CHAPTER 7 Setting Up A Merchandising Company

Let’s Review Let’s review the basic principle of debits and credits and chapter 6 learning objectives

Review In the debit and credit system, debits are always recorded on which side? Left Right Left or right depending on the financial transaction Income statement only

Review An increase to an asset should always be a: Credit Debit Debit or credit depending on the asset

Review An increase to an expense is always a: Debit Credit Debit or credit depending on the type of expense

Review What is the entry to record paying cash for rent? Debit cash, credit rent expense Credit cash, credit rent expense Credit cash, debit rent expense Debit cash, debit rent expense

Review What is the entry to record a payment towards an account that is due? Dr accounts payable, Cr accounts receivable Dr accounts payable, Cr cash Dr accounts receivable, Cr cash Cr accounts payable, Dr cash

Checklist Chapter 7 Financing a Business Merchandising Sales Gross Profit Margin Classified Balance Sheet Multi-Step Income Statement

What is a Merchandising Company? Any business that buys and sells products for the purpose of making a profit Examples: Retailers Supermarkets Car Dealerships

What is a Corporation? A business that is a separate legal entity from its owners Liable for its own debts The owners are separate and financial risk is limited to their investment Net worth of a corporation is called Stockholders’ Equity Stockholder Management

Stockholders’ Equity Stockholders’ Equity is divided amongst the stockholders in proportion to the number of shares they own. Each owner would be entitled to their proportion of profits, or sale price if the business was sold.

Stockholders’ Equity: Two Parts Common Stock (Contributed Capital ): Money invested directly in a company by its owners in the form of stocks COMMON STOCK Retained Earnings: Profits that the business has retained (not distributed to the owners) RETAINED EARNINGS STOCKHOLDERS’ EQUITY Stockholders’ Equity: The net worth of the company

Dividends Corporations can declare dividends: A dividend represents the portion of a company's earning pie (profits) which is divided amongst the stockholders according to their stock.

Financing a Company Example Chad and Joe are two avid skiers who have decided to open a ski shop (as a corporation). Chad agrees to contribute $70,000, and Joe agrees to contribute $30,000. Each owner will receive their shares of stock according to their cash contribution.

Financing a Company Example Record the $100,000 investment by the owners. BALANCE SHEET JOURNAL ACCOUNT TITLE & EXPLANATION DEBIT CREDIT ASSETS LIABILITIES CASH ACCOUNTS PAYABLE 100,000 DR x Cash ? 100,000 ? ACCOUNTS RECEIVABLE UNEARNED REVENUE Common Stock - Chad ? 70,000 x Common Stock - Joe ? 30,000 x BANK LOAN INVENTORY Record investment by owners x x STOCKHOLDERS’ EQUITY PREPAID EXPENSES COMMON STOCK x 100,000 CR PROPERTY, PLANT & EQUIPMENT PROPERTY, PLANT & EQUIPMENT RETAINED EARNINGS 100,000 CR x

Financing a Business - Question What is the effect on retained earnings if a company pays dividends for a given period? Increases retained earnings Decreases retained earnings No effect

Financing a Business - Question What does stockholders’ equity equal? Retained Earnings + Common Stock Retained Earnings + Common Stock + Dividends Paid Common Stock – Dividends Paid Retained Earnings – Common Stock

Checklist Chapter 7 Financing a Business Merchandising Sales Gross Profit Margin Classified Balance Sheet Multi-Step Income Statement

Merchandise Sales Terminology There are different terms for sale of product or services. We will refer to sales as sales revenue. INCOME STATEMENT SALES REVENUE X EXPENSES Cost of Goods Sold (COGS) represents the amount paid to purchase inventory that is sold. COST OF GOODS SOLD x GROSS PROFIT Gross profit = Revenue – COGS ADVERTISING MAINTENANCE x x DEPRECIATION MISCELLANEOUS x x Operating expenses are all those expenses incurred in in order to sell products or services. INCOME TAX PAYROLL x x INSURANCE RENT x x INTEREST TELEPHONE x x Net income = Gross profit - operating expenses NET INCOME (LOSS)

