Financial Accounting Tools for Business Decision Making 2

Financial Accounting: Tools for Business Decision Making, 2 nd Ed. Kimmel, Weygandt, Kieso S EL 1

Chapter 5 2

Chapter 5 Merchandising Operations After studying Chapter 5, you should be able to: z Identify the differences between a service enterprise and a merchandising company. z Explain the recording of purchases under a perpetual inventory system. z Explain the recording of sales revenues under a perpetual inventory system. z Distinguish between a single-step and a multi-step income statement. z Explain the factors affecting the profitability. 3

Service enterprises perform services as their primary source of revenue Merchandising companies buy and sell merchandise 4

Differences Between a Service Enterprise and a Merchandising Company z In a merchandising company, the primary source of revenues is the sale of merchandise, referred to as sales revenue or sales. z Unlike expenses for a service company, expenses for a merchandising company are divided into two categories: y Cost of goods sold - the total cost of merchandise sold during the period. y Operating expenses - selling and administrative expenses. 5

Terms z Sales revenue or sales = sale of merchandise z Cost of goods sold = total cost of merchandise sold 6

Illustration book Page 202 in 5 -1 How Income is Measured in a Merchandising Company Sales Revenue Less Cost of Goods Sold Equals Gross Profit Less Operating Expenses Equals Net Income (Loss) 7

Operating cycle of a company is. . . the average time it takes to go from cash to cash in producing revenues. TO 8

Operating cycle of a merchandising company is. . . z ordinarily longer than that of a service company; z purchase of merchandise and its sale lengthens the cycle. 9

Illustration 5 -2 Service Company Receive Cash Perform Services Accounts Receivable Merchandising Company Receive Cash Buy Inventory Sell Inventory Accounts Receivable Merchandise 10 Inventory

Inventory Systems z Perpetual - detailed inventory system in which the cost of inventory is maintained and the records continuously show the inventory that should be on hand z Periodic -inventory system in which detailed records are not maintained and the cost is goods sold is determined only at end of accounting period 11

Illustration 5 -3 Comparing Periodic and Perpetual Inventory Systems Inventory Purchased Item Sold End of Period Perpetual No Entry Record Purchase of Inventory Purchased Record Revenue and of Goods Sold Item Sold Cost End of Periodic Record Purchase of Inventory Record Revenue Only Compute Cost 12 of Goods Sold

Computers 13

and electronic scanners have enabled many companies to install perpetual inventory systems 14

What Is Charged to Merchandise Inventory? z All Costs of getting the inventory to company and ready to sell y +Freight-In y +Special Permits z Only costs associated with merchandise purchased for resale - not assets acquired for use, such as supplies 15

Merchandise Purchases On May 4 the company bought $ 3, 800 worth of merchandise from PW Audio Supply, Inc. Task: Record the purchase by getting information from the Purchase Invoice. The Purchase Invoice is a copy of the sales invoice. 16

• 1. Seller • 2. Invoice Date • 3. Purchaser • 4. Salesperson • 5. Credit terms • 6. Freight terms • 7. Goods sold: catalog no. , description, quantity, price per unit • 8. Total invoice price Illustration 5 -4 Invoice No. 731 Firm Name: Sauk Stero Attention o f James Hoover, Purchasing Agent Address 125 Main Street City Chelsea State Illinois Zip 60915 Date 5/4/01 Salesperson Maone Terms 2/10, n/30 Freight Paid by Buyer Catalog No. Description A 2547 Z 48 QTY Production Model Circuits IMPORTANT: ALL RETURNS MUST BE MADE WITHIN 10 DAYS 8 Price Amount 300 TOTAL 1, 500 17 $3, 800

Merchandise Purchases On May 4 the company bought $ 3, 800 worth of merchandise from PW Audio Supply, Inc. Merchandise Inventory Accounts Payable May 4 3, 800 GENERAL JOURNAL May 4 Freight-out Merchandise Inventory Accounts Payable Debit Credit 3, 800 To record goods purchased on account 18

Purchases Returns and Allowances On May 8 the company returned $300 worth of merchandise to PW Audio Supply, Inc. Merchandise Inventory May 4 3, 800 May 8 300 Accounts Payable May 8 300 May 4 3, 800 GENERAL JOURNAL May 8 Freight-out Accounts Payable Merchandise Inventory Debit Credit 300 To record goods returned that were purchased on account 19

Freight Costs - On Incoming Inventory 20

Freight Costs - On Incoming Inventory On May 6 the company paid $ 150 to have the merchandise inventory delivered to them. Merchandise Inventory Freight-Out Cash May 4 3, 800 May 8 300 May 6 150 GENERAL JOURNAL May 6 Merchandise Inventory Cash To record payment of freight. Debit Credit 150 21

Freight Costs - On Outgoing Inventory 22

Freight Costs-on outgoing inventory On May 6 the seller company paid $ 150 to have merchandise inventory delivered to the buyer. Merchandise Inventory Freight-Out May 6 Cash 150 GENERAL JOURNAL May 6 Freight-Out Cash May 6 150 Debit Credit 150 To record payment of freight on goods sold. 23

Purchase Discounts • Credit terms of a purchase on account may permit the buyer to claim a cash discount for prompt payment. • Credit terms specify the amount of cash discounts and the time period during which it is offered. • 2/10, n/30 • 1/10 EOM 24

Purchases Discounts Review - Company purchased $3800 of merchandise and returned $300. The credit terms are 2/10, n/30 and the invoice was paid within the discount period Original Invoice -Returns Amount due before discount 2% discount Net due $3, 800 300 $3, 500 70 $3, 430 25

