Accounting Principles Second Canadian Edition Weygandt · Kieso · Kimmel · Trenholm Prepared by: Carole Bowman, Sheridan College CHAPTER ACCOUNTING FOR MERCHANDISING OPERATIONS MERCHANDISING COMPANY A merchandising company is an enterprise that buys and sells goods to earn a profit Wholesalers sell to retailers Retailers sell to consumers A merchandiser’s primary source of revenue is sales, whereas a service company’s primary source of revenue is service revenue OPERATING CYCLES FOR A SERVICE COMPANY AND A MERCHANDISING COMPANY Service Company Receive Cash Cash Perform Services Accounts Receivable Merchandising Company Receive Cash Cash Buy Inventory Sell Inventory Accounts Receivable Merchandise Inventory ILLUSTRATION 5-1 INCOME MEASUREMENT PROCESS FOR A MERCHANDISING COMPANY Sales Revenue Less Equals Cost Costof of Goods GoodsSold Sold Gross Gross Profit Profit Less Equals Operating Expenses Net Income (Loss) INVENTORY SYSTEMS Merchandising entities may use either (or both) of the following inventory systems: Perpetual – where detailed records of each inventory purchase and sale are maintained Cost of goods sold is calculated at the time of each sale Periodic – detailed records are not maintained Cost of goods sold is calculated only at the end of the accounting period This chapter covers the perpetual method RECORDING COST OF GOODS PURCHASED When merchandise is purchased for resale to customers, the account, Merchandise Inventory, is debited for the cost of the goods Purchases may be made for cash or on account (credit) The purchase is normally recorded by the purchaser when the goods are received from the seller PURCHASES OF MERCHANDISE General Journal Date Account Title and Explanation Ref May Merchandise Inventory Accounts Payable To record goods purchased on account, terms n/30 Debit 3,800 For purchases on account, Merchandise Inventory is debited and Accounts Payable is credited For cash purchases, Merchandise Inventory is debited and Cash is credited J1 Credit 3,800 FREIGHT COSTS The sales agreement should indicate whether the seller or the buyer is to pay the cost of transporting the goods to the buyer’s place of business FOB Shipping Point Goods delivered to shipping point by seller Buyer pays freight costs from shipping point to destination FOB Destination Goods delivered to destination by seller Seller pays freight costs ACCOUNTING FOR FREIGHT COSTS Merchandise Inventory is debited by the buyer, if the buyer pays the freight bill (FOB shipping point) Freight Out (or Delivery Expense) is debited by the seller, if the seller pays the freight bill (FOB destination) RECORDING SALES RETURNS AND ALLOWANCES General Journal Date Account Title and Explanation May Sales Returns and Allowances Accounts Receivable To record returned goods May Merchandise Inventory Cost of Goods Sold To record cost of goods returned Ref Debit 300 J1 Credit 300 140 140 The first entry reduces the balance owed by the customer and records the goods returned at retail price The second entry records the physical return of goods to inventory at cost and removes the goods from the cost of goods sold account QUANTITY DISCOUNTS • A quantity discount is the offer of a cash discount to a customer in return for a volume sale • Quantity discounts result in a sales price reduction They are not separately journalized Instead the sale is recorded at the reduced price SALES DISCOUNTS A sales discount is the offer of a cash discount to a customer in exchange for the prompt payment of a balance due Similar to Sales Returns and Allowances, Sales Discounts is also a contra revenue account with a normal debit balance COMPLETING THE ACCOUNTING CYCLE A merchandising company requires the same types of adjusting entries as a service company, with one additional adjustment for inventory to ensure the recorded inventory amount agrees with the actual quantity on hand A physical count is an important control feature since a perpetual system indicates what should be there but a count will determine what is actually there COMPLETING THE ACCOUNTING CYCLE A merchandising company also requires the same types of closing entries as a service company The additional accounts that need to be closed out in a merchandising account include Sales, Sales Returns and Allowances, Cost