Merchandise Sales Example On July 15th, Skyline Enterprise purchased $1,000 of inventory using cash. How should the purchase of inventory be recorded? CASH ASSETS ACCOUNTS RECEIVABLE INVENTORY PREPAID EXPENSES BANK LOAN ACCOUNTS PAYABLE BALANCE SHEET UNEARNED REVENUE LIABILITIES PROPERTY, PLANT & EQUIPMENT RETAINED EARNINGS COMMON STOCK STOCKHOLDERS’ EQUITY - 1,000 CR JOURNAL Date ACCOUNT TITLE DEBIT CREDIT Jul 15 ? Inventory ? 1,000 ? + 1,000 DR ? Cash ? 1,000 Purchased inventory What happened to equity? No change to equity. One asset was exchanged for another.

Merchandise Sales Example On July 21st, Skyline Enterprise sold $1,000 of inventory for $1,500. How should the sale of inventory be recorded? 1. Record the sale (revenue and cash) BAD DEBT SALES REVENUE INCOME STATEMENT EXPENSES NET INCOME (LOSS) INTEREST INSURANCE DEPRECIATION CASH ASSETS ACCOUNTS RECEIVABLE INVENTORY PREPAID EXPENSES BANK LOAN ACCOUNTS PAYABLE BALANCE SHEET UNEARNED REVENUE LIABILITIES PROPERTY, PLANT & EQUIPMENT MAINTENANCE UTILITES RENT SALARIES COST OF GOODS SOLD GROSS PROFIT RETAINED EARNINGS COMMON STOCK STOCKHOLDERS’ EQUITY + 1,500 CR + 1,500 CR + 1,500 DR JOURNAL Date ACCOUNT TITLE DEBIT CREDIT + 1,000 DR Jul 21 ? Cash ? 1,500 ? 2. Match the cost of the product against the sale ? Sales Revenue ? 1,500 Sold product for cash - 1,000 CR Jul 21 ? Cost of Goods Sold ? 1,000 ? ? Inventory ? 1,000 Cost of product sold

Merchandise Sales - Question True or False: If a company sells a product on account, accounts receivable will be credited. True False

Checklist Chapter 7 Financing a Business Merchandising Sales Gross Profit Margin Classified Balance Sheet Multi-Step Income Statement

Gross Profit Margin Gross Profit Gross Profit Margin = Revenue Measures gross profit as a percentage of revenue The higher the percentage, the higher the contribution per dollar of revenue. Gross Profit Gross Profit Margin = Revenue

Gross Profit - Question True or False: When a product is sold, the gross profit on the sale is precisely equal to sales revenue. True False

Gross Profit Margin - Question Which company had the higher gross profit margin? EK Skylines Smart Systems Corporation EK Skylines Smart Systems Corp. Gross Profit $200,000 $300,000 Revenue 1,000,000 2,000,000 Gross Profit Margin 20% 15% This means that EK Skylines was able to generate more gross profit dollars per dollar in sales than Smart Systems Corp.

Checklist Chapter 7 Financing a Business Merchandising Sales Gross Profit Margin Classified Balance Sheet Multi-Step Income Statement

Classified Balance Sheet Assets and liabilities are subdivided into current and long-term categories to further define a company’s financial position.

Classified Balance Sheet Current Assets (less than a year ) Long-Term Assets (longer than a year) Assets likely to convert to cash in the next 12 months through day-to-day operations. Assets that have been bought for the long-term and will not be sold on a daily basis. Also called capital or long-term assets.

