Financial Accounting: Tools for Business Decision Making

1. ELS Financial Accounting:Tools for Business Decision Making Kimmel, Weygandt, Kieso 1

2. Chapter 5

3. Chapter 5Merchandising Operations After studying Chapter 5, you should be able to: • Identify the differences between a service enterprise and a merchandising company. • Explain the recording of purchases under a perpetual inventory system. • Explain the recording of sales revenues under a perpetual inventory system. • Identify the unique features of the financial statements for a merchandising company. • Explain the factors affecting the profitability. 3

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

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

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

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

8. Page 213 in book PW AUDIO SUPPLY, INC.Income Statement (Partial)For the Year Ended December 31, 1998 Sales revenues Sales $ 480,000 Less: Sales returns and allowance $12,000 Sales discounts 8,000 20,000 Net sales 460,000 Cost of goods sold 316,000 Gross profit 144,000 Operating expenses Store salaries expense 45,000 Rent expense 19,000 Utilities expense 17,000 Advertising expense 16,000 Depreciation expense 8,000 Freight-out 7,000 Insurance expense 2,000Total operating expenses 114,000 Net Income $ 30,000

9. TO Operating cycle of a company is... the average time it takes to go from cash to cash in producing revenues. 9

10. Operating cycle of a merchandisingcompany is... • ordinarily longer than than that of a service company; • purchase of merchandise and its sale lengthens the cycle. 10

11. Page 203 in book Service Company Receive Cash Perform Services Cash Accounts Receivable Merchandising Company Receive Cash Buy Inventory Cash Sell Inventory Accounts Receivable Merchandise Inventory 11

12. Page 203 in book Inventory Systems • Perpetual- detailed inventory system in which the cost of inventory is maintained and the records continuously show the inventory that should be on hand • Periodic -inventory system in which detailed records are not maintained and the cost is goods sold is determined only at end of accounting period 12

13. Page 204 in the book Comparing Periodic and Perpetual Inventory Systems End of Period Inventory Purchased Item Sold Point of Sale Perpetual Perpetual Cost of Goods Sold Computed Inventory Purchased End of Period Item Sold Point of Sale Periodic Cost of Goods Sold Computed 13

14. Computers 14

15. and electronic scannershave enabled many companies to install perpetual inventory systems

16. What Is Charged to Merchandise Inventory? • All Costs of getting the inventory to company and ready to sell • +Freight-In • +Special Permits • Only costs associated with merchandise purchased for resale - not assets acquired for use, such as supplies 16

17. 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 just a copy of the sales invoice. 17

18. Invoice No. 731 Firm Name: Sauk Stero City Chelsea State Illinois Zip 60915 • 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 Page 206 in book Attention o f James Hoover, Purchasing Agent Address 125 Main Street Date 8/4/98 Salesperson Maone Terms 2/10,n/30 Freight Paid by Buyer Catalog No. Description QTY Price Amount 18

19. Merchandise Purchases On May 4 the company bought $ 3,800 worth of merchandise from PW Audio Supply, Inc. Merchandise Inventory Accounts Payable Freight-out May 4 3,800 May 4 3,800 GENERAL JOURNAL Debit Credit May 4 Merchandise Inventory 3,800 Accounts Payable 3,800 To record goods purchased on account 19

20. Purchases Returns and Allowances On May 8 the company returned $300 worth of merchandise to PW Audio Supply, Inc. Merchandise Inventory Accounts Payable Freight-out May 4 3,800 May 8 300 May 8 300 May 4 3,800 GENERAL JOURNAL Debit Credit May 8 Accounts Payable 300 Merchandise Inventory 300 To record goods returned that were purchased on account 20

21. Freight Costs - On Incoming Inventory 21

22. Freight Costs - On Incoming Inventory On May 6 the company paid $ 150 to have the merchandise inventory delivered to them. Merchandise Inventory Cash Freight-Out May 4 3,800 May 8300 May 6 150 May 6 150 GENERAL JOURNAL Debit Credit May 6 Merchandise Inventory 150 Cash 150 To record payment of freight. 22

