55 SO 8 Explain the recording of purchases and sales of inventory under a periodic inventory system.

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