Current Assets vs. Long-Term Assets COMMON STOCK CASH ASSETS ACCOUNTS RECEIVABLE INVENTORY PREPAID EXPENSES BANK LOAN ACCOUNTS PAYABLE BALANCE SHEET UNEARNED REVENUE LIABILITIES PROPERTY, PLANT & EQUIPMENT RETAINED EARNINGS STOCKHOLDERS’ EQUITY Current assets Long-term assets

Current vs. Long-Term Liabilities A single loan may be divided into two parts: Current and Long-Term Total Debt Current Portion of Long-term Debt Long-Term Portion Consists of remaining debt Consists of 12 months of debt

Current vs. Long-Term Liabilities Example Scenario: You apply for a $36,000 business loan. Each month $1,000 will be paid to reduce the loan. The current portion of the loan always consists of the next 12 months of payments, $12,000. The long-term portion of the loan is $24,000 ($36,000 - $12,000). $1,000 $1,000 Current Portion Long-Term Portion

Current vs. Long-Term Liabilities Example Each payment reduces the long-term debt. However, the current portion will always consist of the next 12 months. $1,000 $1,000 $1,000 $1,000 $1,000 $1,000 End of month Payment Current Debt LT Debt $1,000 $1,000 $1,000 $1,000 $1,000 $1,000 1 $1,000 $12,000 $23,000 $1,000 $1,000 $1,000 $1,000 $1,000 $1,000 2 $1,000 $12,000 $22,000 $1,000 $1,000 $1,000 24 $1,000 $12,000 $0 $1,000 $1,000 $1,000 25 $1,000 $11,000 $0 $1,000 $1,000 $1,000 $1,000 $1,000 $1,000 Notice there is no long-term loan remaining. $1,000 $1,000 $1,000 $1,000 $1,000 $1,000 From this point forward you can reduce the current portion of debt. Current Portion Long-Term Portion

Current vs. Long-Term Assets and Liabilities Summary Paid in less than 12 months Short-term debt Paid over a period longer than 12 months Long-term debt Similarly Converted to cash in less than 12 months Short-term Assets Used for the long-term (more than 12 months) Long-term Assets

Current vs. Long-Term - Question Suppose that a bank loan is due within one year. What type of debt is the bank loan considered? Long-term Short-term A portion is long-term and the remaining portion is short-term It is not debt, but is equity

Current vs. Long-Term - Question A company holds and sells real estate property as its main business activity. Each piece of property is sold for cash within one year after it is bought. What type of asset is the property? Long-term Short-term

Checklist Chapter 7 Financing a Business Merchandising Sales Gross Profit Margin Classified Balance Sheet Multi-Step Income Statement

Multistep Income Statement Divides revenues and expenses further to show subtotals such as COGS, gross profit, operating expenses and operating income

Multistep Income Statement - Question Which line item is included in a multistep income statement, but not in a tradition single step income statement? Revenue Net Income Gross Profit

Complete the following exercise.

Exercise On January 2nd, AAA Co. purchased $3,500 of inventory with cash. JOURNAL Page 1 DATE ACCOUNT TITLE & EXPLANATION PR DEBIT CREDIT Jan 2 Inventory 3,500 Cash 3,500 Purchased inventory with cash

Exercise On January 12th, AAA Co. sold all of the inventory from the January 2nd purchase for $5,000. JOURNAL Page 1 DATE ACCOUNT TITLE & EXPLANATION PR DEBIT CREDIT Jan 12 Cash 5,000 Sales Revenue 5,000 Made cash sales JOURNAL Page 1 DATE ACCOUNT TITLE & EXPLANATION PR DEBIT CREDIT Jan 12 Cost of Goods Sold 3,500 Inventory 3,500 Sold inventory

Exercise What was the gross profit on this sale? Sales Revenue $5,000 JOURNAL Page 1 DATE ACCOUNT TITLE & EXPLANATION DEBIT CREDIT Jan 12 Cash 5,000 Sales Revenue 5,000 Made cash sales Sales Revenue $5,000 -3,500 $1,500 -Cost of Goods Sold Gross Profit JOURNAL Page 1 DATE ACCOUNT TITLE & EXPLANATION DEBIT CREDIT Jan 12 Cost of Goods Sold 3,500 Inventory 3,500 Sold inventory

End of Chapter 7