23. Freight Costs - On Outgoing Inventory 23

24. Freight Costs-on outgoing inventory On May 6 the seller company paid $ 150 to have merchandise inventory delivered to the buyer. Merchandise Inventory Cash Freight-Out May 6 150 May 6 150 GENERAL JOURNAL Debit Credit May 6 Freight-Out 150 Cash 150 To record payment of freight on goods sold. 24

25. 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 25

26. 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 $3,800 -Returns 300 Amount due before discount $3,500 2% discount 70 Net due $3,430 26

27. 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 Accounts Payable Cash May 4 3,800 May 8300 May 8 300 May 4 3,800 May 14 70 May 14 3430 May 14 3,500 GENERAL JOURNAL Debit Credit May 14 Accounts Payable 3,500 Cash 3,430 Merchandise Inventory 70 To record payment within discount period.

28. Sales Invoice ... a business document that provides written evidence of a credit sale. 28

29. Invoice No. 731 Firm Name: Sauk Stero • 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 City Chelsea State Illinois Zip 60915 Page 206 in book Attention o f James Hoover, Purchasing Agent Address 125 Main Street Date 8/4/98 Salesperson Maone Terms 2/10,n/30 Freight Paid by Buyer Catalog No. Description QTY Price Amount 29

30. Sales Revenues - Under a Perpetual System • are recorded when earned-revenue recognition principle • must be supported by a business document-written evidence • 2 entries are made for each sale • one to record sale • one to record cost of merchandise sold 30

31. Sales - under a perpetual system Assume a CASH sale of $ 2,200 Accounts Receivable Merchandise Inventory Cash Sales Returns & Allowances Cost of Goods Sold Sales For merchandise having a cost of $ 1,400 May 4 2,200 May 4 1.400 May 4 2,200 May 4 1.400

32. Sales Returns and Allowances Flip side of purchase returns and allowance On buyer’s books GENERAL JOURNAL Debit Credit May 8 Accounts Payable 300 Merchandise Inventory 300 To record goods returned that were purchased on account On seller’s books GENERAL JOURNAL Debit Credit May 8 Sales Returns and Allowance 300 Accounts Receivable 300 To record return of goods delivered to Sauk Stero 32

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

34. What Is the Sales Returns and Allowances Account? • Contra Revenue Accountto sales • Used to show how much came in on returns and allowances • Excessive returns and allowances suggest: • inferior merchandise • inefficiencies in filing orders • errors in billing customers • mistakes in delivery or shipment of goods 34

35. What Is the Sales Discount Account? • Contra Revenue Accountto sales • Used to disclose amount of cash discounts taken by customers 35

36. Sales Discounts Flip side of purchase discounts On buyer’s books GENERAL JOURNAL Debit Credit May 14 Accounts Payable 3,500 Cash 3,430 Merchandise Inventory 70 To record payment within discount period On seller’s books GENERAL JOURNAL Debit Credit May 14 Cash 3,430 Sales Discounts 70 Accounts Receivable 3500 To record collection within discount period 36

37. Page 213 in book PW AUDIO SUPPLY, INC.Income Statement (Partial)For the Year Ended December 31, 1998 Sales revenues Sales $ 480,000 Less: Sales returns and allowance $12,000 Sales discounts 8,000 20,000 Net sales 460,000 Cost of goods sold 316,000 Gross profit 144,000 Operating expenses Store salaries expense 45,000 Rent expense 19,000 Utilities expense 17,000 Advertising expense 16,000 Depreciation expense 8,000 Freight-out 7,000 Insurance expense 2,000Total operating expenses 114,000 Net Income $ 30,000

38. Gross Profit Rate= Gross Profit Net Sales Company’s gross profit expressed as a percentage 38

39. 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. 39