of Goods Sold, and Freight Out Merchandise Inventory is an asset account and is not closed at the end of the period ILLUSTRATION 5-9 STATEMENT PRESENTATION OF SALES REVENUE SECTION As contra revenue accounts, sales returns and allowances (and sales discounts, if any) are deducted from sales in the income statement to arrive at Net Sales HIGHPOINT ELECTRONIC Income Statement (Partial) For the Year Ended December 31, 2002 Sales revenue Sales $ 480,000 Less: Sales returns and allowances 20,000 Net sales $ 460,000 ILLUSTRATION 5-10 CALCULATION OF GROSS PROFIT Gross profit is calculated by deducting cost of goods sold from net sales as follows: Net Net sales sales Cost Cost of of goods goods sold sold Gross Gross profit profit $$ 460,000 460,000 316,000 316,000 $$ 144,000 100% 69% 31% Gross profit is often expressed as a percentage of sales ILLUSTRATION 5-12 CALCULATION OF NET INCOME Net income is calculated by deducting operating expenses from gross profit as follows: Gross profit Operating expenses Net income $ 144,000 114,000 $ 30,000 Net income is the “bottom line” of a company’s income statement ILLUSTRATION 5-14 This is the format of a multi-step income statement that has both operating and nonoperating activities As shown, the nonoperating activities are reported immediately after the company’s primary operating activities HIGHPOINT ELECTRONIC Income Statement For the Year Ended December 31, 2002 Sales revenue Sales Less: Sales returns and allowances Net sales Cost of goods sold Gross profit Operating expenses Selling expenses Salaries expense $ Advertising expense Amortization expense Freight out Total selling expenses Administrative expenses Rent expense $ Utilities expense Insurance expense Total administrative expenses Total operating expenses Income from operations Other revenue and gains Interest revenue $ Gain on sale of equipment Total non-operating revenue and gain Other expenses and losses Interest on expense $ Casualty loss from vandalism Total non-operating expense and loss Net non-operating revenue Net income $ 480,000 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 30,000 3,000 600 $ 3,600 1,800 200 2,000 $ 1,600 31,600 CLASSIFIED BALANCE SHEET HIGHPOINT ELECTRONIC Balance Sheet (partial) December 31, 2002 Assets Current assets On the balance sheet, merchandise inventory is Cash reported as a current asset Accounts receivable and appears immediately Merchandise inventory below accounts receivable Prepaid insurance This is because current assets are listed in the Total current assets order of their liquidity Capital assets Store equipment $ 80,000 Less: Accumulated amortization 24,000 Total assets $ 9,500 16,100 40,000 1,800 67,400 56,000 $ 123,400 USING THE INFORMATION IN THE FINANCIAL STATEMENTS Inventory is particularly important because: • It is a large current asset on the balance sheet • It becomes a large expense on the income statement • It is vulnerable to theft or misuse USING THE INFORMATION IN THE FINANCIAL STATEMENTS A balancing act is needed to ensure that a sufficient, but not excessive, quantity of inventory is on hand Two ratios help evaluate the management of inventory: • • Inventory turnover Days sales in inventory INVENTORY TURNOVER Inventory turnover = Cost of goods sold Average inventory DAYS SALES IN INVENTORY Days sales in inventory = 365 days Inventory turnover COPYRIGHT Copyright © 2002 John Wiley & Sons Canada, Ltd All rights reserved Reproduction or translation of this work beyond that permitted by CANCOPY (Canadian Reprography Collective) is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd The purchaser may make back-up copies for his / her own use only and not for distribution or resale The author and the publisher assume no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein .. .CHAPTER ACCOUNTING FOR MERCHANDISING OPERATIONS MERCHANDISING COMPANY A merchandising company is... detailed records are not maintained Cost of goods sold is calculated only at the end of the accounting period This chapter covers the perpetual method RECORDING COST OF GOODS PURCHASED When merchandise... destination FOB Destination Goods delivered to destination by seller Seller pays freight costs ACCOUNTING FOR FREIGHT COSTS Merchandise Inventory is debited by the buyer, if the buyer pays