Purchases Discounts Review - Company purchased $3800 of merchandise and returned $300. The credit terms are 2/10, n/30 and the invoice was paid within the discount period. Merchandise Inventory May 4 3, 800 May 8 300 Accounts Payable May 8 Cash 300 May 4 3, 800 May 14 70 May 14 3, 500 GENERAL JOURNAL May 14 Accounts Payable Cash Merchandise Inventory To record payment within discount period. May 14 3430 Debit Credit 3, 500 3, 430 70 26

Sales Invoice. . . a business document that provides written evidence of a credit sale. 27

• 1. Seller • 2. Invoice Date • 3. Purchaser • 4. Salesperson • 5. Credit terms • 6. Freight terms • 7. Goods sold: catalog no. , description, quantity, price per unit • 8. Total invoice price Illustration 5 -4 Invoice No. 731 Firm Name: Sauk Stero Attention o f James Hoover, Purchasing Agent Address 125 Main Street City Chelsea State Illinois Zip 60915 Date 5/4/01 Salesperson Maone Terms 2/10, n/30 Freight Paid by Buyer Catalog No. Description A 2547 Z 48 QTY Production Model Circuits IMPORTANT: ALL RETURNS MUST BE MADE WITHIN 10 DAYS 8 Price 300 TOTAL Amount 1, 500 28 $3, 800

Sales Revenues Under a Perpetual System z are recorded when earned-revenue recognition principle z must be supported by a business documentwritten evidence z 2 entries are made for each sale y one to record cost of merchandise sold 29

Sales - under a perpetual system Assume a CASH sale of $ 2, 200 For merchandise having a cost of $ 1, 400 Cash Accounts Receivable Merchandise Inventory May 4 2, 200 May 4 1. 400 Sales May 4 2, 200 Sales Returns & Allowances Cost of Goods Sold May 4 1. 400 30

Sales Returns and Allowances Flip side of purchase returns and allowance On buyer’s books GENERAL JOURNAL May 8 Accounts Payable Merchandise Inventory Debit Credit 300 To record goods returned that were purchased on account On seller’s books GENERAL JOURNAL May 8 Sales Returns and Allowance Accounts Receivable Debit Credit 300 To record return of goods delivered to Sauk Stero 300 31

Sales - under a perpetual system Assume a sale of $ 3, 800 ON ACCOUNT For merchandise having a cost of $2, 400 Accounts Merchandise Receivable Cash Inventory May 4 3, 800 Sales Returns & Allowances May 4 2, 400 Cost of Goods Sold May 2, 400 32

What Is the Sales Returns and Allowances Account? z Contra Revenue Account to sales z Used to show much came in on returns and allowances Excessive returns and allowances suggest: z inferior merchandise z inefficiencies in filing orders z errors in billing customers z mistakes in delivery or shipment of goods 33

What Is the Sales Discount Account? z Contra Revenue Account to sales z Used to disclose amount of cash discounts taken by customers 34

Sales Discounts Flip side of purchase discounts On buyer’s books GENERAL JOURNAL Debit May 14 Accounts Payable 3, 500 3, 430 Cash Merchandise Inventory Credit 70 To record payment within discount period On seller’s books GENERAL JOURNAL Debit May 14 Cash Sales Discounts Accounts Receivable 3, 430 70 To record collection within discount period Credit 3500 35

Two Forms Of Income Statements z Single-step income statement z Multiple-step income statement 36

Single-Step Income Statement One step… subtract total expenses from total revenues Revenues $10, 000 Expenses 3, 000 Net income $ 7, 000 37

PW AUDIO, Inc. Illustration 5 -9 Single-step Income Statement For the Year Ended December 31, 2001 Sales Interest Revenue Gain on Sale of equipment Total Revenues $460, 000 3, 000 600 $463, 600 Expenses Cost of goods sold $316, 000 Selling expenses 76, 000 Administrative expenses Interest expense Casualty Loss from vandalism Income tax expense 10, 100 Total expenses 442, 100 Net income 38, 000 1, 800 200 $ 21, 500 38

Illustration 5 -9 PW AUDIO SUPPLY, INC. Multi-step Income Statement For the Year Ended December 31, 2001 Sales revenues Sales Less: Sales returns and allowance Sales discounts Net sales Cost of goods sold Gross profit Operating expenses Selling expenses: Store salaries expense Advertising expense Depreciation expense Freight-out Total selling expenses Administrative expenses Salaries expense Utilities expense Insurance Expense Total administrative expenses Total operating expenses Income from operations $ 480, 000 $12, 000 8, 000 20, 000 460, 000 316, 000 $ 144, 000 $45, 000 16, 000 8, 000 7, 000 $76, 000 $19, 000 17, 000 2, 000 38, 000 114, 000 39 $ 30, 000

PW AUDIO SUPPLY, INC. Multi-step Income Statement For the Year Ended December 31, 2001 Income from operations (continued) Other revenues and gains Interest revenue Gain on sale of equipment Illustration 5 -9 $ 30, 000 $ 3, 000 600 $ 3, 600 Other expenses and losses Interest expense Casualty loss from vandalism $ 1, 800 2, 000 1, 600 31, 600 Income before income taxes Income tax expense Net Income 10, 100 $21, 500 40

Gross Profit Rate= Gross Profit Net Sales Company’s gross profit expressed as a percentage 41

Operating Expenses To Sales Ratio= Operating Expenses Net Sales Many companies have improved the efficiency of their operations, thus reducing the ratio of operating expenses to sales. 42

43